UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ý ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
OR
¨¨ TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF SECURITIES EXCHANGE ACT OF 1934
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)
200 North Canal Street
Natchez, Mississippi
(Address of Principal Executive Offices)
64-0844345
(IRS Employer
Identification No.)
39120
(Zip Code)
(Registrant’s Telephone Number, Including Area Code): 601-442-1601
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Common Stock, $.01 par value
10.0% Series A Cumulative Preferred Stock
Name of Each Exchange on Which Registered
New York Stock Exchange
New York Stock Exchange
Securities registered pursuant to section 12 (g) of the Act:
None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No ýý
Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No ýý
Indicate by check mark whether 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 ý 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 (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files). Yes ý No ¨¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of
registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of
“large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Large accelerated filer ¨ Accelerated filer ýý
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 ýý
Aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of
As of March 10, 2014, 40,465,227 shares of the Registrant’s common stock, par value $.01 per share, were outstanding.
June 30, 2013 was approximately $129.6 million .
Portions of the definitive Proxy Statement of Callon Petroleum Company (to be filed no later than 120 days after December 31, 2013) relating to the Annual Meeting of
Stockholders to be held on May 15, 2014, which are incorporated into Part III of this Form 10-K.
DOCUMENTS INCORPORATED BY REFERENCE
TABLE OF CONTENTS
Special Note Regarding Forward-Looking Statements
Definitions
Part I
Items 1 and 2. Business and Properties
Acquisitions and Divestitures
Oil and Natural Gas Properties
Reserves and Production
Production Wells and Leasehold Acreage
Other
Regulations
Available Information
Risk Factors
Unresolved Staff Comments
Legal Proceedings
Mine Safety Disclosures
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Performance Graph
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 1A.
Item 1B.
Item 3.
Item 4.
Part II
Item 5.
Item 6.
Item 7.
Overview and Outlook
Liquidity and Capital Resources
Results of Operations
Significant Accounting Policies and Critical Accounting Estimates
Subsequent Events
Item 7A.
Item 8.
Quantitative and Qualitative Disclosures About Market Risk
Report of Independent Registered Public Accounting Firm
Financial Statements and Supplementary Data
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Income
Consolidated Statements of Stockholders’ Equity
Consolidated Statements of Cash Flows
Notes to the Consolidated Financial Statements
Item 9.
Item 9A.
Item 9B.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Report of Independent Registered Public Accounting Firm
Part III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Part IV
Item 15.
Signatures
Directors and Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions and Director Independence
Principal Accountant Fees and Services
Exhibits
2
Page(s)
3
4
5
7
8
10
13
16
17
24
25
34
34
34
35
36
37
38
38
40
42
49
51
52
54
53
55
56
57
58
59
60
83
84
84
85
86
86
86
86
86
87
90
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-Q 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:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
to
fund our planned capital
future property acquisition or divestiture
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
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
activities,
the
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.
effects
of
We caution you that the forward-looking statements contained in this Form 10-K 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 oil and natural gas. These risks
include, but are not limited to, the risks described in Item 1A of this Annual Report on Form 10-K for the year ended December 31, 2013
and all quarterly reports on Form 10-Q filed subsequently thereto.
Should one or more of the risks or uncertainties described above or elsewhere in this 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.
3
All defined terms under Rule 4-10(a) of Regulation S-X shall have their statutorily prescribed meanings when used in this report. As used in
this document:
DEFINITIONS
•
•
•
•
•
•
three-
Asset
Retirement
BOE per
billion cubic
3-D:
dimensional.
ARO:
Obligation.
Bbl or Bbls: barrel or barrels of oil or natural gas
liquids.
Bcf:
feet.
BOE: barrel of oil equivalent, determined by using the ratio of one Bbl of oil or NGLs to six Mcf of gas. The ratio of one barrel of
oil or NGL to six Mcf of natural gas is commonly used in the industry and represents the approximate energy equivalence of oil or
NGLs to natural gas, and does not represent the economic equivalency of oil and NGLs to natural gas. The sales price of a barrel of
oil or NGLs is considerably higher than the sales price of six Mcf of natural gas.
BOE/d:
day.
BLM:
Management.
BOEM: Bureau of Ocean Energy Management, Regulation and Enforcement; formerly the Minerals Management
Service.
Btu: a British thermal unit, which is a measure of the amount of energy required to raise the temperature of one pound of water
one degree Fahrenheit.
BSEE: Bureau
Enforcement.
DOI:
Interior.
EPA:
Agency.
• GHG:
and Environmental
Environmental
of Safety
Department
greenhouse
Protection
Bureau
Land
of
of
•
•
•
•
•
•
•
•
gases.
LIBOR:
Rate.
LOE:
expense.
London Interbank Offered
lease
operating
• MBbls: thousand barrels of
oil.
• MBOE:
boe.
• MBOE/d:
day.
thousand
Mboe per
• Mcf: thousand cubic feet of natural
gas.
• Mcfe:
thousand cubic
feet of natural gas
equivalents.
• Mcf/d:
day.
Mcf per
• MMBbls: million barrels of
oil.
• MMBOE:
BOE.
• MMBtu:
Btu.
million
million
• MMcf: million cubic feet of natural
gas.
• MMcf/d:
day.
MMcf per
• MMS: Minerals Management
includes
New York Mercantile
Service.
NGL or NGLs: natural gas liquids, such as ethane, propane, butanes and natural gasoline that are extracted from natural gas
production streams.
NYMEX:
Exchange.
oil:
condensate.
PDPs:
reserves.
PDNPs:
reserves.
PUDs:
proved developed producing
non-producing
undeveloped
developed
proved
proved
crude
and
oil
•
•
•
•
•
•
restricted
stock
•
•
reserves.
RSU:
units.
SEC:
Commission.
United States Securities
and Exchange
• GAAP: Generally Accepted Accounting Principles in the United
States
With respect to information relating to our working interest in wells or acreage, “net” oil and gas wells or acreage is determined by
multiplying gross wells or acreage by our working interest therein. Unless otherwise specified, all references to wells and acres are gross.
4
PART I.
Items 1 and 2 - Business and Properties
Overview
Callon Petroleum Company has been engaged in the exploration, development, acquisition and production of oil and natural gas properties
since 1950. The Company was incorporated under the laws of the state of Delaware in 1994 and succeeded to the business of a publicly
traded limited partnership, a joint venture with a consortium of European investors and an independent energy company partially owned by
a member of current management. As used herein, the “Company,” “Callon,” “we,” “us,” and “our” refer to Callon Petroleum Company and
its predecessors and subsidiaries unless the context requires otherwise.
In 2013, the Company completed its onshore strategic repositioning that began in 2009, shifting its operations from the offshore waters in
the Gulf of Mexico to the onshore, Permian Basin in Texas. In the fourth quarter of 2013, the Company sold its interest in its only
remaining deepwater property, the Medusa field, in addition to the sale of the Medusa spar facility and substantially all remaining offshore
shelf properties. Previously, Callon sold its interest in its deepwater Habanero field in the fourth quarter of 2012. Collectively, these
transactions completed the Company’s transition to an onshore operator with an asset base concentrated exclusively in the Midland Basin, a
sub-basin contained in the broader Permian Basin.
Callon exited 2013 with average Permian production in the month of December of 3,611 BOE/d (approximately 84% oil), a 129% increase
over our exit rate in 2012. We believe that the Company’s transition to a horizontal development program, which was expanded from two
fields to four fields in late 2013, has improved Callon’s overall capital efficiency and has contributed to a net increase of 59% in the
Company’s Permian proven reserve base.
The Company operates 100% of its Permian acreage, which provides additional flexibility to modify development plans to address potential
changes in the operating and commodity price environments. As of December 31, 2013, we had estimated net proved reserves of 11.9
MMBbls and 17.8 Bcf, or 14.9 MMBOE, all of which were located in the Permian Basin, compared with approximately 67% located in the
Permian Basin at December 31, 2012. Additionally, 80% of our proved reserves were crude oil and 50% were proved developed at year-end
2013, on a BOE basis.
Our Business Strategy
Our goal is to enhance stockholder value through the execution of the following strategy:
Drive production and reserve growth through horizontal development of our resource base. Our initial drilling efforts in the Permian
Basin targeted the development of multiple zones with vertical wells as part of the “Wolfberry” play. As part of this drilling program, we
amassed a database related to the subsurface geology and rock characteristics over the last several years. This information, combined with
our review of industry activity and best practices, provided the foundation for Callon to initiate the horizontal development of our resource
base in 2012. Importantly, we believe horizontal development of our resource base will provide the opportunity to improve returns relative
to vertical drilling by accessing a larger base of reserves in target zone with a lateral wellbore. During the fourth quarter of 2013,
approximately 44% of our total Permian production was sourced from horizontal wells. We expect the contribution of horizontal production
volumes from our existing properties to increase with the recent expansion of our horizontal development efforts to four fields as part of our
current two-rig drilling program.
Expand our drilling portfolio through evaluation of existing acreage. Our horizontal development drilling efforts to date have been
primarily focused on the Upper and Lower Wolfcamp B shales, establishing production from both zones in the Southern Midland Basin. We
have been focused on these development zones to reduce drilling risk as we continue to grow our asset base in the Permian Basin. We
believe additional opportunities exist to selectively target various other prospective zones including the Jo-Mill, Lower Spraberry,
Wolfcamp A, Wolfcamp C and Cline formations, and plan to selectively drill potential identified locations to complement our core
development efforts in the Wolfcamp B. Moreover, we will monitor the efficiency of our horizontal wells related to reservoir drainage over
time and pursue downspacing initiatives within target zones if overall returns can be enhanced. We recently transitioned to closer spacing of
our horizontal laterals in the Southern Midland Basin in both the Upper and Lower Wolfcamp B shales.
Outside of our core development areas in the Southern and Central Midland Basin, we maintain an exploration position in the Northern
Midland Basin. Our current activity in the Northern Midland Basin is limited to vertical drilling in order to assess resource potential and
economic returns. If our exploration concept is proven to economically produce hydrocarbons on a repeatable basis from vertical wells, we
will then determine whether the testing of horizontal development concepts is warranted.
5
Pursue selective acquisitions in the Permian Basin. We have demonstrated our ability to acquire and trade acreage in the Midland Basin.
Specifically, we added our Taylor Draw field in 2012 and Garrison Draw Field in 2013 for a total of $23 million, including acquired
production and proved reserves. These two fields are now part of our core horizontal development plan. We have built on these acquisitions
with recent acquisitions of acreage near our existing East Bloxom (see Recent Developments below), as well as completing an acreage trade
at Garrison Draw which added contiguous acreage for effective long lateral horizontal development. We will continue to pursue leasehold
acquisitions in the Permian Basin, and primarily in the Midland Basin, that have horizontal resource potential that can be further augmented
by bolt-on acreage acquisitions and acreage trades over time.
Capitalize on opportunities to further reduce cost of capital. Following the disposition of our offshore properties, we have the opportunity
to recapitalize the Company with a lower cost of capital commensurate with an improved credit risk profile as a purely onshore operator. As
part of an ongoing effort to reduce our cost of capital, we have redeemed nearly $90 million of our 13% Senior Notes due 2016 (the “Senior
Notes”) since 2011 and recently called for the redemption of the remaining $49 million of principal to occur in April 2014, replacing these
Senior Notes with lower cost financing. Additionally, we believe the demonstrated growth in our proved developed reserve base provides
the foundation for a meaningful expansion of our borrowing base capacity under our revolving credit agreement. We recently increased the
notional amount and reduced the interest expense related to our revolving credit agreement, evidencing another step in reducing our overall
cost of capital (see Recent Developments below).
Our Strengths
Established resource base and acreage position in the Permian Basin. Our production is exclusively from the Permian Basin in West
Texas, an area that has supported production since the 1940s. The basin has well-established infrastructure from historical operations, and
we believe the basin also benefits from a relatively stable regulatory environment that has been established over time. We have assembled a
position of approximately 13,600 net acres in the Southern and Central Midland Basin that are prospective for multiple oil-bearing intervals
that have been produced by us and other industry participants. As of December 31, 2013, our estimated net proved reserves were comprised
of approximately 80% oil and 20% natural gas, which includes NGLs in the production stream. This oil exposure provides us the
opportunity to benefit from currently more favorable prices as compared to natural gas.
Multi-year drilling inventory. Our current acreage position in the Permian Basin provides visible growth potential from a horizontal drilling
inventory of almost 20 years based on our current two-rig horizontal drilling program. As of December 31, 2013, based upon the results of
horizontal wells drilled by us and other offsetting operators, and our analysis of core data and historical vertical well performance, we have
identified an inventory of approximately 540 potential horizontal well locations in multiple horizons across our Southern and Central
Midland Basin acreage. Of these potential locations, approximately 225 are identified in the Upper Wolfcamp B, Lower Wolfcamp B and
Wolfcamp A zones which have been drilled on our acreage and are currently producing.
Experienced team operating in the Permian Basin. We have assembled a management team experienced in acquisitions, exploration,
development and production in the Midland Basin. Reflective of this experience, we have realized improvements in our drilling and capital
efficiency since launching our horizontal drilling program in 2012. For example, our average drill time for a typical 7,800 foot lateral
Wolfcamp shale well decreased from approximately 30 days at the start of our drilling program in 2012 to under 20 days as of February
2014. We continue to evaluate our completion techniques, and downspacing initiatives that we believe have the potential to improve
resource recovery and contribute to enhanced returns on capital. In addition, we regularly evaluate our operating results against those of
other operators in the area in an effort to benchmark our performance against the best performing operators and evaluate and adopt best
practices.
High degree of operational control. We operate all of our Permian Basin acreage, providing us the opportunity to modify our operational
plans to respond to changes in operational and commodity price environments. This operating control also allows us to modify drilling and
completion techniques, and change drilling schedules as needed to manage the assimilation of newly acquired acreage that may have drilling
commitments.
Operating culture focused on safety and the environment. We have established a Health, Safety and Environmental department dedicated
to our operations in the Permian Basin. This group is responsible for monitoring the activity and safety compliance of both our employees as
well as third party service providers and consultants. This department also coordinates closely with our operational team to ensure effective
communication with appropriate regulatory bodies as well as landowners. We believe that our proactive efforts in this area have made a
positive impact on our operations and culture. As an example, we were recently awarded the Midland Bruno Hanson/Midland College
Award for Environmental Excellence which is given to companies that demonstrate strong environmental stewardship in the Permian Basin.
6
Financial flexibility to fund growth initiatives. We bolstered our capital structure in 2013 with the issuance of Series A Cumulative
Preferred Stock and the sale of our offshore assets. We have continued to build upon these transactions with the recent completion of the
Amended Credit Facility and Second Lien Facility as described in Recent Developments.
Exploration and Development Activities
Our 2013 total capital expenditures, on a cash basis and including acquisitions, were $171 million, representing a 17% increase over 2012
actual capital expenditures. Of the $171 million, approximately $145 million was allocated to onshore drilling, development and leasehold
acquisition activity in the Permian basin. During 2013, capital expenditures for exploration and development costs related to oil and natural
gas properties included the following expenditures (in millions):
Southern Midland Basin
Central Midland Basin
Northern Midland Basin
Other
Total capital expenditures
Capitalized general and administrative costs allocated directly to exploration and development projects
Capitalized interest
Total capitalized expenses
Total operational expenditures
Acquisitions
Total capital expenditures, including acquisitions
$
$
111
20
7
7
145
11
4
15
160
11
171
We expanded our horizontal pad development efforts from two to four fields in late 2013, adding Carpe Diem in Midland County and
Garrison Draw in Reagan County. We expect our 2014 horizontal drilling program will be primarily focused on development of established
Upper and Lower Wolfcamp zones in the Southern and Central Midland Basin. We also expect to drill two wells in the Southern Midland
Basin to evaluate the Wolfcamp A shale and a test of the Lower Spraberry shale formation in the Central Midland Basin. Planned vertical
drilling activity is anticipated to be limited to five deep Wolfberry wells in the Pecan Acres field and one well in the Garrison Draw field. In
addition, our plans include three vertical exploration wells in the Northern Midland Basin, the timing and location of which being subject to
change as results are evaluated during the course of 2014.
Recent Developments
Credit facilities
On March 11, 2014, we entered into an amended senior secured revolving credit facility (the “Amended Credit Facility”) in the amount of
$500 million with JPMorgan Chase Bank, N.A. as Administrative Agent (“J.P. Morgan”). The Credit Facility will have an initial borrowing
base amount of $95 million and a maturity date of March 11, 2019. In conjunction with the Amended Credit Facility, we entered into a
senior secured second lien term loan facility (the “Second Lien Facility”) in an aggregate amount of up to $125 million with J.P. Morgan as
Administrative Agent and with a maturity date of September 11, 2019. See Note 4 for additional information.
Acquisitions
During the first quarter of 2014, we added 1,280 net acres in Upton County near our existing core development fields for an aggregate
purchase price of $7.0 million. This acreage added an estimated 96 gross potential horizontal well locations from seven prospective zones to
our drilling inventory. In addition, we expect to leverage existing infrastructure from our East Bloxom field in the development of this new
acreage. See Notes 6 and 12 to our financial statements for additional information regarding acquisitions.
7
Table of Contents
Divestitures
Effective December 5, 2013, the Company closed on the sale of its 15.0% working interest in the Medusa field (Mississippi Canyon blocks
582 and 538), our 10.0% membership interest in Medusa Spar LLC, and substantially all of our remaining Gulf of Mexico shelf properties.
The Company sold these assets to W&T Offshore, Inc., an unrelated third-party, for total net cash consideration of approximately $100
million before customary purchase price adjustments. The Medusa field had production net to Callon of 582 MBOE in 2013. Also during
the fourth quarter of 2013, the Company closed on the sale of its 69% interest in the Swan Lake field for $2 million. This field included 429
net acres and produced approximately 107 MMcf during the year ended December 31, 2013. This was the Company’s only field in the
Haynesville shale. See Note 12 to our financial statements for additional information.
Oil and Natural Gas Properties
As of December 31, 2013, our estimated net proved reserves totaled 14.9 MMBOE and included 11.9 MMBbls and 17.8 Bcf, with a pre-tax
present value, discounted at 10%, of $301.1 million. Pre-tax present value is a non-GAAP financial measure, which we reconcile to the
GAAP measure of standardized measure of $283.9 million in note (d) to the table below. Oil constituted approximately 80% of our total
estimated equivalent net proved reserves and approximately 80% of our total estimated equivalent proved developed reserves.
The following table sets forth certain information about our estimated net proved reserves prepared by our independent petroleum reserve
engineers by major area and for all other properties combined at December 31, 2013:
Estimated Net Proved Reserves
Natural Gas
(MMcf)
Oil
(MBbls)
Total
(MBOE)
(a)
Pre-tax
Discounted
Present
Value
($000)
(b)(c)(d)
Southern Midland Basin
Central Midland Basin
Northern Midland Basin
Other (c)
Total
10,103
1,699
96
—
11,898
15,021
2,730
—
—
17,751
12,607 $
2,154
96
—
14,857 $
267,216
39,336
3,921
(9,329)
301,144
(a) We convert Mcf to BOE using a conversion ratio of six Mcf to one Bbl. This ratio, which is typical in the industry and represents the
approximate energy equivalent of a Mcf to a Bbl, does not reflect to market price equivalence of Mcf of natural gas compared with a Bbl
of oil or NGLs. On a market price equivalence basis, a barrel of oil or NGLs has a substantially higher price than six Mcf of natural gas.
(b) Represents the present value of future net cash flows before deduction of federal income taxes, discounted at 10%, attributable to
estimated net proved reserves as of December 31, 2013, as set forth in the Company’s reserve reports prepared by its independent
petroleum reserve engineers, Huddleston & Co., Inc.
(c)
Includes a reduction for estimated plugging and abandonment costs that are reflected as a liability on our balance sheet at December 31,
2013, in accordance with accounting for asset retirement obligations rules. These obligations were retained following the sale of our
offshore operations. The negative Pre-Tax Discounted Present Value of the “Other” reflects plugging and abandonment obligations
exceeding the future net cash flows.
(d) The Company uses the financial measure “Pre Tax Discounted Present Value” which is a non-GAAP financial measure. The Company
believes that Pre Tax Discounted Present Value, while not a financial measure in accordance with GAAP, is an important financial
measure used by investors and independent oil and gas producers for evaluating the relative value of oil and natural gas properties and
acquisitions because the tax characteristics of comparable companies can differ materially. The total standardized measure calculated in
accordance with the guidance issued by the FASB for disclosures about oil and gas producing activities for our proved reserves as of
December 31, 2013 was $283.9 million inclusive of the $17.2 million discounted estimated future income taxes relating to such future net
revenues. The projected per Mcf natural gas price of $5.45 used in the 2013 reserve estimates has been adjusted to reflect the Btu content,
transportation charges and other fees specific to the individual properties. The projected per barrel oil price of $92.16 used in the 2013
reserve estimates has been adjusted to reflect all wellhead deductions and premiums on a property-by-property basis, including
transportation costs, location differentials and crude quality.
8
Permian Basin
As of December 31, 2013, we owned approximately 31,829 net acres in the Permian Basin. Our reserves in the Permian Basin represent all
of our proved reserves at year-end 2013 as compared to 67% at year-end 2012. Average net production from the Company’s Permian Basin
properties increased 38% to 2,227 BOE/d in 2013 from 1,619 BOE/d in 2012. As of December 2013, our average daily net production from
the Permian Basin was 3,611 BOE/d.
Southern Midland Basin
•
•
•
•
•
producing
Counties (fields): Upton (East Bloxom), Reagan (Taylor Draw and Garrison Draw) and Crockett (Block
5)
8,904 net acres as of December 31,
2013
77
horizontal)
Initiated horizontal development
2012
4th quarter 2013 net production: 2,334 BOE/d (72%
horizontal)
wells
(17
in
The Southern Midland Basin is our largest operating area in terms of production. Following recently completed acquisitions in the first
quarter of 2014, we currently have approximately 10,200 net acres in this area. We commenced horizontal drilling efforts at our East
Bloxom field in 2012 and have expanded our efforts to two additional fields in the Southern Midland Basin using pad development. Our
horizontal wells are currently producing from three zones of the Wolfcamp shale (Upper Wolfcamp B, Lower Wolfcamp B and Wolfcamp
A). We plan to continue focusing on these intervals across our entire position in the Southern Midland Basin in 2014 and expect to test
additional zones in future years.
Central Midland Basin
•
•
•
•
•
producing
Counties (fields): Midland (Carpe Diem and Pecan Acres) and Ector
(Kayleigh)
3,359 net acres as of December 31,
2013
50
wells
Initiated horizontal development
2013
4th quarter 2013 net production: 564
BOE/d
vertical
in
The Central Midland Basin has been the focus of our high-graded vertical drilling program, targeting multiple zones down to the Woodford
shale. We have recently shifted our focus to horizontal development of the Carpe Diem field. Our first Wolfcamp B wells were placed on
production in the first quarter of 2014 and we plan to add Carpe Diem to our core development fields going forward. This area is
prospective for multiple horizontal development zones and we plan to target the Lower Spraberry in 2014 as we delineate zones outside of
the Wolfcamp B.
Northern Midland Basin
•
•
•
•
Counties (fields): Borden (Black Magic and Baird Ranch) and Lynn (Tahoka
Prospect)
19,566 net acres as of December 31,
2013
One producing vertical
well
Ongoing going exploration and delineation
activity
Our Northern Midland Basin position was established in 2012 with the acquisition of 21,617 net acres in Borden and Lynn Counties. We
currently own approximately 17,433 net acres following our decision to allow certain acreage in the Northern Midland Basin to expire as
we refine our targeted areas for exploration. We began our exploration program in Borden County during the second half of 2012, drilling
one gross (0.75 net) vertical and two gross (1.5 net) horizontal wells, targeting the Cline and Mississippi lime. We have subsequently
focused our exploration activity on the Mississippi chat, drilling a vertical well (Lacey Newton 2801) in late 2013. We plan to further
evaluate the areal extent of this prospective play with at least one vertical exploration well in Borden County in 2014. We also plan to drill
our first exploration well in Lynn County in the first half of 2014, testing several prospective zones, including the Spraberry.
For additional details regarding our Permian wells and related information, please see “Present Activities and Productive Wells” included
below within this Item.
9
Other Property
We own a leasehold in approximately 65,000 net acres located in various counties in Nevada. These leases are with the Bureau of Land
Management and carry a primary term that expires in 2018. We are evaluating this acreage in conjunction with a third-party consultant and
developing options for future activity. Callon does not have any drilling commitments related to this acreage during the primary term.
Proved Reserves
Estimates of volumes of proved reserves at year-end, net to our interest, are presented in MBbls for oil and in MMcf for natural gas,
including NGLs, at a pressure base of 15.025 pounds per square inch. Total equivalent volumes are presented in BOE. For the BOE
computation, 6,000 cubic feet of gas are the equivalent of one barrel of oil. The ratio of six Mcf of gas to one BOE is typically used in the
oil and gas business and represents the approximate energy equivalent of a barrel of oil and an Mcf of natural gas. The price of a barrel of
oil is much higher than the price of six Mcf of natural gas, so the ratio of six Mcf to one BOE does not reflect the economic equivalent of a
barrel of oil to six Mcf of gas.
The following table sets forth certain information about our estimated net proved reserves. All of our proved reserves are currently located
in the continental United States and also included volumes in federal and state waters in the Gulf of Mexico at year-end 2011 and 2012.
Proved developed:
Oil (MBbls)
Natural gas (MMcf)
MBOE
Proved undeveloped:
Oil (MBbls)
Natural gas (MMcf)
MBOE
Total proved:
Oil (MBbls)
Natural gas (MMcf)
MBOE
Financial Information:
Estimated pre-tax future net cash flows (a)
Pre-tax discounted present value (a) (b)
Standardized measure of discounted future net cash flows (a) (b)
Years Ended December 31,
2012
2013
2011
5,960
9,059
7,470
5,938
8,692
7,387
11,898
17,751
14,857
4,955
10,680
6,735
5,825
9,073
7,337
10,780
19,753
14,072
5,069
11,605
7,003
5,006
23,513
8,925
10,075
35,118
15,928
$
$
$
680,627 $
301,144 $
283,946 $
592,424 $
250,097 $
231,148 $
568,798
309,890
270,357
(a)
Includes a reduction for estimated plugging and abandonment costs that is reflected as a liability on our balance sheet at December 31,
2013, in accordance with accounting for asset retirement obligations rules.
(b) The Company uses the financial measure “Pre-tax discounted present value” which is a non-GAAP financial measure. The Company
believes that Pre-tax discounted present value, while not a financial measure in accordance with GAAP, is an important financial measure
used by investors and independent oil and gas producers for evaluating the relative value of oil and natural gas properties and acquisitions
because the tax characteristics of comparable companies can differ materially. The total standardized measure calculated in accordance
with the guidance issued by the FASB for disclosures about oil and gas producing activities for our proved reserves as of December 31,
2013 was $283.9 million inclusive of the $17.2 million discounted estimated future income taxes relating to such future net revenues. The
natural gas Mcf prices of $5.45 used in the 2013 reserve estimates have been adjusted to reflect the Btu content, transportation charges
and other fees specific to the individual properties. The projected oil prices of $92.16 used in the 2013 reserve estimates have been
adjusted to reflect all wellhead deductions and premiums on a property-by-property basis, including transportation costs, location
differentials and crude quality.
See Note 12 of our Consolidated Financial Statements for the additional information regarding the Company’s reserves including its
estimates of proved reserves, PDPs, PUDs and the Company’s estimates of future net cash flows and discounted future net cash flows from
proved reserves.
10
The Company’s estimated net proved reserves increased 6% to 14,857 MBOE from 14,072 MBOE at December 31, 2013 and 2012,
respectively. Additions during the year were 9,979 MBOE, primarily due to the Company’s horizontal development of a portion of its
Permian Basin properties. These increases were partially offset by (1) 4,057 MBOE related to the sale of the Company’s Gulf of Mexico
assets and Haynesville field, (2) 3,724 MBOE of reductions in the Company’s PUD reserves, primarily related to the reclassification of
certain vertical PUD locations to the horizontal probable category, and a small amount to the horizontal PDP and PUD categories at year
end and (3) 1,413 MBOE related to the Company’s production during 2013. The reclassified vertical PUDs include Wolfberry PUD
locations that included certain target zones that are now expected to be more efficiently developed by the Company’s multi-level horizontal
drilling programs initiated in 2012. The vast majority of these previously booked vertical PUDs are now internally classified as horizontal
probable reserves, with a small amount now captured in horizontal PDPs and PUDs.
Proved Undeveloped Reserves (PUDs)
Annually, the Company reviews its PUDs to ensure appropriate plans exist for development. PUD reserves are recorded only if the
Company has plans to convert these reserves into PDPs within five years of the date they are first recorded. Our development plans include
the allocation of capital to projects included within our 2014 capital budget and, in subsequent years, the allocation of capital within our
long-range business plan to convert PUDs to PDPs within this five year period. In general, our 2014 capital budget and our long-range
capital plans are primarily governed by our expectations of internally generated cash flow and credit facility borrowing availability. Reserve
calculations at any end-of-year period are representative of our development plans at that time. Changes in commodity pricing, oilfield
service costs and availability, and other economic factors may lead to changes in development plans.
The following table summarizes the Company’s recorded PUDs:
Permian Basin
Haynesville shale
Total Onshore
Medusa (a)
Habanero (b)
Total Offshore
Total
PUDs (MBOE) at December
31,
2012
6,040
—
6,040
1,297
—
1,297
7,337
2013
7,387
—
7,387
—
—
—
7,387
2011
4,861
1,730
6,591
1,186
1,148
2,334
8,925
(a) Effective July 1, 2013, we sold our interest in the Medusa field. See Note 12 for additional
information.
(b) Effective December 28, 2012, we sold our interest in the Habanero field. See Note 12 for additional
information.
Our PUDs increased 1% to 7,387 MBOE from 7,337 MBOE at December 31, 2013 and 2012, respectively. We added 5,168 MBOE to the
Company’s PUDs, primarily from the continued horizontal development of our Permian Basin properties. The increase in Permian Basin
PUDs was partially offset by the reclassification of 3,724 MBOE, or 51% of volumes included in year-end 2012 PUD reserves related to
vertical PUD locations that were moved to the horizontal probable category, and a small amount to the horizontal PDP and PUD categories,
as we believe the previously booked Wolfberry PUD locations included certain target zones that we now expect can be more effectively
developed over the next five years by our multi-level horizontal drilling program that was commenced during 2012. Also offsetting our
PUD additions was the sale of 1,297 MBOE, or 18% included in the year-end 2012 PUD reserves related to our Medusa field, and the
conversion of a small portion of our 2012 PUD reserves to PDPs during 2013 from vertical drilling for a net cost of approximately $6
million. Most of our PUDs at year-end 2012 were attributable to vertical well locations. During 2013, our drilling program was
predominantly focused on horizontal wells as we continued to delineate our acreage for horizontal development of multiple zones that were
previously the target of vertical development wells. Based on our horizontal drilling results and subsequent capital allocation decisions, only
three of the vertical wells previously included as PUDs in our 2012 reserve report were drilled in 2013. Our horizontal drilling program
converted 4,431 MBOE of reserves that were not classified as proved at year end 2012 to proved developed reserves at year end 2013.
The Company plans to develop its Permian Basin PUDs as part of a multi-year drilling program. At December 31, 2013, we had no reserves
that remained undeveloepd for five or more years, and all PUD drilling locations are currently scheduled to be drilled within three to five
years of their initial recording.
11
Table of Contents
Controls Over Reserve Estimates
Compliance as it relates to reporting the Company’s reserves is the responsibility of our Senior Vice President of Operations, who has over
35 years of industry experience including 26 years as a manager and is our principal engineer. In addition to his years of experience, our
principal engineer holds a degree in petroleum engineering and is experienced in asset evaluation and management.
Callon’s controls over reserve estimates included retaining Huddleston & Co., Inc. (“Huddleston”), a Texas registered engineering firm, as
our independent petroleum and geological firm. The Company provided to Huddleston information about our oil and gas properties,
including production profiles, prices and costs, and Huddleston prepared its own estimates of the reserves attributable to the Company’s
properties. All of the information regarding reserves in this annual report is derived from Huddleston’s report. Huddleston’s reserve report
letter is included as an Exhibit to this annual report. The principal engineer at Huddleston who is responsible for preparing the Company’s
reserve estimates has over 30 years of experience in the oil and gas industry and is a Texas Licensed Professional Engineer. Further
professional qualifications include a degree in petroleum engineering.
To further enhance the control environment over the reserve estimation process, our Board of Directors includes a Strategic Planning
Committee whose purpose, as stated in the Committee’s charter, includes assisting management and the Board with its oversight of the
integrity of the determination of the Company’s oil and natural gas reserves and the work of Huddleston. The Committee’s charter also
specifies that the Committee shall perform, in consultation with the Company’s management and senior reserves and reservoir engineering
personnel, the following responsibilities:
•
•
•
•
Oversee the appointment, qualification, independence, compensation and retention of the independent petroleum and geological
firm (the “Firm”) engaged by the Company (including resolution of material disagreements between management and the Firm
regarding reserve determination) for the purpose of preparing or issuing an annual reserve report. The Committee shall review any
proposed changes in the appointment of the Firm, determine the reasons for such proposal, and whether there have been any
disputes between the Firm and management.
Review the Company’s significant reserves engineering principles and policies and any material changes thereto, and any proposed
changes in reserves engineering standards and principles which have, or may have, a material impact on the Company’s reserves
disclosure.
Review with management and the Firm the proved reserves of the Company, and, if appropriate, the probable reserves, possible
reserves and the total reserves of the Company, including: (i) reviewing significant changes from prior period reports; (ii)
reviewing key assumptions used or relied upon by the Firm; (iii) evaluating the quality of the reserve estimates prepared by both
the Firm and the Company relative to the Company’s peers in the industry; and (iv) reviewing any material reserves adjustments
and significant differences between the Company’s and Firm’s estimates.
If the Committee deems it necessary, it shall meet in executive session with management and the Firm to discuss the oil and gas
reserve determination process and related public disclosures, and any other matters of concern in respect of the evaluation of the
reserves.
During our last fiscal year, we filed no reports with other federal agencies which contain an estimate of total proved net oil and natural gas
reserves.
12
Production Volumes, Average Sales Prices and Operating Costs
The following table sets forth certain information regarding the production volumes and average sales prices received for, and average
production costs associated with, the Company’s sale of oil and natural gas for the periods indicated.
Production
Oil (MBbls)
Natural gas (Mcf)
Total (MBOE)
Revenues
Oil sales
Natural gas sales
Total revenues
Operating costs
Lease operating expense
Production taxes
Total operating costs
Realized prices
Oil ($/Bbl, including realized gains (losses) on derivatives) (a)
Oil ($/Bbl, excluding realized gains (losses) on derivatives) (a)
Natural gas ($/Mcf, including realized gains (losses) on derivatives) (b)
Natural gas ($/Mcf, excluding realized gains (losses) on derivatives) (b)
Operating costs per BOE
Lease operating expense
Production taxes
Total operating costs per BOE
Years Ended December 31,
2013
2011
2012
(in thousands, except per unit data)
911
3,011
1,413
977
3,588
1,575
996
5,081
1,843
$
88,960 $
13,609
$ 102,569 $
96,584 $
14,149
110,733 $
100,962
26,682
127,644
$
$
$
$
$
19,779 $
4,133
23,912 $
23,330 $
3,224
26,554 $
18,285
2,062
20,347
97.65 $
97.65
4.52
4.52
98.86 $
97.41
3.94
3.94
101.34
101.72
5.25
5.25
14.00 $
2.92
16.92 $
14.81 $
2.05
16.86 $
9.92
1.12
11.04
(a) Oil prices for production from our two divested deepwater fields reflect a premium over NYMEX pricing based on Mars WTI differential
for Medusa production, prior to the sale of Medusa in December 2013, and Argus Bonita WTI differential for Habanero production, prior
to the sale of Habanero during December 2012.
(b) Natural gas prices exceeded the related NYMEX prices, which are quoted on an MMBtu basis, primarily due to the value of the NGLs in
our liquids-rich natural gas stream, primarily from our Permian basin production.
13
Present Activities and Productive Wells
The following table sets forth the wells drilled and completed during the periods indicated. All such wells were drilled in the continental
United States. At December 31, 2013, the Company had four wells awaiting fracture stimulation.
Drilled
Completed (a)
Gross
Net
Gross
Net
Awaiting Completion
Gross
Net
Southern Midland Basin
Vertical wells
Horizontal wells
Total
Central Midland Basin
Vertical wells
Horizontal wells
Total
Northern Midland Basin
Vertical wells
Horizontal wells
Total
Total
Total vertical wells
Total horizontal wells
Total
(a) Completions include wells drilled prior to 2013.
1
17
18
5
2
7
1
—
1
26
7
19
26
1.0
15.5
16.5
3.0
1.7
4.7
1.0
—
1.0
22.2
5.0
17.2
22.2
1
15
16
7
—
7
2
1
3
26
10
16
26
1.0
13.5
14.5
4.4
—
4.4
1.8
0.8
2.5
21.4
7.1
14.3
21.4
—
3
3
—
2
2
—
—
—
5
—
5
5
—
3.0
3.0
—
1.7
1.7
—
—
—
4.7
—
4.7
4.7
The following table sets forth the Company’s drilled and completed wells, none of which were natural gas or nonproductive for the periods
reflected:
Oil
Development
Exploratory
Total
2013
2012
2011
Gross
Net
Gross
Net
Gross
Net
25
1
26
21.2
1.0
22.2
14
7
21
9.7
6.2
15.9
36
—
36
32.8
—
32.8
Wells drilled within the productive boundaries of statistical plays, such as on our Southern Midland Basin acreage, have been classified as
development wells.
The following table sets forth productive wells as of December 31, 2013:
Oil Wells
Natural Gas Wells
Gross
Net
Gross
Net
Working interest
Royalty interest
Total
128
3
131
107.7
0.1
107.8
—
—
—
—
—
—
A well is categorized as an oil well or a natural gas well based upon the ratio of oil to natural gas reserves on a Mcfe basis. However, most
of our wells produce both oil and natural gas.
14
For the periods presented, the following table sets forth by major field(s) net production volumes and estimated proved reserves:
Production Volumes (MBOE)
% of Total Proved Reserves
2013
2012
2011
2013
2012
2011
Year ended December 31,
Onshore
Permian Basin
Southern Midland Basin
Central Midland Basin
Northern Midland Basin
Total Permian Basin
Haynesville shale
Total onshore
Offshore
Medusa
Habanero
Gulf of Mexico shelf and other
Total offshore
612
193
8
813
18
831
302
—
280
582
402
189
—
591
46
637
464
134
340
938
254
99
—
353
101
454
641
197
551
1,389
85%
14%
1 %
100 %
—%
100 %
—%
—%
—%
—%
51%
16%
—%
67%
1 %
68%
28%
—%
4 %
32%
31%
17%
—%
48%
13%
61%
27%
8 %
4 %
39%
Total
1,413
1,575
1,843
100 %
100 %
100 %
Leasehold Acreage
The following table shows our approximate developed and undeveloped (gross and net) leasehold acreage as of December 31, 2013.
Louisiana
Texas (a)
Federal onshore (b)
Total
Developed
Undeveloped
Total
Gross
Net
Gross
Net
Gross
1,091
13,038
—
14,129
158
11,144
—
11,302
233
22,889
64,963
88,085
1,324
167
35,927
20,685
64,963
64,963
85,815 102,214
Net
325
31,829
64,963
97,117
(a) A portion of our Texas acreage requires continued drilling to hold the acreage for which we have included in our development plans,
though the cost to renew this acreage, if necessary, is not considered material.
(b) The Company’s lease of this acreage, located in Nevada, has approximate ly four years remaining, and had a carrying value at
December 31, 2013 of approximately $2.6 million included in the Company’s unevaluated properties balance. The lease requires no
drilling activity to hold the acreage, and we continue to evaluate our position and monitor the activity of other operators conducting
drilling in the area.
15
Undeveloped Acreage Expirations
The following table sets forth by geographic area as of December 31, 2013 the number of our leased gross and net undeveloped acres that
will expire over the next three years unless production begins before lease expiration dates. Gross amounts may be more than net amounts
in a particular year due to timing of expirations.
Table of Contents
Texas:
Southern Permian Basin
Central Permian Basin
Northern Permian Basin (a)
Nevada: (b)
Total acreage
2014
2015
2016
Total
Net
Gross
165
—
10,586
—
10,751
—
—
7,282
—
7,282
—
—
327
—
327
165
—
18,195
—
18,360
165
—
19,755
—
19,920
(a) 2,133 net acres have expired as of March 7, 2014. 16,062 of the total remaining net acres include extension options that would allow us
to extend the primary term for a period of two years.
(b) The Company’s lease of this acreage does not expire until 2018.
The expiring acreage set forth in the table above accounts for 21% of our net undeveloped acreage (85,815 total net acres). We are
continually engaged in a combination of drilling and development and discussions with mineral lessors for lease extensions, renewals, new
drilling and development units and new leases to address the expiration of undeveloped acreage that occurs in the normal course of our
business.
Title to Properties
The Company believes that the title to its oil and natural gas properties is good and defensible in accordance with standards generally
accepted in the oil and gas industry, subject to such exceptions which, in our opinion, are not so material as to detract substantially from the
use or value of such properties. The Company’s properties are typically subject, in one degree or another, to one or more of the following:
•
•
•
•
•
•
•
royalties and other burdens and obligations, express or implied, under oil and natural gas
leases,
overriding royalties and other burdens created by us or our predecessors in
title,
a variety of contractual obligations (including, in some cases, development obligations) arising under operating agreements, farm-
out agreements, production sales contracts and other agreements that may affect the properties or their titles,
back-ins and reversionary
assignments,
liens that arise in the normal course of operations, such as those for unpaid taxes, statutory liens securing obligations to unpaid
suppliers and contractors and contractual liens under operating agreements,
pooling, unitization and communitization agreements, declarations and orders,
and
easements, restrictions, rights-of-way and other matters that commonly affect
property.
interests existing under purchase agreements and
leasehold
To the extent that such burdens and obligations affect the Company’s rights to production revenues, these characteristics have been taken
into account in calculating Callon’s net revenue interests and in estimating the size and value of its reserves. The Company believes that the
burdens and obligations affecting our properties are typical within the industry for properties of the kind owned by Callon.
Insurance
In accordance with industry practice, the Company maintains insurance against some, but not all, of the operating risks to which its business
is exposed. While not all inclusive, the Company’s insurance policies include coverage for general liability insuring onshore operations
(including sudden and accidental pollution), aviation liability, auto liability, worker’s compensation, and employer’s liability. The company
carries control of well insurance for only those onshore operations that it is contractually bound to do so. At the depths and in the areas in
which the Company operates, and in light of the vertical and horizontal drilling that it undertakes, the Company typically does not encounter
high pressures or extreme drilling conditions onshore.
16
Table of Contents
Currently, the Company has general liability insurance coverage up to $1 million per occurrence and $2 million per policy in the aggregate,
which includes sudden and accidental environmental liability coverage for the effects of pollution on third parties arising from its
operations. The Company’s insurance policies contain high policy limits, and in most cases, deductibles (generally ranging from $0 to
$250,000) that must be met prior to recovery. These insurance policies are subject to certain customary exclusions and limitations. In
addition, the Company maintains up to $100 million in excess liability coverage, which is in addition to and triggered if the underlying
liability limits have been reached.
The Company requires all of its third-party contractors to sign master service agreements in which they agree to indemnify the Company for
injuries and deaths of the service provider’s employees, as well as contractors and subcontractors hired by the service provider. Similarly,
the Company generally agrees to indemnify each third-party contractor against claims made by employees of the Company and the
Company’s other contractors. Additionally, each party generally is responsible for damage to its own property.
The third-party contractors that perform hydraulic fracturing operations for the Company sign master service agreements generally
containing the indemnification provisions noted above. The Company does not currently have any insurance policies in effect that are
intended to provide coverage for losses solely related to hydraulic fracturing operations. However, the Company believes its general liability
and excess liability insurance policies would cover foreseeable third party claims related to hydraulic fracturing operations and associated
legal expenses, in accordance with, and subject to, the terms of such policies.
The Company re-evaluates the purchase of insurance, coverage limits and deductibles annually. Future insurance coverage for the oil and
natural gas industry could increase in cost and may include higher deductibles or retentions. In addition, some forms of insurance may
become unavailable in the future or unavailable on terms that are economically acceptable. While based on the Company’s risk analysis, it
believes that it is properly insured, no assurance can be given that the Company will be able to maintain insurance in the future at rates that
it considers reasonable. In such circumstances, the Company may elect to self-insure or maintain only catastrophic coverage for certain risks
in the future.
Major Customers
Our production is sold generally on month-to-month contracts at prevailing prices. The following table identifies customers to whom we
sold a significant percentage of our total oil and natural gas production, on an equivalent basis, during each of the 12-month periods ended:
Enterprise Crude Oil, LLC
Shell Trading Company
Plains Marketing, L.P.
Other
Total
December 31,
2012
2013
2011
38%
31%
15%
16%
100%
32%
39%
15%
14%
100%
16%
45%
17%
22%
100%
Because alternative purchasers of oil and natural gas are readily available, the Company believes that the loss of any of these purchasers
would not result in a material adverse effect on Callon’s ability to market future oil and natural gas production. We are not currently
committed to provide a fixed and determinable quantity of oil or gas in the near future under our contracts.
Corporate Offices
The Company’s headquarters are located in Natchez, Mississippi, in approximately 51,500 square feet of owned space. We also maintain
leased business offices in Houston and Midland, Texas. Because alternative locations to our leased spaces are readily available, the
replacement of any of our leased offices would not result in material expenditures.
Employees
Callon had 94 employees as of December 31, 2013. None of the Company’s employees are currently represented by a union, and the
Company believes that it has good relations with its employees.
17
Regulations
General. Oil and natural gas operations such as ours are subject to various types of legislation, regulation and other legal requirements
enacted by governmental authorities. This legislation and regulation affecting the entire oil and natural gas industry is continuously being
reviewed for amendment or expansion. Some of these requirements carry substantial penalties for failure to comply.
Exploration and Production. Our operations are subject to federal, state and local regulations that include requirements for permits to drill
and to conduct other operations and for provision of financial assurances (such as bonds and letters of credit) covering drilling and well
operations. Other activities subject to regulation are:
•
•
•
•
•
•
•
•
•
•
of
and method
location and spacing of
the
wells,
the method of drilling and completing and operating
wells,
the
rate
production,
the surface use and restoration of properties upon which wells are drilled and other exploration
activities,
notice to surface owners and other third
parties,
the plugging and abandoning of
wells,
the discharge of contaminants into water and the emission of contaminants into
air,
the disposal of fluids used or other wastes obtained in connection with
operations,
the marketing, transportation and reporting of production,
and
the valuation
royalties.
and payment of
Operations conducted on federal or state oil and natural gas leases must comply with numerous regulatory restrictions, including various
nondiscrimination statutes, royalty and related valuation requirements, and certain of these operations must be conducted pursuant to certain
on-site security regulations and other appropriate permits issued by the Department of the Interior (“DOI”) Bureaus or other appropriate
federal or state agencies.
Our sales of oil and natural gas are affected by the availability, terms and cost of pipeline transportation. The price and terms for access to
pipeline transportation remain subject to extensive federal and state regulation. If these regulations change, we could face higher
transmission costs for our production and, possibly, reduced access to transmission capacity.
Various proposals and proceedings that might affect the petroleum industry are pending before Congress, the Federal Energy Regulatory
Commission, or FERC, various state legislatures, and the courts. The industry historically has been heavily regulated and we can offer you
no assurance that the less stringent regulatory approach recently pursued by the FERC and Congress will continue nor can we predict what
effect such proposals or proceedings may have on our operations.
We do not currently anticipate that compliance with existing laws and regulations governing exploration and production will have a
significantly adverse effect upon our capital expenditures, earnings or competitive position.
Environmental Matters and Regulation. Our oil and natural gas exploration, development and production operations are subject to
stringent laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection.
Numerous federal, state and local governmental agencies, such as the U.S. Environmental Protection Agency, or the EPA, issue regulations
which often require difficult and costly compliance measures that carry substantial administrative, civil and criminal penalties and may
result in injunctive obligations for non-compliance. These laws and regulations may require the acquisition of a permit before drilling
commences, restrict the types, quantities and concentrations of various substances that can be released into the environment in connection
with drilling and production activities, limit or prohibit construction or drilling activities on certain lands lying within wilderness, wetlands,
ecologically sensitive and other protected areas, require action to prevent or remediate pollution from current or former operations, such as
plugging abandoned wells or closing pits, result in the suspension or revocation of necessary permits, licenses and authorizations, require
that additional pollution controls be installed and impose substantial liabilities for pollution resulting from our operations or relate to our
owned or operated facilities. Violations of environmental laws could result in administrative, civil or criminal fines and injunctive relief.
The strict and joint and several liability nature of such laws and regulations could impose liability upon us regardless of fault. Moreover, it
is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused
by the release of hazardous substances, hydrocarbons or other waste products into the environment. Changes in environmental laws and
regulations occur frequently, and any changes that result in more stringent and costly pollution control or waste handling, storage, transport,
disposal or cleanup requirements could materially adversely affect our operations and financial position, as well as the oil and natural gas
industry in general. Our management believes that we are in substantial compliance with applicable environmental laws and regulations and
we have not experienced any material adverse effect from compliance with these
18
environmental requirements. Our management believes that we are in substantial compliance with applicable environmental laws and
regulations and we have not experienced any material adverse effect from compliance with these environmental requirements.
Waste Handling. The Resource Conservation and Recovery Act, as amended, or RCRA, and comparable state statutes and regulations
promulgated thereunder, affect oil and natural gas exploration, development and production activities by imposing requirements regarding
the generation, transportation, treatment, storage, disposal and cleanup of hazardous and non-hazardous wastes. With federal approval, the
individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements.
Although most wastes associated with the exploration, development and production of oil and natural gas are exempt from regulation as
hazardous wastes under RCRA, such wastes may constitute “solid wastes” that are subject to the less stringent requirements of non-
hazardous waste provisions may not be exempt under state programs. However, we cannot assure you that the EPA or state or local
governments will not adopt more stringent requirements for the handling of non-hazardous wastes or categorize some non-hazardous wastes
as hazardous for future regulation. Indeed, legislation has been proposed from time to time in Congress to re-categorize certain oil and
natural gas exploration, development and production wastes as “hazardous wastes.” Any such changes in the laws and regulations could
have a material adverse effect on our capital expenditures and operating expenses.
Administrative, civil and criminal penalties can be imposed for failure to comply with waste handling requirements. We believe that we are
in substantial compliance with applicable requirements related to waste handling, and that we hold all necessary and up-to-date permits,
registrations and other authorizations to the extent that our operations require them under such laws and regulations. We believe that we are
in substantial compliance with applicable requirements related to waste handling, and that we hold all necessary and up-to-date permits,
registrations and other authorizations to the extent that our operations require them under such laws and regulations. Although we do not
believe the current costs of managing our wastes, as presently classified, to be significant, any legislative or regulatory reclassification of oil
and natural gas exploration and production wastes could increase our costs to manage and dispose of such wastes.
Water Discharges. The Federal Water Pollution Control Act of 1972, as amended, also known as the “Clean Water Act,” the Safe Drinking
Water Act, the Oil Pollution Act, or OPA, and analogous state laws and regulations promulgated thereunder impose restrictions and strict
controls regarding the unauthorized discharge of pollutants, including produced waters and other gas and oil wastes, into navigable waters
of the United States, as well as state waters for analogous state programs. The discharge of pollutants into regulated waters is prohibited,
except in accordance with the terms of a permit issued by the EPA or the state. The Clean Water Act and regulations implemented
thereunder also prohibit the discharge of dredge and fill material into regulated waters, including jurisdictional wetlands, unless authorized
by an appropriately issued permit. Spill prevention, control and countermeasure plan requirements under federal law require appropriate
containment berms and similar structures to help prevent the contamination of navigable waters in the event of a petroleum hydrocarbon
tank spill, rupture or leak. These laws and regulations also prohibit certain activity in wetlands unless authorized by a permit issued by the
U.S. Army Corps of Engineers. The EPA has also adopted regulations requiring certain oil and natural gas exploration and production
facilities to obtain individual permits or coverage under general permits for storm water discharges. In addition, on October 20, 2011, the
EPA announced a schedule to develop pre-treatment standards for wastewater discharges produced by natural gas extraction from
underground coalbed and shale formations. The EPA stated that it will gather data, consult with stakeholders, including ongoing
consultation with industry, and solicit public comment on a proposed rule for coalbed methane and shale gas in 2014. Costs may be
associated with the treatment of wastewater or developing and implementing storm water pollution prevention plans, as well as for
monitoring and sampling the storm water runoff from certain of our facilities. Some states also maintain groundwater protection programs
that require permits for discharges or operations that may impact groundwater conditions.
The Oil Pollution Act is the primary federal law for oil spill liability. The OPA contains numerous requirements relating to the prevention of
and response to petroleum releases into waters of the United States, including the requirement that operators of offshore facilities and
certain onshore facilities near or crossing waterways must develop and maintain facility response contingency plans and maintain certain
significant levels of financial assurance to cover potential environmental cleanup and restoration costs. The OPA subjects owners of
facilities to strict, joint and several liability for all containment and cleanup costs and certain other damages arising from a release, including,
but not limited to, the costs of responding to a release of oil to surface waters.
Noncompliance with the Clean Water Act or OPA may result in substantial administrative, civil and criminal penalties, as well as injunctive
obligations. We believe we are in material compliance with the requirements of each of these laws. We believe we are in material
compliance with the requirements of each of these laws.
Air Emissions. The federal Clean Air Act, as amended, and comparable state laws and regulations, regulate emissions of various air
pollutants through the issuance of permits and the imposition of other requirements. The EPA has developed, and continues to develop,
stringent regulations governing emissions of air pollutants at specified sources. New facilities may be required to obtain permits before
work can begin, and existing facilities may be required to obtain additional permits and incur capital costs in order to remain in compliance.
For example, on August 16, 2012, the EPA published final regulations under the federal Clean Air Act
19
that establish new emission controls for oil and natural gas production and processing operations, which regulations are discussed in more
detail below in “-Regulation of Hydraulic Fracturing.” These laws and regulations may increase the costs of compliance for some facilities
we own or operate, and federal and state regulatory agencies can impose administrative, civil and criminal penalties and seek injunctive
relief for non-compliance with air permits or other requirements of the federal Clean Air Act and associated state laws and regulations. We
believe that we are in substantial compliance with all applicable air emissions regulations and that we hold all necessary and valid
construction and operating permits for our operations. We believe that we are in substantial compliance with all applicable air emissions
regulations and that we hold all necessary and valid construction and operating permits for our operations. Obtaining or renewing permits
has the potential to delay the development of oil and natural gas projects.
Greenhouse Gas (GHG) Regulation. Although federal legislation regarding the control of greenhouse gasses, or GHGs, thus far has been
unsuccessful, the EPA has moved forward with rulemaking to regulate GHGs as pollutants under the CAA. These GHG regulations may
require us to incur increased operating costs and may have an adverse effect on demand for the oil and natural gas we produce.
The EPA, as of January 2, 2011, requires the permitting of GHG emissions from stationary sources under the Prevention of Significant
Deterioration (“PSD”) and Title V permitting programs in a multi-step process, with the largest sources first subject to permitting. Those
permitting provisions, should they become applicable to our operations, could require controls or other measures to reduce GHG emissions
from new or modified sources, and we could incur additional costs to satisfy those requirements. EPA has adopted a rule establishing GHG
reporting requirements for sources in the petroleum and natural gas industry, requiring those sources to monitor, maintain records on, and
annually report their GHG emissions if the total emissions within a basin exceed 25,000 metric tons CO2 equivalent per year. Although this
rule does not limit the amount of GHGs that can be emitted, it requires us to incur costs to monitor, keep records of, and potentially report
GHG emissions associated with our operations if the reporting threshold is reached with production growth.
In addition to federal regulation, a number of states, individually and regionally, also are considering or have implemented GHG regulatory
programs. These potential regional and state initiatives may result in so-called “Cap-and-Trade programs”, under which overall GHG
emissions are limited and GHG emissions are then allocated and sold, and possibly other regulatory requirements, that could result in our
incurring material expenses to comply, such as by being required to purchase or to surrender allowances for GHGs resulting from our
operations. The federal, regional and local regulatory initiatives also could adversely affect the marketability of the oil and natural gas we
produce. The impact of such future programs cannot be predicted, but we do not expect our operations to be affected any differently than
other similarly situated domestic competitors.
Regulation of Hydraulic Fracturing. Hydraulic fracturing is an important common practice that is used to stimulate production of
hydrocarbons, particularly natural gas, from tight formations, including shales. The process involves the injection of water, sand and
chemicals under pressure into formations to fracture the surrounding rock and stimulate production. The federal Safe Drinking Water Act, or
SDWA, regulates the underground injection of substances through the Underground Injection Control, or UIC, program. Hydraulic
fracturing generally is exempt from regulation under the UIC program, and the hydraulic fracturing process is typically regulated by state
oil and gas commissions. Legislation to amend the SDWA to repeal the exemption for hydraulic fracturing from the definition of
“underground injection” and require federal permitting and regulatory control of hydraulic fracturing, as well as legislative proposals to
require disclosure of the chemical constituents of the fluids used in the fracturing process, have been proposed in recent sessions of
Congress but have not passed.
The EPA, however, issued guidance on permitting hydraulic fracturing that uses fluids containing diesel fuel under the UIC program,
specifically as “Class II” UIC wells. At the same time, the White House Council on Environmental Quality is coordinating an
administration-wide review of hydraulic fracturing practices and the EPA has commenced a study of the potential impacts of hydraulic
fracturing activities on drinking water resources. The EPA has announced that it plans to propose standards in 2014 that such wastewater
must meet before being transported to a treatment plant. As part of these studies, the EPA has requested that certain companies provide
them with information concerning the chemicals used in the hydraulic fracturing process. These studies, depending on their results, could
spur initiatives to regulate hydraulic fracturing under the SDWA or otherwise.
On August 16, 2012, the EPA approved final regulations under the federal Clean Air Act that establish new air emission controls for oil and
natural gas production and natural gas processing operations. Specifically, the EPA’s rule package includes New Source Performance
Standards to address emissions of sulfur dioxide and volatile organic compounds, or VOCs, and a separate set of emission standards to
address hazardous air pollutants frequently associated with oil and natural gas production and processing activities. The final rule seeks to
achieve a 95% reduction in VOCs emitted by requiring the use of reduced emission completions or “green completions” on all
hydraulically-fractured wells constructed or refractured after January 1, 2015. The rules also establish specific new requirements regarding
emissions from compressors, controllers, dehydrators, storage tanks and other production equipment. These rules will require a number of
modifications to our operations, including the installation of new equipment to control emissions from our wells by January 1, 2015. The
EPA received numerous requests for reconsideration of these rules from
20
both industry and the environmental community, and court challenges to the rules were also filed. The EPA may issue revised rules that are
likely responsive to some of these requests. For example, on April 12, 2013, the EPA published a proposed amendment extending
compliance dates for certain storage vessels. The final revised rules could require modifications to our operations or increase our capital and
operating costs without being offset by increased product capture. At this point, we cannot predict the final regulatory requirements or the
cost to comply with such requirements with any certainty. In addition, the U.S. Department of the Interior published a revised proposed rule
on May 24, 2013 that would update existing regulation for hydraulic fracturing activities on federal lands, including requirements for
disclosure, well bore integrity and handling of flowback water. EPA has announced that it is considering regulations under the Toxic
Substance Control Act to require evaluation and disclsoure of hydraulic fracturing.
In addition, there are certain governmental reviews either underway or being proposed that focus on environmental aspects of hydraulic
fracturing practices. The federal government is currently undertaking several studies of hydraulic fracturing’s potential impacts, the results
of which are expected in 2014. These ongoing or proposed studies, depending on their degree of pursuit and whether any meaningful results
are obtained, could spur initiatives to further regulate hydraulic fracturing under the SDWA or other regulatory authorities.
Several states, including Texas, have adopted, or are considering adopting, regulations that could restrict or prohibit hydraulic fracturing in
certain circumstances and/or require the disclosure of the composition of hydraulic fracturing fluids. The Texas Legislature adopted new
legislation requiring oil and gas operators to publicly disclose the chemicals used in the hydraulic fracturing process, effective as of
September 1, 2011. The Texas Railroad Commission has adopted rules and regulations implementing this legislation that apply to all wells
for which the Railroad Commission issues an initial drilling permit after February 1, 2012. The new law requires that the well operator
disclose the list of chemical ingredients subject to the requirements of the federal Occupational Safety and Health Act (OSHA) for
disclosure on an internet website and also file the list of chemicals with the Texas Railroad Commission with the well completion report.
The total volume of water used to hydraulically fracture a well must also be disclosed to the public and filed with the Texas Railroad
Commission.
There has been increasing public controversy regarding hydraulic fracturing with regard to the use of fracturing fluids, impacts on drinking
water supplies, use of water and the potential for impacts to surface water, groundwater and the environment generally. A number of
lawsuits and enforcement actions have been initiated across the country implicating hydraulic fracturing practices. If new laws or
regulations that significantly restrict hydraulic fracturing are adopted, such laws could make it more difficult or costly for us to perform
fracturing to stimulate production from tight formations as well as make it easier for third parties opposing the hydraulic fracturing process
to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process could adversely affect groundwater.
In addition, if hydraulic fracturing is further regulated at the federal or state level, our fracturing activities could become subject to
additional permitting and financial assurance requirements, more stringent construction specifications, increased monitoring, reporting and
recordkeeping obligations, plugging and abandonment requirements and also to attendant permitting delays and potential increases in costs.
Such legislative changes could cause us to incur substantial compliance costs, and compliance or the consequences of any failure to comply
by us could have a material adverse effect on our financial condition and results of operations. At this time, it is not possible to estimate the
impact on our business of newly enacted or potential federal or state legislation governing hydraulic fracturing.
Surface Damage Statutes (“SDAs”). In addition, a number of states and some tribal nations have enacted SDAs. These laws are designed
to compensate for damage caused by oil and gas development operations. Most SDAs contain entry notification and negotiation
requirements to facilitate contact between operators and surface owners/users. Most also contain binding requirements for payments to the
operator in connection with exploration and operating activities. Costs and delays associated with SDAs could impair operational
effectiveness and increase development costs.
National Environmental Policy Act and Endangered Species Act . Oil and natural gas exploration and production activities on federal lands
may be subject to the National Environmental Policy Act, or NEPA, which requires federal agencies, including the Department of Interior,
to evaluate major agency actions having the potential to significantly impact the environment. In the course of such evaluations, an agency
will prepare an Environmental Assessment that assesses the potential direct, indirect and cumulative impacts of a proposed project and, if
necessary, will prepare a more detailed Environmental Impact Statement that may be made available for public review and comment. To the
extent that our current exploration and production activities, as well as proposed exploration and development plans, on federal lands require
governmental permits that are subject to the requirements of NEPA, this process has the potential to delay or impose additional conditions
upon the development of oil and natural gas projects.
The Endangered Species Act (“ESA”) was established to protect endangered and threatened species. Pursuant to that act, if a species is listed
as threatened or endangered, restrictions may be imposed on activities adversely affecting that species’ habitat. Similar protections are
offered to migratory birds under the Migratory Bird Treaty Act. The U.S. Fish and Wildlife Service must also designate the species’ critical
habitat and suitable habitat as part of the effort to ensure survival of the species. A critical habitat
21
or suitable habitat designation could result in further material restrictions to land use and may materially delay or prohibit land access for oil
and natural gas development. If the Company were to have a portion of its leases designated as critical or suitable habitat, it may adversely
impact the value of the affected leases.
Mineral Leasing Act of 1920 (“Mineral Act”). The Mineral Act prohibits direct or indirect ownership of any interest in federal onshore oil
and natural gas leases by a foreign citizen or a foreign corporation except through stock ownership in a corporation formed under the laws of
the United States or of any U.S. state or territory, and only if the laws, customs, or regulations of their country of origin or domicile do not
deny similar or like privileges to citizens or corporations of the United States. If these restrictions are violated, the oil and gas lease or
leases can be canceled in a proceeding instituted by the United States Attorney General. Although the regulations of the Bureau of Land
Management (“BLM”) (which administers the Mineral Act) provide for agency designations of non-reciprocal countries, there are presently
no such designations in effect. The Company owns an interest in federal leaseholds in Nevada. It is possible that holders of the Company’s
equity interests may be citizens of foreign countries, which could be determined to be citizens of a non-reciprocal country under the Mineral
Act. In such event, the federal onshore oil and gas leases held by the Company could be subject to cancellation based on such
determination.
Other Regulation of the Oil and Natural Gas Industry. The oil and natural gas industry is extensively regulated by numerous federal, state
and local authorities. Legislation affecting the oil and natural gas industry is under constant review for amendment or expansion, frequently
increasing the regulatory burden. Also, numerous departments and agencies, both federal and state, are authorized by statute to issue rules
and regulations that are binding on the oil and natural gas industry and its individual members, some of which carry substantial penalties for
failure to comply. Although the regulatory burden on the oil and natural gas industry increases our cost of doing business and, consequently,
affects our profitability, these burdens generally do not affect us any differently or to any greater or lesser extent than they affect other
companies in the industry with similar types, quantities and locations of production.
The availability, terms and cost of transportation significantly affect sales of oil and natural gas. The interstate transportation and sale for
resale of oil and natural gas is subject to federal regulation, including regulation of the terms, conditions and rates for interstate
transportation, storage and various other matters, primarily by the Federal Energy Regulatory Commission, or FERC. Federal and state
regulations govern the price and terms for access to oil and natural gas pipeline transportation. FERC’s regulations for interstate oil and
natural gas transmission in some circumstances may also affect the intrastate transportation of oil and natural gas.
Although oil and natural gas prices are currently unregulated, Congress historically has been active in the area of oil and natural gas
regulation. We cannot predict whether new legislation to regulate oil and natural gas might be proposed, what proposals, if any, might
actually be enacted by Congress or the various state legislatures, and what effect, if any, the proposals might have on our operations. Sales
of condensate and oil and natural gas liquids are not currently regulated and are made at market prices.
Drilling and Production. Our operations are subject to various types of regulation at the federal, state and local level. These types of
regulation include requiring permits for the drilling of wells, drilling bonds and reports concerning operations. The state, and some counties
and municipalities, in which we operate also regulate one or more of the following:
•
•
•
•
•
•
•
location
of
the
wells;
the method of drilling and casing
wells;
the timing of construction or drilling activities, including seasonal wildlife
closures;
the
rates
“allowables”;
of
production
or
the surface use and restoration of properties upon which wells are
drilled;
the plugging and abandoning of wells;
and
notice to, and consultation with, surface owners and other third
parties.
State laws regulate the size and shape of drilling and spacing units or proration units governing the pooling of oil and natural gas properties.
Some states allow forced pooling or integration of tracts to facilitate exploration while other states rely on voluntary pooling of lands and
leases. In some instances, forced pooling or unitization may be implemented by third parties and may reduce our interest in the unitized
properties. In addition, state conservation laws establish maximum rates of production from oil and natural gas wells, generally prohibit the
venting or flaring of natural gas and impose requirements regarding the ratability of production. These laws and regulations may limit the
amount of oil and natural gas we can produce from our wells or limit the number of wells or the locations at which we can drill. Moreover,
each state generally imposes a production or severance tax with respect to the production and sale of oil, natural gas and natural gas liquids
within its jurisdiction. States do not regulate wellhead prices or engage in other similar direct regulation, but we cannot assure you that they
will not do so in the future. The effect of
22
such future regulations may be to limit the amounts of oil and natural gas that may be produced from our wells, negatively affect the
economics of production from these wells or to limit the number of locations we can drill.
Federal, state and local regulations provide detailed requirements for the abandonment of wells, closure or decommissioning of production
facilities and pipelines and for site restoration in areas where we operate. The U.S. Army Corps of Engineers and many other state and local
authorities also have regulations for plugging and abandonment, decommissioning and site restoration. Although the U.S. Army Corps of
Engineers does not require bonds or other financial assurances, some state agencies and municipalities do have such requirements.
Natural Gas Sales and Transportation. Historically, federal legislation and regulatory controls have affected the price of the natural gas we
produce and the manner in which we market our production. FERC has jurisdiction over the transportation and sale for resale of natural gas
in interstate commerce by natural gas companies under the Natural Gas Act of 1938 and the Natural Gas Policy Act of 1978. Since 1978,
various federal laws have been enacted which have resulted in the complete removal of all price and non-price controls for sales of domestic
natural gas sold in “first sales,” which include all of our sales of our own production. Under the Energy Policy Act of 2005, FERC has
substantial enforcement authority to prohibit the manipulation of natural gas markets and enforce its rules and orders, including the ability to
assess substantial civil penalties.
FERC also regulates interstate natural gas transportation rates and service conditions and establishes the terms under which we may use
interstate natural gas pipeline capacity, which affects the marketing of natural gas that we produce, as well as the revenues we receive for
sales of our natural gas and release of our natural gas pipeline capacity. Commencing in 1985, FERC promulgated a series of orders,
regulations and rule makings that significantly fostered competition in the business of transporting and marketing gas. Today, interstate
pipeline companies are required to provide nondiscriminatory transportation services to producers, marketers and other shippers, regardless
of whether such shippers are affiliated with an interstate pipeline company. FERC’s initiatives have led to the development of a
competitive, open access market for natural gas purchases and sales that permits all purchasers of natural gas to buy gas directly from third-
party sellers other than pipelines. However, the natural gas industry historically has been very heavily regulated; therefore, we cannot
guarantee that the less stringent regulatory approach currently pursued by FERC and Congress will continue indefinitely into the future nor
can we determine what effect, if any, future regulatory changes might have on our natural gas related activities.
Under FERC’s current regulatory regime, transmission services must be provided on an open-access, non-discriminatory basis at cost-based
rates or at market-based rates if the transportation market at issue is sufficiently competitive. Gathering service, which occurs upstream of
jurisdictional transmission services, is regulated by the states onshore and in state waters. Although its policy is still in flux, FERC has in the
past reclassified certain jurisdictional transmission facilities as non-jurisdictional gathering facilities, which has the tendency to increase our
costs of transporting gas to point-of-sale locations.
Oil and NGLs Sales and Transportation. Sales of oil and condensate and natural gas liquids are not currently regulated and are made at
negotiated prices. Nevertheless, Congress could reenact price controls in the future.
Our oil sales are affected by the availability, terms and cost of transportation. The transportation of oil in common carrier pipelines is also
subject to rate regulation. FERC regulates interstate oil pipeline transportation rates under the Interstate Commerce Act and intrastate oil
pipeline transportation rates are subject to regulation by state regulatory commissions. The basis for intrastate oil pipeline regulation, and
the degree of regulatory oversight and scrutiny given to intrastate oil pipeline rates, varies from state to state. Insofar as effective interstate
and intrastate rates are equally applicable to all comparable shippers, we believe that the regulation of oil transportation rates will not affect
our operations in any materially different way than such regulation will affect the operations of our competitors.
Further, interstate and intrastate common carrier oil pipelines must provide service on a non-discriminatory basis. Under this open access
standard, common carriers must offer service to all shippers requesting service on the same terms and under the same rates. When oil
pipelines operate at full capacity, access is governed by prorationing provisions set forth in the pipelines’ published tariffs. Accordingly, we
believe that access to oil pipeline transportation services generally will be available to us to the same extent as to our competitors.
State Regulation. Texas regulates the drilling for, and the production, gathering and sale of, oil and natural gas, including imposing
severance taxes and requirements for obtaining drilling permits. Texas currently imposes a 4.6% severance tax on oil production and a 7.5%
severance tax on natural gas production. States also regulate the method of developing new fields, the spacing and operation of wells and
the prevention of waste of oil and natural gas resources. States may regulate rates of production and may establish maximum daily
production allowables from oil and natural gas wells based on market demand or resource conservation, or both. States do not regulate
wellhead prices or engage in other similar direct economic regulation, but we cannot assure you that they will not do so in the future. The
effect of these regulations may be to limit the amount of oil and natural gas that may be produced from our wells and to limit the number of
wells or locations we can drill.
23
The petroleum industry is also subject to compliance with various other federal, state and local regulations and laws. Some of those laws
relate to resource conservation and equal employment opportunity. We do not believe that compliance with these laws will have a material
adverse effect on us.
Commitments and Contingencies
The Company’s activities are subject to federal, state and local laws and regulations governing environmental quality and pollution
control. Although no assurances can be made, the Company believes that, absent the occurrence of an extraordinary event, compliance with
existing federal, state and local laws, rules and regulations governing the release of materials into the environment or otherwise relating to
the protection of the environment will not have a material effect upon the capital expenditures, earnings or the competitive position of the
Company with respect to its existing assets and operations. The Company cannot predict what effect additional regulation or legislation,
enforcement policies included, and claims for damages to property, employees, other persons, and the environment resulting from the
Company’s operations could have on its activities. See Note 13 for additional information.
Available Information
We make available free of charge on our Internet web site (www.callon.com) our Annual Report on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K and other filings pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and
amendments to such filings, as soon as reasonably practicable after each are electronically filed with, or furnished to, the SEC. You may
read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE., Washington, DC 20549. You
may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an
Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers, like Callon,
that file electronically with the SEC.
We also make available within the Investors section of our Internet web site our Code of Business Conduct and Ethics, Corporate
Governance Guidelines, and Audit, Compensation and Nominating and Governance Committee Charters, which have been approved by our
board of directors. We will make timely disclosure by a Current Report on Form 8-K and on our web site of any change to, or waiver from,
the Code of Business Conduct and Ethics for our principal executive and senior financial officers. A copy of our Code of Business Conduct
and Ethics is also available, free of charge by writing us at: Chief Financial Officer, Callon Petroleum Company, P.O. Box 1287, Natchez,
MS 39121.
24
Item 1A. Risk Factors
Risk Factors
Table of Contents
Depressed oil and natural gas prices may adversely affect our results of operations and financial condition . Our success is highly
dependent on prices for oil and natural gas, which are extremely volatile, and the oil and natural gas markets are cyclical. Extended periods
of low prices for oil or natural gas will have a material adverse effect on us. The prices of oil and natural gas depend on factors we cannot
control such as weather, economic conditions, and levels of production, actions by OPEC and other countries and government actions.
Prices of oil and natural gas will affect the following aspects of our business:
flows
revenues,
and
•
cash
our
earnings;
the amount of oil and natural gas that we are economically able to
produce;
our ability to attract capital to finance our operations and the cost of the
capital;
the amount we are allowed to borrow under our credit
facilities;
the profit or loss we incur in exploring for and developing our reserves;
and
the value of our oil and natural gas
properties.
•
•
•
•
•
Any substantial and extended decline in the price of oil or natural gas could have an adverse effect on our borrowing capacity, our ability to
obtain additional capital, and our revenues, profitability and cash flows.
If oil and natural gas prices decrease and remain depressed for extended periods of time, we may be required to take additional
writedowns of the carrying value of our oil and natural gas properties. We may be required to writedown the carrying value of our oil
and natural gas properties when oil and natural gas prices are low. Under the full-cost method, which we use to account for our oil and
natural gas properties, the net capitalized costs of our oil and natural gas properties may not exceed the present value, discounted at 10%, of
future net cash flows from estimated net proved reserves, using the preceding 12-months’ average oil and natural gas prices based on
closing prices on the first day of each month, plus the lower of cost or fair market value of our unproved properties. If net capitalized costs
of our oil and natural gas properties exceed this limit, we must charge the amount of the excess to earnings. This type of charge will not
affect our cash flows, but will reduce the book value of our stockholders’ equity. We review the carrying value of our properties quarterly
and once incurred, a writedown of oil and natural gas properties is not reversible at a later date, even if prices increase. See Note 12 to our
Consolidated Financial Statements.
Our actual recovery of reserves may substantially differ from our proved reserve estimates and our proved reserve estimates may
change over time. This Form 10-K contains estimates of our proved oil and natural gas reserves and the estimated future net cash flows
from such reserves. These estimates are based upon various assumptions, including assumptions required by the SEC relating to oil and
natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. The process of estimating oil and
natural gas reserves is complex. This process requires significant decisions and assumptions in the evaluation of available geological,
geophysical, engineering and economic data for each reservoir and is therefore inherently imprecise. In addition, drilling, testing and
production data acquired since the date of an estimate may justify revising an estimate.
Actual future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of
recoverable oil and natural gas reserves most likely will vary from the estimates. Any significant variance could materially affect the
estimated quantities and present value of reserves shown in this report. Additionally, reserves and future cash flows may be subject to
material downward or upward revisions, based on production history, development drilling and exploration activities and prices of oil and
natural gas. We incorporate many factors and assumptions into our estimates including:
•
•
•
•
production
Expected reservoir characteristics based on geological, geophysical and engineering
assessments;
Future
rates;
Future oil and natural gas prices and quality and locational differences;
and
Future development and operating
costs.
You should not assume that any present value of future net cash flows from our estimated net proved reserves contained in this Form 10-K
represents the market value of our oil and natural gas reserves. We base the estimated discounted future net cash flows from our proved
reserves at December 31, 2013 on average 12-month prices and costs as of the date of the estimate. Actual future prices and costs may be
materially higher or lower. Further, actual future net revenues will be affected by factors such as the amount and timing of actual
development expenditures, the rate and timing of production, and changes in governmental regulations or taxes. At December 31, 2013,
approximately 33% of the discounted present value of our estimated net proved reserves consisted of PUDs. PUDs represented 50% of total
proved reserves by volume. Recovery of PUDs generally requires significant capital expenditures and successful drilling operations. Our
reserve estimates include the assumption that we will make significant capital expenditures to develop these undeveloped reserves and the
actual costs, development schedule, and results associated with these
25
Table of Contents
properties may not be as estimated. In addition, the 10% discount factor that we use to calculate the net present value of future net revenues
and cash flows may not necessarily be the most appropriate discount factor based on our cost of capital in effect from time to time and the
risks associated with our business and the oil and gas industry in general.
Information about reserves constitutes forward-looking information. See “Forward-Looking Statements” for information regarding forward-
looking information.
Unless we replace our oil and gas reserves, our reserves and production will decline. Our future oil and gas production depends on our
success in finding or acquiring additional reserves. If we fail to replace reserves through drilling or acquisitions, our production, revenues,
reserve quantities and cash flows will decline. In general, production from oil and gas properties declines as reserves are depleted, with the
rate of decline depending on reservoir characteristics. Our ability to make the necessary capital investment to maintain or expand our asset
base of oil and gas reserves would be limited to the extent cash flow from operations is reduced and external sources of capital become
limited or unavailable. We may not be successful in exploring for, developing or acquiring additional reserves.
Exploring for, developing, or acquiring reserves is capital intensive and uncertain. We may not be able to economically find, develop,
or acquire additional reserves, or may not be able to make the necessary capital investments to develop our reserves, if our cash flows from
operations decline or external sources of capital become limited or unavailable. As part of our exploration and development operations, we
have expanded, and expect to further expand, the application of horizontal drilling and multi-stage hydraulic fracture stimulation techniques.
The utilization of these techniques requires substantially greater capital expenditures, currently expected to be in excess of three times the
cost, as compared to the drilling of a traditional vertical well. If we do not replace the reserves we produce, our reserves revenues and cash
flow will decrease over time, which will have an adverse effect on our business.
Our business requires significant capital expenditures and we may not be able to obtain needed capital or financing on satisfactory
terms or at all. Our exploration and development activities are capital intensive. We make and expect to continue to make substantial
capital expenditures in our business for the development, exploitation, production and acquisition of oil and natural gas reserves.
Historically, we have funded our capital expenditures through a combination of cash flows from operations, borrowings under our credit
facility and public debt and equity financings. In 2013, our total capital expenditures, including expenditures for leasehold interests and
property acquisitions, drilling, seismic and infrastructure, were approximately $171 million. Our 2014 capital budget for drilling,
completion and infrastructure is estimated to be approximately $185 million. The actual amount and timing of our future capital
expenditures may differ materially from our estimates as a result of, among other things, commodity prices, actual drilling results, the
availability of drilling rigs and other services and equipment, and regulatory, technological and competitive developments.
If the borrowing base under our revolving credit facility or our revenues decrease as a result of lower oil or natural gas prices, operating
difficulties, declines in reserves or for any other reason, we may have limited ability to obtain the capital necessary to sustain our operations
at current levels. If additional capital is needed, we may not be able to obtain debt or equity financing on terms favorable to us, or at all. If
cash generated by operations or cash available under our revolving credit facility is not sufficient to meet our capital requirements, the
failure to obtain additional financing could result in a curtailment of our operations relating to development of our drilling locations, which
in turn could lead to a possible expiration of our leases and a decline in our estimated net proved reserves, and could adversely affect our
business, financial condition and results of operations.
Our revolving credit facility and second lien term loan facility contain restrictive covenants that may limit our ability to respond to
changes in market conditions or pursue business opportunities. Our credit facilities restrictive covenants that limit our ability to, among
other things:
additional
additional
•
•
•
incur
indebtedness;
create
liens;
sell
assets;
• merge or consolidate with another
•
•
•
dividends
or make
entity;
pay
distributions;
engage in transactions with affiliates;
and
enter
agreements.
certain
swap
into
other
In addition, we will be required to use substantial portions of our future cash flow to repay principal and interest on our indebtedness. Our
credit facilities require us to maintain certain financial ratios and tests, including a minimum asset value coverage ratio of total debt. The
requirement that we comply with these provisions may materially adversely affect our ability to react to changes
26
Table of Contents
in market conditions, take advantage of business opportunities we believe to be desirable, obtain future financing, fund needed capital
expenditures or withstand a continuing or future downturn in our business.
Our borrowings under our revolving credit facility and second lien term loan facility expose us to interest rate risk. Our earnings are
exposed to interest rate risk associated with borrowings under our revolving credit facility, which bear interest at a rate elected by us that is
based on the prime, LIBOR or federal funds rate plus margins ranging from 0.75% to 2.75% depending on the base rate used and the
amount of the loan outstanding in relation to the borrowing base. Our second lien term loan facility bears interest at a rate of LIBOR plus
7.75%. If interest rates increase, so will our interest costs, which may have a material adverse effect on our results of operations and
financial condition.
The unavailability or high cost of drilling rigs, pressure pumping equipment and crews, other equipment, supplies, water, personnel
and oil field services could adversely affect our ability to execute our exploration and development plans on a timely basis and
within our budget. From time to time, our industry has experiences a shortage of drilling rigs, equipment, supplies, water or qualified
personnel. During these periods, the costs and delivery times of rigs, equipment and supplies are substantially greater. In addition, the
demand for, and wage rates of, qualified drilling rig crews rise as the number of active rigs in service increases. Increasing levels of
exploration and production may increase the demand for oilfield services and equipment, and the costs of these services and equipment may
increase, while the quality of these services and equipment may suffer. The unavailability or high cost of drilling rigs, pressure pumping
equipment, supplies or qualified personnel can materially and adversely affect our operations and profitability.
Our operations substantially depend on the availability of water. Restrictions on our ability to obtain, dispose of or recycle water
may impact our ability to execute our drilling and development plans in a timely or cost-effective manner. Water is an essential
component of our drilling and hydraulic fracturing processes. Historically, we have been able to secure water from local landowners and
other sources for use in our operations. During the last few years, West Texas has experienced extreme drought conditions. As a result of
the severe drought, some local water districts may begin restricting the use of water under their jurisdiction for drilling and hydraulic
fracturing to protect the local water supply. If we are unable to obtain water to use in our operations from local sources, we may be unable to
economically produce oil, NGLs and natural gas, which could have an adverse effect on our business, financial condition and results of
operations.
Our producing properties are located in the Permian Basin of West Texas, making us vulnerable to risks associated with operating
in a single geographic area. In addition, we have a large amount of proved reserves attributable to a small number of producing
horizons within this area. All of our producing properties are geographically concentrated in the Permian Basin of West Texas. As a result
of this concentration, we may be disproportionately exposed to the impact of regional supply and demand factors, delays or interruptions of
production from wells in this area caused by governmental regulation, processing or transportation capacity constraints, availability of
equipment, facilities, personnel or services market limitations or interruption of the processing or transportation of oil, natural gas or natural
gas liquids. In addition, the effect of fluctuations on supply and demand may become more pronounced within specific geographic oil and
natural gas producing areas such as the Permian Basin, which may cause these conditions to occur with greater frequency or magnify the
effects of these conditions. Due to the concentrated nature of our portfolio of properties, a number of our properties could experience any of
the same conditions at the same time, resulting in a relatively greater impact on our results of operations than they might have on other
companies that have a more diversified portfolio of properties. Such delays or interruptions could have a material adverse effect on our
financial condition and results of operations.
Our exploration projects increase the risks inherent in our oil and natural gas activities. We may seek to replace reserves through
exploration, where the risks are greater than in acquisitions and development drilling. During 2012, we purchased 21,419 net acres in the
Northern Midland basin, an area that has seen only limited drilling activity. We expect to continue exploration of this acreage over the next
several years, although our position is subject to meaningful lease expirations through 2015. Our exploration drilling operations may be
curtailed, delayed or canceled as a result of a variety of factors, including:
•
•
the results of our exploration drilling
activities;
receipt of additional seismic data or other geophysical data or the reprocessing of existing
data;
• material changes in oil or natural gas
•
•
•
•
•
prices;
the costs and availability of drilling
rigs;
the success or failure of wells drilled in similar formations or which would use the same production
facilities;
availability and cost of
capital;
changes in the estimates of the costs to drill or complete wells;
and
changes to governmental
regulations.
27
Table of Contents
Delays in exploration, cost overruns or unsuccessful drilling results could have a material adverse effect on our business and future growth.
Our exploration and development drilling efforts and the operation of our wells may not be profitable or achieve our targeted
returns. Exploration, development, drilling and production activities are subject to many risks, including the risk that commercially
productive deposits will not be discovered. We may invest in property, including undeveloped leasehold acreage, which we believe will
result in projects that will add value over time. However, we cannot guarantee that any leasehold acreage acquired will be profitably
developed, that new wells drilled will be productive or that we will recover all or any portion of our investment in such leasehold acreage or
wells. Drilling for oil and natural gas may involve unprofitable efforts, not only from dry wells but also from wells that are productive but do
not produce sufficient net reserves to return a profit after deducting operating and other costs. In addition, wells that are profitable may not
achieve our targeted rate of return.
In addition, we may not be successful in controlling our drilling and production costs to improve our overall return. We may be forced to
limit, delay or cancel drilling operations as a result of a variety of factors, including:
•
•
•
•
or
drilling
irregularities
unexpected
conditions;
pressure
formations;
equipment failures or accidents and shortages or delays in the availability of drilling rigs and the delivery of equipment;
and
compliance
requirements.
governmental
with
in
Failure to conduct our oil and gas operations in a profitable manner may result in write downs of our proved reserves quantities, impairment
of our oil and gas properties, and a write down in the carrying value of our unproved properties, and over time may adversely affect our
growth, revenues and cash flows.
Our identified drilling locations are scheduled to be drilled over many years, making them susceptible to uncertainties that could
prevent them from being drilled or delay their drilling. Our management team has identified drilling locations as an estimation of our
future development activities on our existing acreage. These identified drilling locations represent a significant part of our growth strategy.
Our ability to drill and develop these identified drilling locations depends on a number of uncertainties, including oil and natural gas prices,
the availability and cost of capital, drilling and production costs, availability of drilling services and equipment, drilling results, lease
expirations, gathering system, marketing and transportation constraints, regulatory approvals and other factors. Because of these uncertain
factors, we do not know if the identified drilling locations will ever be drilled or if we will be able to produce oil or natural gas from these
drilling locations. In addition, unless production is established within the spacing units covering the undeveloped acres on which some of
the identified locations are located, the leases for such acreage will expire. Therefore, our actual drilling activities may materially differ
from those presently identified.
We may be unable to integrate successfully the operations of future acquisitions with our operations, and we may not realize all the
anticipated benefits of these acquisitions. Our business may include producing property acquisitions that would include undeveloped
acreage. We can offer no assurance that we will achieve the desired profitability from any acquisitions we may complete in the future. In
addition, failure to assimilate recent and future acquisitions successfully could adversely affect our financial condition and results of
operations. Our acquisitions may involve numerous risks, including:
•
•
•
•
•
•
•
•
•
larger combined organization and adding
operating a
operations;
difficulties in the assimilation of the assets and operations of the acquired business, especially if the assets acquired are in a new
geographic area;
risk that oil and natural gas reserves acquired may not be of the anticipated magnitude or may not be developed as
anticipated;
loss of significant key employees from the acquired
business:
diversion of management’s attention from other business
concerns;
failure
growth;
failure to realize expected synergies and cost
savings;
coordinating geographically disparate organizations, systems and facilities;
and
coordinating or consolidating corporate and administrative
functions.
to realize expected profitability or
Further, unexpected costs and challenges may arise whenever businesses with different operations or management are combined, and we
may experience unanticipated delays in realizing the benefits of an acquisition. If we consummate any future acquisition, our capitalization
and results of operation may change significantly, and you may not have the opportunity to evaluate the economic, financial and other
relevant information that we will consider in evaluating future acquisitions. The inability to effectively manage the integration of
acquisitions could reduce our focus on subsequent acquisition and current operations, which in turn, could negatively impact our results of
operations.
28
Table of Contents
We may fail to fully identify problems with any properties we acquire, and as such, assets we acquire may prove to be worth less
than we paid because of uncertainties in evaluating recoverable reserves and potential liabilities. We are actively seeking to acquire
additional acreage in Texas or other regions in the future. Successful acquisitions require an assessment of a number of factors, including
estimates of recoverable reserves, exploration potential, future oil and natural gas prices, operating and capital costs and potential
environmental and other liabilities. Although we conduct a review of properties we acquire which we believe is consistent with industry
practices, we can give no assurance that we have identified or will identify all existing or potential problems associated with such properties
or that we will be able to mitigate any problems we do identify. Such assessments are inexact and their accuracy is inherently uncertain. In
addition, our review may not permit us to become sufficiently familiar with the properties to fully assess their deficiencies and capabilities.
We do not inspect every well. Even when we inspect a well, we do not always discover structural, subsurface and environmental problems
that may exist or arise. We are generally not entitled to contractual indemnification for preclosing liabilities, including environmental
liabilities. Normally, we acquire interests in properties on an “as is” basis with limited remedies for breaches of representations and
warranties. As a result of these factors, we may not be able to acquire oil and natural gas properties that contain economically recoverable
reserves or be able to complete such acquisitions on acceptable terms.
Unexpected subsurface conditions and other unforeseen operating hazards may adversely impact our ability to conduct business.
There are many operating hazards in exploring for and producing oil and natural gas, including:
•
•
•
•
our drilling operations may encounter unexpected formations or pressures, which could cause damage to equipment or personal
injury;
we may experience equipment failures which curtail or stop
production;
we could experience blowouts or other damages to the productive formations that may require a well to be re-drilled or other
corrective action to be taken;
storms and other extreme weather conditions could cause damages to our production facilities or
wells.
Because of these or other events, we could experience environmental hazards, including release of oil and natural gas from spills, natural
gas-leaks, accidental leakage of toxic or hazardous materials, such as petroleum liquids, drilling fluids or fracturing fluids, including
chemical additives, underground migration, and ruptures.
If we experience any of these problems, it could affect well bores, gathering systems and processing facilities, which could adversely affect
our ability to conduct operations. We could also incur substantial losses in excess of our insurance coverage as a result of:
•
•
•
•
•
•
•
loss of
injury or
life;
severe damage to and destruction of property, natural resources and
equipment;
pollution and other environmental
damage;
clean-up
responsibilities;
regulatory investigation and
penalties;
suspension of our operations;
and
repairs to resume
operations.
We cannot assure you that we will be able to maintain adequate insurance at rates we consider reasonable to cover our possible losses from
operating hazards. The occurrence of a significant event not fully insured or indemnified against could materially and adversely affect our
financial condition and results of operations.
Factors beyond our control affect our ability to market production and our financial results. The ability to market oil and natural gas
from our wells depends upon numerous factors beyond our control. These factors could negatively affect our ability to market all of the oil
or natural gas we produce. In addition, we may be unable to obtain favorable prices for the oil and natural gas we produce. These factors
include:
•
•
•
•
•
•
•
of
pipeline
availability
the extent of domestic production and imports of oil and natural
gas;
the proximity of the natural gas production to natural gas and NGL
pipelines;
the
capacity;
the demand for oil and natural gas by utilities and other end
users;
the availability of alternative
sources;
the
weather;
state and federal regulation of oil and natural gas marketing;
inclement
effects
fuel
of
and
•
federal regulation of natural gas sold or transported in interstate
commerce.
29
Table of Contents
In particular, in areas with increasing non-conventional shale drilling activity, capacity may be limited and it may be necessary for new
interstate and intrastate pipelines and gathering systems to be built.
Part of our strategy involves drilling in new or emerging shale formations using horizontal drilling and completion techniques. The
results of our planned drilling program in these formations may be subject to more uncertainties than conventional drilling
programs in more established formations and may not meet our expectations for reserves or production. The results of our recent
horizontal drilling efforts in new or emerging formations, including the Wolfcamp shale, Cline shale, and Mississippian lime in the Permian
basin, are generally more uncertain than drilling results in areas that are developed and have established production. Because new or
emerging formations have limited or no production history, we are less able to rely on past drilling results in those areas as a basis predict
our future drilling results. Further, access to adequate gathering systems or pipeline takeaway capacity and the availability of drilling rigs
and other services may be more challenging in new or emerging areas. If our drilling results are less than anticipated or we are unable to
execute our drilling program because of capital constraints, access to gathering systems and takeaway capacity or otherwise, and/or natural
gas and oil prices decline, our investment in these areas may not be as economic as we anticipate, we could incur material writedowns of
unevaluated properties and the value of our undeveloped acreage could decline in the future.
The loss of key personnel could adversely affect our ability to operate. We depend, and will continue to depend in the foreseeable
future, on the services of our senior officers and other key employees, as well as other third-party consultants with extensive experience and
expertise in evaluating and analyzing drilling prospects and producing oil and natural gas from proved properties and maximizing production
from oil and natural gas properties. Our ability to retain our senior officers, other key employees and our third party consultants, none of
whom are subject to employment agreements, is important to our future success and growth. The unexpected loss of the services of one or
more of these individuals could have a detrimental effect on our business.
We may not be insured against all of the operating risks to which our business is exposed. In accordance with industry practice, we
maintain insurance against some, but not all, of the operating risks to which our business is exposed. We cannot assure you that our
insurance will be adequate to cover losses or liabilities. Also, we cannot predict the continued availability of insurance at premium levels
that justify its purchase. No assurance can be given that we will be able to maintain insurance in the future at rates we consider reasonable
and may elect none or minimal insurance coverage. The occurrence of a significant event, not fully insured or indemnified against, could
have a material adverse effect on our financial condition and operations.
Competitive industry conditions may negatively affect our ability to conduct operations. We compete with numerous other companies
in virtually all facets of our business. Our competitors in development, exploration, acquisitions and production include major integrated oil
and gas companies and smaller independents as well as numerous financial buyers, including many that have significantly greater resources.
Therefore, competitors may be able to pay more for desirable leases and evaluate, bid for and purchase a greater number of properties or
prospects than our financial or personnel resources permit. We also compete for the materials, equipment and services that are necessary for
the exploration, development and operation of our properties. Our ability to increase reserves in the future will be dependent on our ability
to select and acquire suitable prospects for future exploration and development. Factors that affect our ability to compete in the marketplace
include:
•
•
•
•
•
our access to the capital necessary to drill wells and acquire
properties;
our ability to acquire and analyze seismic, geological and other information relating to a
property;
our ability to retain the personnel necessary to properly evaluate seismic and other information relating to a
property;
our ability to procure materials, equipment and services required to explore, develop and operate our properties, including the
ability to procure fracture stimulation services on wells drilled; and
our ability to access pipelines, and the location of facilities used to produce and transport oil and natural gas
production.
Current or proposed financial legislation and rulemaking could have an adverse effect on our ability to use derivative instruments
to reduce the effect of commodity price, interest rate and other risks associated with our business.
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”) establishes federal oversight and regulation of
over-the-counter derivatives and requires the Commodity Futures Trading Commission (the “CFTC”) and the SEC to enact further
regulations affecting derivative contracts, including the derivative contracts we use to hedge our exposure to price volatility through the
over-the-counter market.
In its rulemaking under the new legislation, the CFTC has issued a final rule on position limits for certain futures and option contracts in the
major energy markets and for swaps that are their economic equivalents (with exemptions for certain bona fide hedging transactions); the
CFTC’s final rule was set aside by the U.S. District Court for the District of Columbia on September 28, 2012 and remanded to the CFTC to
resolve ambiguity as to whether statutory requirements for such limits to be determined
30
Table of Contents
necessary and appropriate were satisfied. The CFTC appealed this ruling but subsequently withdrew its appeal. On November 5, 2013, the
CFTC approved a Notice of Proposed Rulemaking designed to implement new position limits regulation. The impact of such regulations
upon our business is not yet clear. Certain of our hedging and trading activities and those of our counterparties may be subject to the
position limits, which may reduce our ability to enter into hedging transactions.
The Act provides a limited exception to end users (such as us) from the requirement to use cleared exchanges, rather than hedging over-the-
counter and authorizes the CFTC to set requirements to post margin in connection with hedging activities. While it is not possible at this
time to predict when the CFTC will finalize certain other related rules and regulations, the Act and related regulations may require us to
comply with margin requirements and with certain clearing and trade-execution requirements in connection with our derivative activities,
although whether these requirements will apply to our business is uncertain at this time. If the regulations ultimately adopted require that
we post margin for our hedging activities or require our counterparties to hold margin or maintain capital levels, the cost of which could be
passed through to us, or impose other requirements that are more burdensome than current regulations, hedging transactions in the future
would become more expensive than we experienced in the past.
We may not have production to offset hedges. Part of our business strategy is to reduce our exposure to the volatility of oil and natural
gas prices by hedging a portion of our production. In a typical hedge transaction, we will have the right to receive from the other parties to
the hedge the excess of the fixed price specified in the hedge over a floating price based on a market index, multiplied by the quantity
hedged. If the floating price exceeds the fixed price, we are required to pay the other parties this difference multiplied by the quantity
hedged. Additionally, we are required to pay the difference between the floating price and the fixed price when the floating price exceeds
the fixed price regardless of whether we have sufficient production to cover the quantities specified in the hedge. Significant reductions in
production at times when the floating price exceeds the fixed price could require us to make payments under the hedge agreements even
though such payments are not offset by sales of production.
By hedging, we may not benefit from price increases. Hedging can prevent us from receiving the full advantage of increases in oil or
natural gas prices above the fixed amount specified in a hedge transaction in the case of a swap. We also enter into price “collars” to reduce
the risk of changes in oil and natural gas prices. Under a collar, no payments are due by either party so long as the market price is above a
floor set in the collar and below a ceiling. If the price falls below the floor, the counter-party to the collar pays the difference to us and if the
price is above the ceiling, we pay the counter-party the difference. Another type of hedging contract we have entered into is a put contract.
Under a put, if the price falls below the set floor price, the counter-party to the contract pays the difference to us. See “Quantitative and
Qualitative Disclosures About Market Risks” for a discussion of our hedging practices.
Our hedging transactions expose us to counterparty credit risk. Our hedging transactions expose us to risk of financial loss if a
counterparty fails to perform under a derivative contract. Disruptions in the financial markets could lead to sudden decreases in a
counterparty’s liquidity, which could make them unable to perform under the terms of the derivative contract and we may not be able to
realize the benefit of the derivative contract.
The inability of one or more of our customers to meet their obligations to us may adversely affect our financial results . Our principal
exposures to credit risk are through receivables resulting from the sale of our oil and natural gas production, which we market to energy
marketing companies, refineries and affiliates, advances to joint interest parties and joint interest receivables. We are also subject to credit
risk due to the concentration of our oil and natural gas receivables with several significant customers. The largest purchaser of our oil and
natural gas accounted for approximately 38% of our total oil and natural gas revenues for the year ended December 31, 2013. We do not
require any of our customers to post collateral. The inability or failure of our significant customers to meet their obligations to us or their
insolvency or liquidation may adversely affect our financial results. Joint interest receivables arise from billing entities who own a partial
interest in the wells we operate. These entities participate in our wells primarily based on their ownership in leases on which we choose to
drill. We have limited ability to control participation in our wells.
Compliance with environmental and other government regulations could be costly and could negatively impact production. Our
operations are subject to numerous laws and regulations governing the operation and maintenance of our facilities and the discharge of
materials into the environment or otherwise relating to environmental protection. For a discussion of the material regulations applicable to
us, see “Regulations.” These laws and regulations may:
•
•
•
•
require that we acquire permits before commencing
drilling;
impose operational, emissions control and other conditions on our
activities;
restrict the substances that can be released into the environment in connection with drilling and production
activities;
limit or prohibit drilling activities on protected areas such as wetlands and wilderness areas;
and
31
Table of Contents
•
require measures to remediate or mitigate pollution and environmental impacts from current and former operations, such as
cleaning up spills or dismantling abandoned production facilities.
Under these laws and regulations, we could be liable for costs of investigation, removal and remediation, damages to and loss of use of
natural resources, loss of profits or impairment of earning capacity, property damages, costs of and increased public services, as well as
administrative, civil and criminal fines and penalties, and injunctive relief. We could also be affected by more stringent laws and regulations
adopted in the future, including any related climate change, greenhouse gases and hydraulic fracturing. Under the common law, we could be
liable for injuries to people and property. We maintain limited insurance coverage for sudden and accidental environmental damages. We do
not believe that insurance coverage for environmental damages that occur over time is available at a reasonable cost. Also, we do not believe
that insurance coverage for the full potential liability that could be caused by sudden and accidental environmental damages is available at a
reasonable cost. Accordingly, we may be subject to liability or we may be required to cease production from properties in the event of
environmental incidents.
Climate change legislation or regulations restricting emissions of “greenhouse gasses” could result in increased operating costs and
reduced demand for the oil and natural gas we produce. The EPA has adopted its so-called “GHG tailoring rule” that phases in federal
PSD permit requirements for GHG emissions from new sources and modification of existing sources, federal Title V operating permit
requirements for all sources, based upon their potential to emit specific quantities of GHGs. These permitting provisions to the extent
applicable to our operations could require us to implement emission controls or other measures to reduce GHG emissions and we could
incur additional costs to satisfy those requirements.
In addition, , the EPA requires the reporting of GHG emissions from specified large GHG emission sources in the United States beginning
in 2011 for emissions occurring in 2010. In November 2010, the EPA published its amendments to the GHG reporting rule to include
onshore and offshore oil and natural gas production facilities and onshore oil and natural gas processing, transmission, storage and
distribution facilities, which may include facilities we operate. Reporting of GHG emissions from such facilities is required on an annual
basis, beginning in 2012 for emissions occurring in 2011, if the total emissions within a basin exceed 25,000 metric tons CO2 equivalent per
year. We will incur costs associated with this monitoring obligation and potentially additional reporting costs if production growth triggers
the emission threshold.
In addition, the United States Congress has considered legislation to reduce emissions of GHGs and many states have already taken or have
considered legal measures to reduce or measure GHG emissions, often involving the planned development of GHG emission inventories
and/or cap and trade programs. Most of these cap and trade programs would require major sources of emissions or major producers of fuels
to acquire and surrender emission allowances. The number of allowances available for purchase is reduced each year in an effort to achieve
the overall GHG emission reduction goal. These allowances would be expected to escalate significantly in cost over time. The adoption and
implementation of any legislation or regulatory programs imposing GHG reporting obligations on, or limiting emissions of GHGs from, our
equipment and operations could require us to incur costs to reduce emissions of GHGS associated with our operations or could adversely
affect demand for the oil and natural gas that we produce.
Significant physical effects of climatic change have the potential to damage our facilities, disrupt our production activities and cause
us to incur significant costs in preparing for or responding to those effects. In an interpretative guidance on climate change disclosures,
the SEC indicates that climate change could have an effect on the severity of weather (including storms and floods), the arability of
farmland, and water availability and quality. If such effects were to occur, our exploration and production operations have the potential to be
adversely affected. Potential adverse effects could include damages to our facilities from powerful winds or rising waters in low-lying areas,
disruption of our production activities either because of climate-related damages to our facilities in our costs of operation potentially arising
from such climatic effects, less efficient or non-routine operating practices necessitated by climate effects or increased costs for insurance
coverages in the aftermath of such effects. Significant physical effects of climate change could also have an indirect affect on our financing
and operations by disrupting the transportation or process-related services provided by midstream companies, service companies or
suppliers with whom we have a business relationship. We may not be able to recover through insurance some or any of the damages, losses
or costs that may result from potential physical effects of climate change. In addition, our hydraulic fracturing operations require large
amounts of water. Should drought conditions occur, our ability to obtain water in sufficient quality and quantity could be impacted and in
turn, our ability to perform hydraulic fracturing operations could be restricted or made more costly.
Federal legislation and state legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and
additional operating restrictions or delays. Hydraulic fracturing is used to stimulate production of hydrocarbons, particularly natural gas,
from tight formations. The process involves the injection of water, sand and chemicals under pressure into formations to fracture the
surrounding rock and stimulate production. The process is typically regulated by state oil and gas commissions but is not subject to
regulation at the federal level (except for fracturing activity involving the use of diesel). We engage third parties to provide hydraulic
fracturing or other well stimulation services to us in connection with the wells for which we are the operator. Contamination of groundwater
by oil and natural gas drilling, production, and related operations may result
32
Table of Contents
in fines, penalties, and remediation costs, among other sanctions and liabilities under federal and state laws. In addition, third party claims
may be filed by landowners and other parties claiming damages for alternative water supplies, property damages, and bodily injury. In
March 2010, the EPA announced that it would conduct a wide-ranging study on the effects of hydraulic fracturing on drinking water
resources. A progress report was issued in December 2012, with final results expected in 2014. The agency also announced that one of its
enforcement initiatives for 2011 to 2013 would be to focus on environmental compliance by the energy extraction sector. This study and
enforcement initiative, could result in additional regulatory scrutiny that could make it difficult to perform hydraulic fracturing and increase
our costs of compliance and doing business.
A committee of the U.S. House of Representatives conducted an investigation of hydraulic fracturing practices. Legislation was introduced
before Congress, but not passed to provide for federal regulation of hydraulic fracturing and to require disclosure of the chemicals used in
the fracturing process. In addition, some states and local or regional regulatory authorities have adopted or are considering adopting,
regulations that could restrict hydraulic fracturing in certain circumstances. For example, New York has imposed a de facto moratorium on
the issuance of permits for high-volume, horizontal hydraulic fracturing until state-administered environmental studies are finalized.
Further, Pennsylvania has adopted a variety of regulations limiting how and where fracturing can be performed. While we have no
operations in either New York or Pennsylvania, any other new laws or regulations that significantly restrict hydraulic fracturing in areas in
which we do operate could make it more difficult or costly for us to perform hydraulic fracturing activities and thereby affect the
determination of whether a well is commercially viable. Further, EPA has announced initiatives under the CWA to establish standards of
wastewater from hydraulic fracturing and under TSCA to develop regulations governing the disclosure and evaluation of hydraulic
fracturing chemicals, and the BLM has indicated that it will continue with rulemaking to regulate hydraulic fracturing on federal lands. In
addition, if hydraulic fracturing is regulated at the federal level, our fracturing activities could become subject to additional permit
requirements or operational restrictions and also to associated permitting delays and potential increases in costs. Such federal or state
legislation could require the disclosure of chemical constituents used in the fracturing process to state or federal regulatory authorities who
could then make such information publicly available. In addition, restrictions on hydraulic fracturing could reduce the amount of oil and
natural gas that we are ultimately able to produce in commercial quantities.
Certain U.S. federal income tax preferences currently available with respect to oil and natural gas production may be eliminated as
a result of future legislation. In recent years, the Obama administration’s budget proposals and other proposed legislation have included
the elimination of certain key U.S. federal income tax incentives currently available to oil and gas exploration and production. If enacted
into law, these proposals would eliminate certain tax preferences applicable to taxpayers engaged in the exploration or production of natural
resources. These changes include, but are not limited to (1) the repeal of the percentage depletion allowance for oil and gas properties, (2)
the elimination of current deductions for intangible drilling and development costs, (3) the elimination of the deduction for U.S. production
activities and (4) the increase in the amortization period from two years to seven years for geophysical costs paid or incurred in connection
with the exploration for or development of, oil and gas within the United States. It is unclear whether any such changes will be enacted or
how soon any such changes would become effective. The passage of any legislation as a result of these proposals or any other similar
changes in U.S. federal income tax laws could negatively affect the Company’s financial condition and results of operations.
There are inherent limitations in all control systems, and misstatements due to error or fraud that could seriously harm our
business may occur and not be detected. Our management, including our Chief Executive Officer and Chief Financial Officer, do not
expect that our internal controls and disclosure controls will prevent all possible error and all fraud. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. In addition,
the design of a control system must reflect the fact that there are resource constraints and the benefit of controls must be relative to their
costs. Because of the inherent limitations in all control systems, an evaluation of controls can only provide reasonable assurance that all
material control issues and instances of fraud, if any, in our company have been detected. These inherent limitations include the realities that
judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Further, controls can be
circumvented by the individual acts of some persons or by collusion of two or more persons. The design of any system of controls is based
in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions. Because of inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected. A failure of our controls and procedures to detect error or fraud could
seriously harm our business and results of operations.
We have no plans to pay cash dividends on our common stock in the foreseeable future. We have no plans to pay cash dividends in the
foreseeable future. Any future determination as to the declaration and payment of cash dividends will be at the discretion of our board of
directors and will depend upon our financial condition, results of operations, contractual restrictions, capital requirements, business
prospects and other factors deemed relevant by our board of directors. In addition, the terms of our credit facilities prohibit us from paying
dividends and making other distributions.
33
Table of Contents
Cyber-attacks targeting systems and infrastructure used by the oil and gas industry may adversely impact our operations. Our
business has become increasingly dependent on digital technologies to conduct certain exploration, development, production and financial
activities. We depend on digital technology to estimate quantities of oil and gas reserves, process and record financial and operating data,
analyze seismic and drilling information, and communicate with our employees and third party partners. Unauthorized access to our seismic
data, reserves information or other proprietary information could lead to data corruption, communication interruption, or other operational
disruptions in our exploration or production operations. Also, computers control nearly all of the oil and gas distribution systems in the
United States and abroad, which are necessary to transport our production to market. A cyber-attack directed at oil and gas distribution
systems could damage critical distribution and storage assets or the environment, delay or prevent delivery of production to markets and
make it difficult or impossible to accurately account for production and settle transactions.
While we have not experienced cyber-attacks, there is no assurance that we will not suffer such attacks and resulting losses in the future.
Further, as cyber-attacks continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance
our protective measures or to investigate and remediate any vulnerability to cyber-attacks.
ITEM 1B. Unresolved Staff Comments
None.
ITEM 3. Legal Proceedings
We are a defendant in various legal proceedings and claims, which arise in the ordinary course of our business. We do not believe the
ultimate resolution of any such actions will have a material effect on our financial position or results of operations.
ITEM 4. Mine Safety Disclosures
Not applicable.
34
PART II.
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock trades on the New York Stock Exchange under the symbol “CPE”. The following table sets forth the high and low sale
prices per share as reported for the periods indicated.
First quarter
Second quarter
Third quarter
Fourth quarter
Holders
Stock Price
2013
2012
High
Low
High
Low
$
5.82 $
4.00
5.49
7.60
3.62 $
3.19
3.40
5.18
7.95 $
6.45
6.55
6.36
5.09
3.80
4.11
4.05
As of March 10, 2014 the Company had approximately 3,111 common stockholders of record.
Dividends
We have not paid any cash dividends on our common stock to date and presently do not expect to declare or pay any cash dividends on our
common stock in the foreseeable future as we intend to reinvest our cash flows and earnings into our business. The declaration and payment
of dividends is subject to the discretion of our Board of Directors and to certain limitations imposed under Delaware corporate law and the
agreements governing our debt obligations. The timing, amount and form of dividends, if any, will depend on, among other things, our
results of operations, financial condition, cash requirements and other factors deemed relevant by our Board of Directors.
Holders of our Series A preferred stock are entitled to a cumulative dividend whether or not declared, of $5.00 per annum, payable
quarterly, equivalent to 10% of the liquidation preference of $50.00 per share. Unless the full amount of the dividends for the Series A
Preferred Stock is paid in full, we cannot declare or pay any dividend on our common stock. In addition, certain of our debt facilities contain
restrictions on the payment of dividends to the holders of our common stock.
During the fourth quarter of 2013, neither the Company nor any affiliated purchasers made repurchases of Callon’s equity securities.
Equity Compensation Plan Information
The following table summarizes information regarding the number of shares of our common stock that are available for issuance under all
of our existing equity compensation plans as of December 31, 2013 (securities amounts are presented in thousands).
Plan Category
Equity compensation plans approved by security holders
Equity compensation plans not approved by security holders
Total
Outstanding Options
Number of
securities to be
issued upon
exercise of
outstanding
options
Weighted-average
exercise price of
outstanding
options
Number of securities
remaining available for
future issuance under
equity compensation
plans
37 $
15
52
13.51
14.37
13.75
1,192
—
1,192
For additional information regarding the Company’s benefit plans and share-based compensation expense, see Notes 7 and 8 to the
Consolidated Financial Statements.
35
Performance Graph
The following stock price performance graph is intended to allow review of stockholder returns, expressed in terms of the performance of
the Company’s common stock relative to four broad-based stock performance indices. The information is included for historical
comparative purposes only and should not be considered indicative of future stock performance.
Consistent with the Company’s prior year performance graph, the graph below compares the yearly percentage change in the cumulative
total stockholder return on the Company’s common stock with the cumulative total return of the New York Stock Exchange Market Index
and New York Stock Exchange Market Index from December 31, 2008, through December 31, 2013. The Company plans to replace these
indexes with S&P 500 Index and the SIG Oil Exploration & Production Index, which is believes provides a more meaningful comparison
and is reflective of the indexes more commonly used by the Company’s peer group. Consequently, these indexes have also been added to
the graph below, and we expect will be used in future year’s performance graphs.
The stock performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall
information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as
amended, except to the extent that the Company specifically incorporates it by reference into such filing.
Comparison of Five Year Cumulative Total Return
Assumes Initial Investment of $100
December 2013
Company/Market/Peer Group
Callon Petroleum Company
S&P 500 Index - Total Returns
NYSE Composite Index
SIG Oil Exploration & Production Index
Morningstar Group Index
$
2008
100.00 $
100.00
100.00
100.00
100.00
2009
57.69 $
126.46
128.95
161.62
185.22
2010
227.69 $
145.51
146.69
198.98
194.51
2011
191.15 $
148.59
141.46
180.95
167.95
2012
180.77 $
172.37
164.45
168.41
189.60
2013
251.15
228.19
207.85
213.16
216.25
For the Year Ended December 31,
36
ITEM 6. Selected Financial Data
The following table sets forth, as of the dates and for the periods indicated, selected financial information about us. The financial
information for each of the five years in the period ended December 31, 2013 has been derived from our audited Consolidated Financial
Statements for such periods. The information should be read in conjunction with “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and the Consolidated Financial Statements and Notes thereto. The following information is not
necessarily indicative of our future results.
Statement of Operations Data:
Operating revenues:
Oil and natural gas sales
Medusa BOEM royalty recoupment (a)
Total operating revenues
Total operating expenses
Income (loss) from continuing operations
Net income (loss) (b)
Earnings (loss) per share ("EPS"):
Basic
Diluted
Weighted average number of shares outstanding for Basic EPS
Weighted average number of shares outstanding for Diluted EPS
Statement of Cash Flows Data:
Net cash provided by operating activities
Net cash used in investing activities
Net cash provided by (used in) financing activities
Balance Sheet Data:
Oil and gas properties, net
Total assets
Long-term debt (c)
Stockholders' equity (deficit)
Proved Reserves Data:
Total oil (MMBbls)
Total natural gas (MMcf)
Total proved reserves (MBOE)
Standardized measure (d)
$
$
$
$
$
$
$
$
For the year ended December 31,
2013
2012
2011
2010
2009
(In thousands, except per share amounts)
102,569 $
110,733 $ 127,644 $
—
—
—
102,569 $
91,905 $
10,664
4,304
110,733 $ 127,644 $
88,022 $
100,043 $
39,622
10,690
106,396
2,747
—
89,882 $ 101,259
40,886
89,882 $ 142,145
68,692 $
68,692
21,179
73,453
8,386
46,796
(0.01 ) $
(0.01 ) $
40,133
40,133
0.07 $
0.07 $
2.81 $
2.76 $
0.29 $
0.28 $
39,522
40,337
37,908
38,582
28,817
29,476
2.12
2.11
22,072
22,200
54,329 $
(79,804 )
27,348
51,290 $
(93,703 )
(243)
79,167 $ 100,102 $
(91,511 )
38,703
(59,738 )
(26,252 )
19,698
(43,189 )
10,000
324,187 $
423,953
75,748
279,094
11,898
17,751
14,857
283,946 $
269,521 $ 215,912 $ 168,868 $ 130,608
378,173
227,991
120,668
179,174
205,971
(80,854 )
218,326
165,504
15,810
369,707
125,345
201,202
10,780
6,479
19,753
19,103
14,072
9,663
231,148 $ 270,357 $ 198,916 $ 135,921
8,149
32,957
13,641
10,075
35,118
15,928
(a) Following the decisions resulting from several court cases brought by another oil and gas company, the court ruled that the BOEM was not
entitled to receive these royalty payments. The amount above reflects royalty recoupments for production from the fields 2003 inception
through December 31, 2008, which were accrued at December 31, 2009 and paid by the BOEM during 2010.
(b) Net income for 2011 includes $69.3 million of income tax benefit related to the reversal of the Company’s deferred tax asset valuation
allowance. See Note 10 for additional information.
(c) 2013 and 2012 long-term debt includes a non-cash deferred credit of $5,267 and $13,707, respectively that will be amortized into
earnings as a reduction to interest expense over the life of the 13% Senior Notes due 2016. See Note 4 for additional information.
(d) Standardized measure is the future net cash flows related to estimated proved oil and natural gas reserves together with changes therein,
including a reduction for estimated plugging and abandonment costs that are also reflected as a liability on the balance sheet. Prices are
based on either the preceding 12-months’ average price, based on closing prices on the first day of each month, or prices defined by
existing contractual arrangements. Future production and development costs are based on current estimates with no escalations. Estimated
future cash flows have been discounted to their present values based on a 10% discount rate.
37
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
The following management’s discussion and analysis is intended to assist in understanding 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 audited consolidated financial statements, information about our business practices, significant accounting policies, risk
factors, and the transactions that underlie our financial results, which are included in various parts of this filing.
We have been engaged in the exploration, development, acquisition and production of oil and natural gas properties since 1950.
Significant accomplishments for 2013 include:
•
•
•
•
Increased 2013 Permian Basin annual production by 38% to 813 MBOE as compared to
2012;
Exceeded our “exit rate” target production rate for 2013, producing 3,611 BOE/d from our Permian operations in the month of
December;
Increased 2013 Permian Basin proved reserves by 58% to 14.9 MMBOE as compared to
2012;
Replaced 708% of Permian production with net Permian proved reserve additions, net of
revisions;
• Drilled a total of 17 horizontal wells in the Southern Midland Basin, producing from two established zones in the Wolfcamp B
and the Wolfcamp A;
• Acquired our Garrison Draw field inclusive of 2,186 net acres and associated production in Reagan County for $11 million,
which further added to our inventory of horizontal well locations. Subsequently, we expanded this acreage position to
accommodate the drilling of long laterals;
• Accelerated offshore cash flows for onshore redeployment with the sale of our interest in the Medusa and our remaining shelf
•
•
•
fields for $100 million before customary purchase price adjustments, and
Raised $70.0 million from the issuance of Series A Cumulative Preferred
Stock,
Retired 50% of our Senior Notes, improving our cost of capital,
and
Received the Midland Bruno Hanson/Midland College Award for Environmental Excellence recognizing our commitment to
strong environmental stewardship in the Permian Basin.
Permian Production Growth and Well Counts
Following the sale of our remaining offshore and Haynesville properties in the fourth quarter of 2013, all of our producing properties are
located in the Permian Basin. Our production in the Permian grew 38% in 2013 compared to 2012, increasing to 813 MBOE from 591
MBOE, respectively. Production in 2013 continued to benefit from high oil concentrations including 64% oil and 36% natural gas, which we
anticipate to further increase following the sale of our offshore assets.
38
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
Onshore:
Southern Midland Basin
Central Midland Basin
Northern Midland Basin
Total Permian
Offshore:
Medusa
Habanero
Total offshore
Other:
Haynesville shale
Gulf of Mexico shelf and other
Total other
Total
Net Production (MBOE)
Twelve Months Ended December 31,
2013
2012
Change
% Change
612
193
8
813
302
—
302
18
280
298
402
189
—
591
464
134
598
46
340
386
210
4
8
222
(162)
(134)
(296)
(28)
(60)
(88)
52 %
2 %
100 %
38 %
(35)%
(100)%
(49)%
(61)%
(18)%
(23)%
1,413
1,575
(162)
(10)%
On average, we operated 1.4 horizontal rigs and one vertical rig in 2013, and drilled a total of 26 gross (22.2 net) wells, of which 1 gross (0.4
net) well was recompleted during the year and 5 gross (4.7 net) were awaiting completion at December 31, 2013.
Drilled
Completed (a)
Gross
Net
Gross
Net
Awaiting Completion
Gross
Net
Southern Midland Basin
Vertical wells
Horizontal wells
Total
Central Midland Basin
Vertical wells
Horizontal wells
Total
Northern Midland Basin
Vertical wells
Horizontal wells
Total
Total
Total vertical wells
Total horizontal wells
Total
(a) Completions include wells drilled prior to 2013.
Permian Reserve Growth
1
17
18
5
2
7
1
—
1
26
7
19
26
1.0
15.5
16.5
3.0
1.7
4.7
1.0
—
1.0
22.2
5.0
17.2
22.2
1
15
16
7
—
7
2
1
3
26
10
16
26
1.0
13.5
14.5
4.4
—
4.4
1.8
0.8
2.5
21.4
7.1
14.3
21.4
—
3
3
—
2
2
—
—
—
5
—
5
5
—
3.0
3.0
—
1.7
1.7
—
—
—
4.7
—
4.7
4.7
As of December 31, 2013, our estimated Permian proved reserves increased 58% to 14.9 MMBOE compared to 9.4 MMBOE of Permian
proved reserves at year-end 2012. In total, proved reserves increased 6%, or 0.8 MMBOE, to 14.9 MMBOE from 14.1 MMBOE for as of the
same date in 2012 as our significant growth in Permian proved reserves was largely offset by the sale of our offshore and Haynesville
properties and by the reclassification of previously recorded Permian vertical development proved undeveloped reserves as we focus on
horizontal development. Our Permian Basin proved reserves at year-end 2013 were 80% oil and 20% natural gas, compared to 76% oil and
24% natural gas at year-end 2012.
39
Callon Petroleum
Company
2013 Preferred Equity Offering
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
On May 30, 2013, the Company issued $75.0 million of 10.0% Series A Cumulative Preferred Stock (the “Preferred Stock”) and received
$70.0 million net proceeds after deducting the underwriting commissions and offering expenses. We used the proceeds of this equity
offering to repay outstanding borrowings under our revolving Credit Facility, to fund accelerated capital expenditures to further develop and
evaluate our Permian asset base, and for general corporate purposes.
Liquidity and Capital Resources
Historically, our primary sources of capital have been cash flows from operations, borrowings from financial institutions and the sale of
debt and equity securities. Our primary uses of capital have been for the acquisition, development and exploration of oil and natural gas
properties. Cash and cash equivalents increased $1.9 million during 2013 to $3.0 million compared to $1.1 million at December 31,
2012. We recently entered into the Amended Credit Facility and Second Lien Facility to support the funding of our ongoing operations . For
additional information, see Note 4 to the Consolidated Financial Statements. We believe that, as discussed below, our operating cash flows
combined with our bank borrowing ability provides the liquidity necessary to meet our operational cash flow needs.
Liquidity and cash flow:
Net cash provided by operating activities
Net cash used in investing activities
Net cash provided by (used in) financing activities
Net change in cash
For the Year Ended December 31,
2011
2012
2013
54.3
(79.8)
27.3
1.8
51.3
(93.7)
(0.3)
(42.7)
79.2
(91.5)
38.7
26.4
Operating Activities. For the year ended December 31, 2013, net cash provided by operating activities was $54.3 million, compared to
$51.3 million for the same period in 2012. The increase was related primarily to a 15% decrease in lease operating expenses coupled with a
3% increase in the average sales price on an equivalent basis partially offset by lower revenues as oil and natural gas production decreased
7% and 16%, respectively. Production and realized prices are discussed below in Results of Operations.
Investing Activities. For the year ended December 31, 2013, net cash used in investing activities was $79.8 million as compared to $93.7
million for the same period in 2012. The net $13.9 million decrease in cash used in investing activities is primarily attributable to a $50.1
million increase in proceeds from the sale of mineral interests and equipment offset by a 26.4 million increase in capital expenditures related
to development activity on our Permian basin acreage and $10.9 million for producing property acquisitions. The $50.1 million increase in
the previously mentioned proceeds relates to the proceeds in 2013 of $90.0 million, primarily attributable to the sale of our Medusa and
offshore properties compared to proceeds in 2012 of $39.9 million, primarily related to the sale of our Habanero offshore property, which
are both discussed below and in Note 12 to the financial statements. The $26.4 million increase in capital expenditures included the costs
associated with expanding to a two-rig drilling program and the acquisition of the Garrison Draw property.
2014 Budgeted Capital Expenditures
In early February 2014, we announced our operational capital budget for 2014:
Category
Horizontal wells
Vertical wells
Facilities and equipment
Total operational capital
Gross Wells
Drill
27
9
Complete
26
8
($ millions)
$
$
155
15
15
185
40
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
We expanded our horizontal pad development efforts from two to four fields in late 2013, adding Carpe Diem in Midland County and
Garrison Draw in Reagan County. We expect our 2014 horizontal drilling program will be primarily focused on program development of
established Upper and Lower Wolfcamp zones in the Southern and Central Midland Basin, but will also include two wells in the Southern
Midland Basin to evaluate the Wolfcamp A shale and a test of the Lower Spraberry shale formation in the Central Midland Basin. In
addition, we anticipate the average lateral length of our horizontal wells in 2014 to be approximately 7,000’ per well.
Planned vertical drilling activity is anticipated to be limited to five deep Wolfberry wells in the Pecan Acres field, one well in the Garrison
Draw field. We have included three vertical exploration wells in the Northern Midland Basin, the timing and location of which being
subject to change as results are evaluated during the course of 2014.
In addition to the operational capital expenditures above, we budgeted approximately $25 million for capitalized expenses and certain
retained plugging abandonment expenses related to divested Gulf of Mexico shelf assets.
Our 2014 capital program is 100% operated and, as a result, the amount and timing of these capital expenditures are largely discretionary
depending on commodity prices and other factors. We expect to fund our 2014 capital program through a combination of cash flow from
operations, bank borrowings and term debt issuance, including our recently executed Second Lien Facility.
Financing Activities. For the year ended December 31, 2013, net cash provided by financing activities was $27.3 million compared to cash
used by financing activities of $0.3 million during the same period of 2012. Net cash provided by financing activities for 2013 included
proceeds of $70.4 million, net from our Preferred Stock offering (see Note 9 for additional information) and a $12 million draw, net on our
Credit Facility offset by the $50 million redemption of our Senior Notes, and approximately $4.6 million in preferred stock dividends.
Senior Secured Credit Facility (“Credit Facility”)
The Company’s $200 million Credit Facility, for which Regions Bank serves as the Administrative Agent, matures March 15, 2016 and
includes Citibank, NA, IberiaBank, Whitney Bank and OneWest Bank, FSB as participating lenders. As of December 31, 2013, the
Company’s Credit Facility had an approved borrowing base at December 31, 2013 of $83 million. The Credit Facility was secured by
mortgages covering the Company’s major producing fields. As of December 31, 2013, the balance outstanding on the Credit Facility was
$22 million with an interest rate of 2.92%, 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.
Subsequent to December 31, 2013, the Company amended its existing Credit Facility as discussed below. Additionally, the Company
executed the Second Lien Facility also discussed below.
Amended Credit Facility (the “Amended Credit Facility”) and Second Lien Term Loan Facility (the “Second Lien Facility”)
On March 11, 2014, we entered into an amended senior secured revolving credit facility (the “Amended Credit Facility”) in the amount of
$500 million with JPMorgan Chase Bank, N.A. as Administrative Agent (“J.P. Morgan”). The Credit Facility will have an initial borrowing
base amount of $95 million and a maturity date of March 11, 2019. In conjunction with the Amended Credit Facility, we entered into a
senior secured second lien term loan facility (the “Second Lien Facility”) in an aggregate amount of up to $125 million with J.P. Morgan as
Administrative Agent and with a maturity date of September 11, 2019. See Note 4 for additional information.
13% Senior Notes due 2016 (the “Senior Notes”) and Deferred Credit
As of December 31, 2013, following a $48.5 million principal redemption in December 2013, we had approximately $48.5 million principal
amount of the 13% Senior Notes due 2016 outstanding with interest payable quarterly.
41
Callon Petroleum
Company
Contractual Obligations
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
The following table includes the Company’s current contractual obligations and purchase commitments, at which time the Company had no
product delivery commitments:
(amounts in thousands)
Payments due by Period
13% Senior Notes
Drilling rig leases and related (a)
Office space lease and other commitments
Total
Total
< 1 Year
Years 2 - 3 Years 4 - 5
$
$
48,481 $
42,482
3,208
94,171 $
— $
19,732
618
20,350 $
48,481 $
22,750
1,096
72,327 $
— $
—
717
717 $
>5 Years
—
—
777
1,124
(a) The <1 Year column includes $2,055 related to the early termination provisions of one of the Company’s horizontal drilling rigs (See Note
13), which the Company replaced with a different horizontal rig, and the amount assumes the lessor is unable to re-charter the rig and
staffing personnel to another lessee. Should the lessor re-charter the rig and its related personnel to a new lessee, the $2,055 would be
reduced by the value of the new lessee’s rentals. Also includes an anticipated contract renewal of our Cactus 1 Rig lease.
Income Taxes
The Company’s income tax expense varies from the statutory rate primarily due to the effect of state taxes, non deductible compensation
under Section 162(m) and restricted stock offset by percentage depletion. Prior to 2012, we carried a full valuation allowance against our net
deferred tax asset. The income tax benefit of $69.3 million in 2011 resulted primarily from the reversal of the valuation allowance
established in 2008 against our net deferred tax assets. For additional information, see the Income Tax discussion included below in Results
of Operations and Note 10 to the Consolidated Financial Statements.
42
Callon Petroleum
Company
Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
The following table sets forth certain unaudited operating information with respect to the Company’s oil and natural gas operations for the
periods indicated:
2013
2012
For the Year Ended December 31,
% Change
2011
Change
Change
% Change
Net production:
Oil (MBbls)
Natural gas (MMcf)
Total production (MBOE)
Average daily production (BOE)
Average realized sales price (see below):
Oil (Bbl)
Natural gas (Mcf)
Total (BOE)
Oil and natural gas revenues (in thousands):
Oil revenue
Natural gas revenue
Total
Additional per BOE data:
Sales price
Lease operating expense
Production taxes
Operating margin
911
3,011
1,413
3,871
977
3,588
1,575
4,303
(66 )
(577)
(162)
(432)
(7)%
(16 )%
(10 )%
(10 )%
996
5,081
1,843
5,049
(19 )
(1,493)
(268)
(746)
$
97.65 $
4.52
72.59
98.86 $
3.94
70.31
(1.21 )
0.58
2.28
(1)% $
15 %
3 %
101.34 $
5.25
69.26
(2.48 )
(1.31 )
1.05
$ 88,960 $
13,609
96,584 $
14,149
$ 102,569 $ 110,733 $
(7,624)
(540)
(8,164)
(4,378)
(8)% $ 100,962 $
(4)%
(12,533 )
26,682
(7)% $ 127,644 $ (16,911 )
$
$
72.59 $
(14.00)
(2.92 )
55.67 $
70.31 $
(14.81)
(2.05 )
53.45 $
2.28
0.81
(0.87 )
2.22
3 % $
5 %
(42 )%
4 % $
69.26 $
(9.92 )
(1.12 )
58.22 $
1.05
(4.89 )
(0.93 )
(4.77 )
Below is a reconciliation of the average NYMEX price to the average realized sales price per Bbl of oil and Mcf of natural gas:
Average NYMEX oil price ($/Bbl)
Basis differential and quality adjustments (a)
Transportation
Hedging (b)
Average realized oil price ($/Bbl)
Average NYMEX natural gas price
($/MMBtu)
Basis differential and quality adjustments (c)
Average realized natural gas price ($/Mcf)
$
$
$
$
97.96 $
0.12
(0.43 )
—
97.65 $
94.19 $
3.97
(0.75 )
1.45
98.86 $
3.77
(3.85 )
0.32
(1.45 )
(1.21 )
4 % $
(97 )%
43 %
100 %
(1)% $
95.14 $
7.58
(1.00 )
(0.38 )
101.34 $
(0.95 )
(3.61 )
0.25
1.83
(2.48 )
3.73 $
0.79
4.52 $
2.82 $
1.12
3.94 $
0.91
(0.33 )
0.58
32 % $
(29 )%
15 % $
4.03 $
1.22
5.25 $
(1.21 )
(0.10 )
(1.31 )
(2)%
(29 )%
(15 )%
(15 )%
(2)%
(25 )%
2 %
(4)%
(47 )%
(13 )%
2 %
49 %
83 %
(8)%
(1)%
(48 )%
(25 )%
100 %
(2)%
(30 )%
(8)%
(25 )%
(a) Oil prices for production from our two divested deepwater fields reflect a premium over NYMEX pricing based on Mars WTI differential
for Medusa production, prior to the sale of Medusa in December 2013, and Argus Bonita WTI differential for Habanero production, prior
to the sale of Habanero during December 2012.
(b) As discussed in Note 5, the Company discontinued hedge accounting beginning with derivative contracts executed on January 1, 2012.
Consequently, the gain or loss on derivative contracts, settled is now included in the statement of operations within Loss (Gain) on
derivative contracts. The amounts reported above reflect the realized portion of derivative contracts designated as cash flow hedges.
(c) Natural gas prices exceeded the related NYMEX prices, which are quoted on an MMBtu basis, primarily due to the value of the NGLs in
our liquids-rich natural gas stream, primarily from our Permian basin production.
43
Callon Petroleum
Company
Revenues
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
The following tables are intended to reconcile the change in oil, natural gas and total revenue for the respective periods presented by
reflecting the effect of changes in volume, changes in the underlying commodity prices and the impact of our hedge program. (in
thousands)
Revenues for the year ended December 31, 2010
$
24,639 $
89,882
Natural Gas
Total
Oil
65,243 $
Volume increase
Price increase
Impact of hedges decrease
Net increase in 2011
10,406
25,688
(375)
35,719
952
1,091
—
2,043
11,358
26,779
(375)
37,762
Revenues for the year ended December 31, 2011
$
100,962 $
26,682 $
127,644
Volume decrease
Price decrease
Impact of hedges increase
Net decrease in 2012
(1,926)
(3,872)
1,420
(4,378)
(7,840)
(4,693)
—
(12,533)
(9,766)
(8,565)
1,420
(16,911)
Revenues for the year ended December 31, 2012
$
96,584 $
14,149 $
110,733
Volume decrease
Price increase
Net decrease in 2013
(10,065)
2,441
(7,624)
(540)
—
(540)
(10,605)
2,441
(8,164)
Revenues for the year ended December 31, 2013
$
88,960 $
13,609 $
102,569
Oil Revenue
For the year ended December 31, 2013, oil revenues of $89.0 million decreased $7.6 million, or 8%, compared to revenues of $96.6 million
for the year ended December 31, 2012. Lower production from our offshore properties, primarily related to the sale of Habanero field in
December 2012 and our Medusa and shelf properties in the fourth quarter of 2013, drove the revenue decline. Also contributing to the
production decline were 20 days of down time for scheduled downstream pipeline maintenance at our Medusa field in the second quarter of
2013, approximately five days of production downtime at our key producing Permian Basin fields in the fourth quarter of 2013 due to
severe winter weather causing electricity outages and the extended curtailment of trucking capacity to transport offtake and due to normal
and expected declines from other producing wells. Collectively, these declines were offset by the 222 MBbls increase in our oil production
from our Permian properties.
For the year ended December 31, 2012, oil revenues of $96.6 million decreased $4.4 million, or 4%, compared to revenues of $101.0
million for the year ended December 31, 2011. A decrease in commodity prices and production resulted in decreased oil revenue. The
average price realized decreased 2% to $98.86 per barrel compared to $101.34 for the same period of 2011. Similarly, production decreased
by 2% to 977 MBbls compared to 996 MBbls during the same period in 2011. Oil prices for production from our two deepwater fields are
adjusted and reflect a premium over NYMEX pricing based on Mars WTI differential for Medusa production and Bonita WTI differential
for Habanero production. Production decreases relate primarily to the down-time at the Habanero and Medusa fields and the normal and
expected declines from our other offshore properties. These production declines were offset by production from our new Permian wells, 22
vertical and two horizontal, brought onto production during 2012.
44
Callon Petroleum
Company
Natural Gas Revenue
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
For the year ended December 31, 2013, natural gas revenues of $13.6 million represented a decrease of 4%, or $0.5 million, compared to
natural gas revenues of $14.1 million for the year ended December 31, 2012. While the average realized price increased 15%, a 16%
decrease in production reduced total revenue. The production declines were primarily attributable to the shut-in of production of our Mobile
Bay 908 property, the sale of our offshore fields, the sale of our Haynesville well in the fourth quarter of 2013 as well as normal and
expected declines from our existing wells. Offsetting these declines was a 248 MMcf increase in horizontal well production from our
Permian properties.
For the year ended December 31, 2012, natural gas revenues of $14.1 million represented a decrease of 47%, or $12.5 million, when
compared to natural gas revenues of $26.7 million for the year ended December 31, 2011. Natural gas production decreased 29%, driven
primarily by down time at our Haynesville well, which was shut-in for 70 days during the first quarter of 2012 due to well interference from
an offsetting well, and due to down time at our East Cameron 257 well, which was suspended in the fourth quarter of 2011 due to a natural
gas leak in an upstream section of the Stingray Pipeline that transports production volumes from the field. Also contributing to the decline
was down-time at our Habanero and Medusa fields and normal and expected declines in natural gas production from our offshore and
Haynesville wells. In addition to production decreases, the average realized price decreased 25% to $3.94 per Mcf compared to an average
realized price of $5.25 per Mcf in 2011. Our natural gas prices on an MMBtu equivalent basis exceeded the related NYMEX prices
primarily due to the value of the NGLs in our natural gas stream, primarily from our Permian basin and deepwater production.
Operating Expenses
Principal components of our cost structure
Lease operating expenses. These are daily costs incurred to bring oil and natural gas out of the ground and to the market, together with the
daily costs incurred to maintain our producing properties. Such costs also include maintenance, repairs and workover expenses related to our
oil and natural gas properties.
Production taxes. Production taxes include severance and ad valorem taxes. Severance taxes are paid on produced oil and natural gas based
on a percentage of revenues from products sold at fixed rates established by federal, state or local taxing authorities. Where available, we
benefit from tax credits and exemptions in our various taxing jurisdictions. We are also subject to ad valorem taxes in the counties where our
production is located. Ad valorem taxes are generally based on the valuation of our oil and gas properties.
Depreciation, depletion and amortization. Under the full cost accounting method, we capitalize costs within a cost center and then
systematically expense those costs on a units of production basis based on proved oil and natural gas reserve quantities. We calculate
depletion on the following types of costs: (i) all capitalized costs, other than the cost of investments in unproved properties and major
development projects for which proved reserves cannot yet be assigned, less accumulated amortization; (ii) the estimated future
expenditures to be incurred in developing proved reserves; and (iii) the estimated dismantlement and abandonment costs, net of estimated
salvage values. Depreciation of other property and equipment is computed using the straight line method over their estimated useful lives,
which range from three to fifteen years.
General and administrative. These are costs incurred for overhead, including payroll and benefits for our corporate staff, costs of
maintaining our headquarters, costs of managing our production and development operations, franchise taxes, audit and other fees for
professional services and legal compliance.
Accretion expense. The Company is required to record its estimate of the fair value of liabilities for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement costs. Interest is accreted on the present value of the asset
retirement obligations and reported as accretion expense within operating expenses in the consolidated statements of operations.
45
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
For the Year Ended December 31,
Total Change
BOE Change
Lease operating expenses
Production taxes
Depreciation, depletion and amortization
General and administrative
Accretion expense
Impairment of other property and equipment
Total operating expenses
Lease operating expenses
Production taxes
Depreciation, depletion and amortization
General and administrative
Accretion expense
Impairment of other property and equipment
Total operating expenses
Lease Operating Expenses (LOE)
Per
BOE
Per
BOE
$
2013
2012
$ 19,779 $14.00 $ 23,330 $14.81 $ (3,551)
909
(5,734)
176
(468)
530
2.92
4,133
43,967 31.12
20,534 14.53
1.26
1,785
1.21
1,707
$ 91,905
3,224
2.05
49,701 31.56
20,358 12.93
1.43
2,253
1,177
0.75
$ 100,043
%
$
%
(15 )% $ (0.81 )
0.87
28 %
(0.44 )
(12 )%
1.6
1 %
(0.17 )
(21 )%
0.46
45 %
(5)%
42 %
(1)%
12 %
(12 )%
100 %
For the Year Ended December 31,
Total Change
BOE Change
Per
BOE
Per
BOE
$
2012
2011
$ 23,330 $14.81 $ 18,285 $ 9.92 $ 5,045
1,162
1,000
3,722
(85 )
1,177
2.05
3,224
49,701 31.56
20,358 12.93
1.43
2,253
1,177
0.75
$ 100,043
2,062
1.12
48,701 26.42
9.03
16,636
1.27
2,338
—
—
$ 88,022
%
$
%
28 % $ 4.89
0.93
56 %
5.14
2 %
3.90
22 %
0.16
(4)%
0.75
100 %
49 %
83 %
19 %
43 %
13 %
100 %
For the year ended December 31, 2013, LOE of $19.8 million decreased 15%, or $3.6 million, compared to $23.3 million for the year ended
December 31, 2012. The decrease was primarily due to $3.4 million of remediation costs on our Haynesville well in 2012, for which we had
no similar costs in 2013, and an estimated decrease of $3.2 million of LOE resulting from the previously discussed sale of our interests in
Habanero, Medusa, the Medusa Spar LLC, our Haynesville property and substantially all our remaining shelf properties. These decreases
were partially offset by $3.0 million in LOE costs related to the growth in Permian production and operations, including an increase in
workover expenses associated with accelerated horizontal well activity.
For the year ended December 31, 2012, LOE of $23.3 million increased 28%, or $5.0 million, compared to $18.3 million for the year ended
December 31, 2011. The increase was primarily due to $3.0 million in costs related to growth in the number of wells producing from
Permian Basin properties and $3.3 million in remediation work at our Haynesville well in 2012 for which we had no similar costs in 2011.
These increases were partially offset by a $1.3 million decline in LOE for our deepwater properties due to lower throughput charges as a
result of reduced production volumes.
Production Taxes
For the year ended December 31, 2013, production taxes of $4.1 million increased 28%, or $0.9 million, compared to $3.2 million for the
year ended December 31, 2012. The increase was predominantly attributable to an increase of onshore production subject to these taxes and
a decline in offshore production, resulting from the sale of our Gulf of Mexico position in 2013, which is exempt from production taxes.
For the year ended December 31, 2012, production taxes of $3.2 million increased 56%, or $1.2 million, compared to $2.1 million for the
year ended December 31, 2011. The increase was predominantly attributable to an increased proportion of onshore production subject to
these taxes relative to offshore production, which was predominantly exempt from production taxes.
46
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
Depreciation, Depletion and Amortization (DD&A)
For the year ended December 31, 2013, DD&A of $31.12 per BOE was relatively flat compared to $31.56 per BOE for the year ended
December 31, 2012.
DD&A for the year ended December 31, 2012 increased 19% per BOE to $31.56 per BOE compared to $26.42 per BOE for the year ended
December 31, 2011. Increases in the DD&A rate are attributable to our planned exploration and development expenditures related to our
onshore reserve development including the ongoing onshore development cost increases in the Permian Basin area.
General and Administrative, net of amounts capitalized (G&A)
G&A remained relatively flat at $20.5 million (including $6.4 million non-cash) for the year ended December 31, 2013 compared to $20.4
million (including $4.7 million non-cash) for the same period of 2012. The $0.1 million increase was due to an increase in non-cash charges
of $1.7 million related to incentive compensation share-based instruments offset by a $1.6 million decrease primarily related to non-
recurring employee-related expenses including early retirement and severance expense incurred in 2012. The non-cash portions primarily
relate to our liability-based incentive compensation share based instruments (see Notes 7 and 8 ) and to depreciation and amortization
expense (see Note 2).
For the year ended December 31, 2012, G&A, increased $3.7 million, or 22%, to $20.4 million (including $4.7 million non-cash) from
$16.6 million (including $3.2 million non-cash) for the same period of 2011. The increase is due mainly to $1.6 million in costs for non-
recurring employee-related expenses including early retirement and severance expense for which we had no expense during 2011.
Additionally, we incurred an increase in non-cash charges of $1.2 million related to incentive compensation share-based instruments
awarded during 2012. The remaining increase related primarily to higher compensation-related expenses including the costs associated with
employing staff to support our onshore growth and 100% operated Permian production, as well as relocation and related costs.
Accretion Expense (ARO)
Accretion expense related to our asset retirement obligation decreased 21% for the year ended December 31, 2013 compared to the same
periods of 2012. Accretion expense correlates directionally with the Company’s ARO which was $6.7 million at December 31, 2013 versus
$13.3 million at December 31, 2012. See Note 11 for additional information regarding the Company’s ARO.
For the year ended December 31, 2012, accretion expense decreased 4% for the year ended December 31, 2012 compared to the same
periods of 2011. At December 31, 2012, our ARO of $13.3 million was lower than the $13.9 million ARO at December 31, 2011.
Impairment of Other Property and Equipment
During 2012 and 2013, the Company recorded a write-down of the value of certain assets acquired in 2011 as part of a settlement reached
with a former joint interest partner on a deepwater project. For information concerning the impairment of these assets, please see Note 13 to
the Consolidated Financial Statements.
Other (Income) Expense
Interest expense. We finance a portion of our working capital requirements, capital expenditures and acquisitions with borrowings under our
credit facility or with term debt. We incur interest expense that is affected by both fluctuations in interest rates and our financing decisions.
We reflect interest paid to our lender in interest expense. In addition, we include the amortization of deferred financing costs (including
origination and amendment fees), commitment fees and annual agency fees in interest expense. The amortization of the deferred credit
related to our 13% Senior Notes is recorded as an offset to interest expense.
Gain/Loss on derivative instruments. We utilize commodity derivative financial instruments to reduce our exposure to fluctuations in the
price of oil. This amount represents the (i) gain (loss) related to derivatives, net of settlement that relate to our open derivative contracts as
commodity prices change and commodity derivative contracts expire or new ones are entered into and (ii) gains (losses) on derivatives,
settled that is equal to the summation of gains and losses on positions that have settled within the period. We provide a reconciliation of the
these components of the gain/loss on derivative contracts in Note 5.
Income tax expense. We use the asset and liability method of accounting for income taxes, under which deferred tax assets and liabilities are
recognized for the future tax consequences of (1) temporary differences between the financial statement carrying amounts and
47
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
the tax bases of existing assets and liabilities and (2) operating loss and tax credit carryforwards. Deferred income tax assets and liabilities
are based on enacted tax rates applicable to the future period when those temporary differences are expected to be recovered or settled. The
effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period the rate change is enacted. When
appropriate based on our analysis, we record a valuation allowance for deferred tax assets when it is more likely than not that the deferred
tax assets will not be realized.
For the Year Ended December 31,
Interest expense
Gain on early extinguishment of debt
Gain on acquired equipment
Loss (gain) on derivative contracts
Other income
Total other expenses, net
Income tax expense (benefit)
Equity in earnings of Medusa Spar LLC
Preferred stock dividends
Interest Expense
$
$
$
$ Change % Change
2011
2013
6,094 $
(3,696)
—
1,360
(485)
3,273 $
2012
9,108 $
(1,366)
—
(1,717)
(79 )
5,946
(3,014)
(2,330)
—
3,077
(406)
$ Change % Change
(22 )%
(30 )%
(100)%
100 %
(94 )%
(2,609)
576
5,041
(1,717)
1,347
(33 )% $ 11,717 $
171 %
— %
(179)%
514 %
(1,942)
(5,041)
—
(1,426)
3,308
$
3,104 $
17
(4,627)
2,223 $
226
—
881
(209)
(4,627)
(40 )% $ (69,283 ) $ 71,506
(573)
799
(92 )%
—
—
100 %
103 %
(72 )%
— %
Interest expense on Callon’s debt obligations decreased 3.0 million to $6.1 million for the year ended December 31, 2013 compared to $9.1
million for the same period of 2012. The decrease was related primarily to an additional $2.3 million of interest capitalized in 2013 versus
2012, to approximately $0.3 million of reduced interest payments attributable to the redemption of $48.5 million principal of the
Company’s Senior Notes in December 2013 and to $0.1 million of additional deferred credit amortization recognized in 2013 compared with
2012. The additional capitalized interest was related to a higher balance year-over-year in average unevaluated oil and natural gas properties
following the purchase of additional unevaluated acreage with exploration costs in the Permian Basin.
Interest expense on Callon’s debt obligations decreased 22% to $9.1 million for the year ended December 31, 2012 compared to $11.7
million for the same period of 2011. The decrease was related primarily to the redemption of $10 million principal of Senior Notes during
June 2012 in addition to a $1.5 million increase in capitalized interest compared to 2011, partially offset by interest expense related to
increased borrowings under our Credit Facility and decreases in the deferred credit amortization. The increase in capitalized interest was
related to a higher balance year-over-year in average unevaluated oil and natural gas properties, mentioned above.
(Gain) Loss on Early Extinguishment of Debt
During December 2013, the Company redeemed $53.8 million carrying value of its Senior Notes using a portion of the proceeds from the
Company’s May 2013 preferred equity offering. The $53.8 million of carrying value included $48.5 million of principal value and $5.3
million of unamortized deferred credit. The Company recognized a net gain of $3.7 million on the early extinguishment of debt, comprised
of the recognition of $5.3 million in deferred credit, offset by $1.6 million of redemption expenses. See Note 4 for additional information
concerning the gain on early extinguishment of debt.
During June 2012, the Company redeemed $10 million of its Senior Notes with a carrying value of $11.6 million, including $1.6 million of
the Senior Notes’ deferred credit. The Company recognized a net gain of $1.4 million on the early extinguishment of debt, comprised of the
recognition of $1.6 million in deferred credit, offset by $0.2 million of redemption expenses.
Gain on Acquired Equipment
See Note 13 for additional information concerning the gain on acquired equipment.
48
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
Loss (Gain) on Derivative Contracts
Beginning in 2012, the Company elected to no longer designate its derivative contracts as accounting hedges. For the year ended
December 31, 2013, net losses on mark-to-market derivative instruments, net of settlements were $1.4 million, compared to $1.7 million
gain in 2012. See Notes 5 and 6 for a reconciliation of the components of the Company’s derivative contracts and disclosures related to
derivative instruments including their composition and valuation.
Income Tax Expense (Benefit)
The income tax expense of $3.1 million in 2013 resulted primarily from pre-tax income earnings of $7.4 million. The effective tax rate of
42% in 2013 and 47% in 2012 differed from the federal income tax rate of 35% primarily due to the effect of state taxes, non-deductible
compensation under Section 162(m) and restricted stock offset by percentage depletion. See Note 10 for a discussion of our effective tax
rate. Prior to 2012, we carried a full valuation allowance against our net deferred tax asset. The income tax benefit of $69.3 million in 2011
resulted primarily from the reversal of the valuation allowance established in 2008 against our net deferred tax assets as we achieved
income on an aggregate basis for a cumulative three-year period and expect to generate the taxable income necessary to fully utilize the
deferred tax assets prior to their expiration. For additional information, see Note 11 to the Consolidated Financial Statements.
Preferred Stock Dividends
Preferred Stock dividends for the year ended December 31, 2013 increased $4.6 million compared to the same period of 2012 in which we
had no dividend expense. The expense is reflective of the Preferred Stock being outstanding only since its issuance on May 30, 2013,
resulting in a reduced stub period payment during the second quarter of 2013.
Summary of Significant Accounting Policies and Critical Accounting Estimates
The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which
have been prepared in accordance with GAAP. The preparation of our consolidated financial statements requires us to make estimates and
assumptions that affect our reported results of operations and the amount of reported assets, liabilities and proved oil and natural gas
reserves. Some accounting policies involve judgments and uncertainties to such an extent that there is reasonable likelihood that materially
different amounts could have been reported under different conditions, or if different assumptions had been use. Actual results may differ
from the estimates and assumptions used in the preparation of our consolidated financial statements. Described below are the most
significant policies we apply in preparing our consolidated financial statements, some of which are subject to alternative treatments under
GAAP. We also describe the most significant estimates and assumptions we make in applying these policies. See Note 2 to our consolidated
financial statements included elsewhere in this Annual Report on Form 10-K for a discussion of additional accounting policies and estimates
made by management.
Property and Equipment
The Company utilizes the full-cost method of accounting for its oil and natural gas properties whereby all costs incurred in connection with
the acquisition, exploration and development of oil and natural gas reserves, including certain overhead costs, are capitalized into the “full-
cost pool.” The amounts capitalized into the full-cost pool are depleted (charged against earnings) using the unit-of-production
method. The full-cost method of accounting for our proved oil and natural gas properties requires that the Company makes estimates based
on its assumptions of future events that could change. These estimates are described below.
Depreciation, Depletion and Amortization (DD&A) of Oil and Natural Gas Properties
The Company calculates depletion by using the depletable base, equal to the net capitalized costs in our full-cost pool plus estimated future
development costs, and the estimated net proved reserve quantities. Capitalized costs added to the full-cost pool include the following:
•
•
costs of drilling and equipping productive wells, dry hole costs, acquisition costs of properties with proved reserves, delay rentals
and other costs related to exploration and development of our oil and natural gas properties;
payroll costs including the related fringe benefits paid to employees directly engaged in the acquisition, exploration and/or
development of oil and natural gas properties as well as other directly identifiable general and administrative costs
49
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
associated with such activities. Such capitalized costs do not include any costs related to the production of oil and natural gas or
general corporate overhead;
•
•
•
•
costs associated with unevaluated properties, those lacking proved reserves, are excluded from the depletable base. These
unevaluated property costs are added to the depletable base at such time as wells are completed on the properties, the properties are
sold or the Company determines these costs have been impaired. The Company’s determination that a property has or has not been
impaired (which is discussed below) requires assumptions about future events;
estimated costs to dismantle, abandon and restore properties that are capitalized to the full-cost pool when the related liabilities are
incurred (see also the discussion below regarding Asset Retirement Obligations);
estimated future costs to develop proved properties are added to the full-cost pool for purposes of the DD&A computation. The
Company uses assumptions based on the latest geologic, engineering, regulatory and cost data available to it to estimate these
amounts. However, the estimates made are subjective and may change over time. The Company’s estimates of future development
costs are reviewed at least annually and as additional information becomes available; and
capitalized costs included in the full-cost pool plus estimated future development costs are depleted and charged against earnings
using the unit-of-production method. Under this method, the Company estimates the proved reserves quantities at the beginning of
each accounting period. For each BOE produced during the period, the Company records a depletion charge equal to the amount
included in the depletable base (net of accumulated depreciation, depletion and amortization) divided by our estimated net proved
reserve quantities.
Because the Company uses estimates and assumptions to calculate proved reserves (as discussed below) and the amounts included in the
depletable base, our depletion rates may materially change if actual results differ from these estimates.
Ceiling Test
Under the full cost method of accounting, the Company compares, at the end of each financial reporting period, the present value of
estimated future net cash flows from proved reserves (excluding cash flows related to estimated abandonment costs), to the net capitalized
costs of proved oil and natural gas properties net of related deferred taxes. The Company refers to this comparison as a “ceiling test.” If the
net capitalized costs of proved oil and natural gas properties exceed the estimated discounted (at 10%) future net cash flows from proved
reserves, the Company is required to write-down the value of its oil and natural gas properties to the value of the discounted cash flows.
Estimated future net cash flows from proved reserves are based on a twelve-month average pricing assumption and include consideration of
existing cash flow hedges. Given the volatility of oil and natural gas prices, it is reasonably possible that the Company’s estimates of
discounted future net cash flows from proved oil and natural gas reserves could change in the near term. If oil and natural gas prices decline
significantly, even if only for a short period of time, it is possible that write-downs of oil and natural gas properties could occur in the
future. See Notes 2 and 12 for additional information regarding the Company’s oil and natural gas properties.
Estimating Reserves and Present Value of Estimated Future Net Cash Flows
Estimates of quantities of proved oil and natural gas reserves, including the discounted present value of estimated future net cash flows from
such reserves at the end of each quarter, are based on numerous assumptions, which are likely to change over time. These assumptions
include:
•
•
the prices at which the Company can sell its oil and natural gas production in the future. Oil and natural gas prices are volatile, but
we are required to assume that they remain constant, using the twelve-month average pricing assumption. In general, higher oil and
natural gas prices will increase quantities of proved reserves and the present value of estimated future net cash flows from such
reserves, while lower prices will decrease these amounts; and
the costs to develop and produce the Company’s reserves and the costs to dismantle its production facilities when reserves are
depleted. These costs are likely to change over time, but we are required to assume that they remain constant. Increases in costs will
reduce estimated oil and natural gas quantities and the present value of estimated future net cash flows, while decreases in costs
will increase such amounts.
Changes in these prices and/or costs will affect the present value of estimated future net cash flows more than the estimated quantities of oil
and natural gas reserves for the Company’s properties that have relatively short productive lives.
50
Callon Petroleum
Company
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
In addition, the process of estimating proved oil and natural gas reserves requires that the Company’s independent and internal reserve
engineers exercise judgment based on available geological, geophysical and technical information. We have described the risks associated
with reserve estimation and the volatility of oil and natural gas prices under “Risk Factors.”
Sales of oil and natural gas properties are accounted for as adjustments to the net full cost pool with no gain or loss recognized unless the
adjustment would significantly alter the relationship between capitalized costs and proved reserves.
Unproved Properties
Costs, including capitalized interest, associated with properties that do not have proved reserves are excluded from the depletable base, and
are included in the line item “Unevaluated properties excluded from amortization.” Unproved property costs are transferred to the depletable
base when wells are completed on the properties or the properties are sold. In addition, the Company is required to determine whether its
unproved properties are impaired and, if so, include the costs of such properties in the depletable base. The Company determines whether
an unproved property is impaired by periodically reviewing its exploration program on a property-by-property basis. This determination
may require the exercise of substantial judgment by management.
Asset Retirement Obligations
We are required to record its estimate of the fair value of liabilities for obligations associated with the retirement of tangible long-life assets
and the associated asset retirement costs. Interest is accreted on the present value of the asset retirement obligation and reported as accretion
expense within operating expenses in the Consolidated Statements of Operations. See Note 11 for additional information.
Derivatives
To manage oil and natural gas price risk on a portion of our planned future production, we have historically utilized commodity derivative
instruments (including collars, swaps, puts, and other structures) on approximately 50% of our projected production volumes in any given
year. We do not use these instruments for trading purposes. Settlement of derivative contracts are generally based on the difference between
the contract price and prices specified in the derivative instrument and a NYMEX price or other cash or futures index price.
Beginning in 2012, we elected to no longer designate derivative contracts executed after January 1, 2012 as accounting hedges under FASB
ASC 815-20-25. As such and beginning with derivative contracts executed during 2012, all derivative positions are carried at their fair value
on the balance sheet and are marked-to-market through earnings at the end of each period. Gains and losses on derivatives that are not
designated as hedges are recorded in earnings as a component of gain (loss) on derivative contracts. Within gain (loss) on derivative
contracts line in the statement of operations are gains (losses) on derivatives, net of settlement and gains (losses) on derivatives, settled.
Derivative contracts that were entered into at and prior to December 31, 2011 were accounted for as cash flow hedges, and were recorded at
fair market value on its consolidated balance sheet. Changes in fair value were recorded through other comprehensive income (loss), net of
tax, in stockholders’ equity. The changes in fair value related to ineffective derivative contracts were recognized as derivative expense
(income). The estimated fair value of our derivative contracts is based upon closing exchange prices on NYMEX and in the case of collars
and floors, the time value of options. For additional information regarding derivatives and their fair values, see Notes 5 and 6 to the
Consolidated Financial Statements and Part II, Item 7A Commodity Price Risk.
Income Taxes
The amount of income taxes recorded requires interpretations of complex rules and regulations of federal and state tax jurisdictions. We
recognize current tax expense based on estimated taxable income for the current period and the applicable statutory tax rates. We routinely
assess potential uncertain tax positions and, if required, estimate and establish accruals for such amounts. We have recognized deferred tax
assets and liabilities for temporary differences, operating losses and other tax carryforwards. We routinely assess our deferred tax assets and
reduce such assets by a valuation allowance if we deem it is more likely than not that some portion or all of the deferred tax assets will not
be realized. Numerous judgments and assumptions are inherent in the determination of future taxable income, including factors such as
future operating conditions (particularly as related to prevailing oil and natural gas prices). See Note 10 for additional information regarding
Income Taxes.
51
Callon Petroleum
Company
Recent Accounting Standards
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Table of Contents
Various accounting standards and interpretations were issued in 2013 with effective dates subsequent to December 31, 2013. We have
evaluated the recently issued accounting pronouncements that are effective in 2014 and believe that none of them will have a material effect
on our financial position, results of operations or cash flows when adopted. For a discussion of recently issued accounting standards, see
Note 2 to the Consolidated Financial Statements.
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 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.
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risks
We are exposed to a variety of market risks including commodity price risk, interest rate risk and counterparty and customer risk. We
address these risks through a program of risk management including the use of derivative instruments.
Commodity Price Risk
The Company’s revenues, earnings, cash flow, capital investments and, ultimately, future rate of growth are highly dependent on the prices
we receive for our oil and natural gas, which have historically been very volatile due to unpredictable events such as economic growth or
retraction, weather and climate, changes in supply and government actions. Oil and natural gas price declines and volatility could adversely
affect the Company’s revenues, cash flows and profitability. Price volatility is expected to continue. Using the Company’s annual sales
volumes for 2013, excluding the effects of the Company’s hedging program, a 10% decline in the NYMEX price of oil and natural gas
would have reduced our revenues by approximately $8.9 million and $1.2 million, respectively.
While the Company does not enter into derivative transactions for speculative purposes, the Company sometimes utilizes price collars,
swaps, puts and other structures to reduce the risk of changes in oil and natural gas prices. Under a collar arrangements, no payments are
due by either party as long as the market price is above the floor price and below the ceiling price set in the collar. If the price falls below
the floor, the counterparty to the collar pays the difference to Callon, and if the price rises above the ceiling, Callon pays the difference to
the counterparty. Fixed price swaps reduce the Company’s exposure to decreases in commodity prices, while simultaneously limiting the
benefit the Company might otherwise have received from any increases in commodity prices. The Company’s derivatives policy also allows
Callon to, at its discretion, purchase or sell puts. Purchased puts reduce the Company’s exposure to decreases in prices of the hedged
commodity while allowing realization of the full benefit from any increases those prices. If the commodity price falls below the put price,
the counter-party pays the difference to Callon. Conversely, sold puts expose the Company to risk whereby Callon would pay its counter-
party if prices fall below the put price. See Note 5 to the Consolidated Financial Statements for a description of our hedged position at
December 31, 2013.
Interest Rate Risk
On December 31, 2013, the majority of the Company’s debt consisted of its fixed-rate 13% Senior Notes. However, we are subject to
market risk exposure related to changes in interest rates on our indebtedness under our revolving credit facility and our Second Lien Facility
into which we entered during March 2014. As of December 31, 2013, the weighted average interest rate on our Credit Facility borrowings
was 2.9%. An increase or decrease of 1% in the interest rate would have a corresponding decrease or increase in our net income of
approximately $0.2 million based on the $22 million outstanding in the aggregate under our Credit Facility on December 31, 2013.
52
Table of Contents
Counterparty and Customer Credit Risk
Our principal exposures to credit risk are through receivables resulting from derivatives financial contracts, joint interest receivables and the
receivables from the sale of our oil and natural gas production, which we market to energy marketing companies.
At December 31, 2013 our receivables resulting from derivative financial contracts was approximately $0.1 million. Our oil and natural gas
derivative arrangements expose us to credit risk in the event of nonperformance by counterparties. The counterparties on our derivative
instruments currently in place are lenders under our revolving credit facility. We are likely to enter into additional derivative instruments
with these or other lenders under our revolving credit facility, representing institutions with an investment grade ratings. We have existing
International Swap Dealers Association Master Agreements (“ISDA Agreements”) with our derivative counterparties. The terms of the
ISDA Agreements provide us and the counterparties with rights of set off upon the occurrence of defined acts of default by either us or a
counterparty to a derivative, whereby the party not in default may set off all derivative liabilities owed to the defaulting party against all
derivative asset receivables from the defaulting party. At December 31, 2013 we had a net derivative asset position of $0.1 million and a net
derivative liability position of $1.1 million.
Joint interest receivables arise from billings to entities that own partial interests in the wells we operate. These entities participate in our
wells primarily based on their ownership in leases on which we intend to drill. We have little ability to control whether these entities will
participate in our wells. At December 31, 2013 our joint interest receivables were approximately $4.4 million.
We are subject to credit risk due to the concentration of our oil and natural gas receivables with several significant customers. We do not
require any of our customers to post collateral, and the inability of our significant customers to meet their obligations to us or their
insolvency or liquidation may adversely affect our financial results. For the year ended December 31, 2013, three purchasers accounted for
more than 10% of our revenue: Enterprise Crude Oil, LLC (38%); Shell Trading Company (31%); and Plains Marketing, L.P. (15%). At
December 31, 2013 our receivables from the sale of our oil and natural gas production were approximately $13.2 million in total.
ITEM 8. Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2013 and 2012
Consolidated Statements of Operations for Each of the Three Years in the Period Ended December 31, 201 3
Consolidated Statements of Comprehensive Income (Loss) for the Three Years in the Period Ended December 31, 2013
Consolidated Statements of Stockholders' Equity (Deficit) for Each of the Three Years in the Period Ended December 31, 201 3
Consolidated Statements of Cash Flows for Each of the Three Years in the Period Ended December 31, 201 3
Notes to Consolidated Financial Statements
53
Page
54
55
56
57
58
59
60
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders of
Callon Petroleum Company
We have audited the accompanying consolidated balance sheets of Callon Petroleum Company as of December 31, 2013 and 2012, and the
related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for each of the three years in the
period ended December 31, 2013. These financial statements are the responsibility of the Company’s management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Callon
Petroleum Company as of December 31, 2013 and 2012, and the consolidated results of its operations and its cash flows for each of the
three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Callon
Petroleum Company’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control—
Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our
report dated March 12, 2014, expressed an unqualified opinion thereon.
New Orleans, Louisiana
March 12, 2014
/s/Ernst & Young LLP
54
CALLON PETROLEUM COMPANY
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
For the Year Ended December, 31
2013
2012
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable
Fair market value of derivatives
Deferred tax asset, current
Other current assets
Total current assets
Oil and natural gas properties, full-cost accounting method:
Evaluated properties
Less accumulated depreciation, depletion and amortization
Net oil and natural gas properties
Unevaluated properties excluded from amortization
Total oil and natural gas properties
Other property and equipment, net
Restricted investments
Investment in Medusa Spar LLC
Deferred tax asset
Other assets, net
Total assets
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities
Asset retirement obligations
Fair market value of derivatives
Total current liabilities
13% Senior Notes:
Principal outstanding
Deferred credit, net of accumulated amortization of $20,814 and $17,800, respectively
Total 13% Senior Notes
Credit facility
Asset retirement obligations
Other long-term liabilities
Total liabilities
Stockholders' equity:
Preferred Stock, series A cumulative, $.01 par value and $50.00 liquidation preference, 2,500
shares authorized; 1,579 and 0 shares outstanding, respectively
Common Stock, $.01 par value, 60,000 shares authorized; 40,345 and 39,801 shares
outstanding at December 31, 2013 and 2012, respectively
Capital in excess of par value
Retained deficit
Total stockholders' equity
Total liabilities and stockholders' equity
$
$
$
$
3,012 $
20,586
60
3,843
2,063
29,564
1,701,577
(1,420,612 )
280,965
43,222
324,187
7,255
3,806
—
57,765
1,376
423,953 $
57,637 $
4,120
1,036
62,793
48,481
5,267
53,748
22,000
2,612
3,706
144,859
16
404
401,540
(122,866 )
279,094
423,953 $
1,139
15,608
1,674
—
1,502
19,923
1,497,010
(1,296,265 )
200,745
68,776
269,521
10,058
3,798
8,568
64,383
1,922
378,173
36,016
2,336
125
38,477
96,961
13,707
110,668
10,000
10,965
2,092
172,202
—
398
328,116
(122,543 )
205,971
378,173
The accompanying notes are an integral part of these financial statements.
55
CALLON PETROLEUM COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Operating revenues:
Oil sales
Natural gas sales
Total operating revenues
Operating expenses:
Lease operating expenses
Production taxes
Depreciation, depletion and amortization
General and administrative
Accretion expense
Impairment of other property and equipment
Total operating expenses
Income from operations
Other (income) expenses:
Interest expense
Gain on early extinguishment of debt
Gain on acquired equipment
Loss (gain) on derivative contracts
Other income
Total other expenses
Income before income taxes
Income tax expense (benefit)
Income before equity in earnings of Medusa Spar LLC
Equity in earnings of Medusa Spar LLC, net of tax
Net income
Preferred stock dividends
Income (loss) available to common shareholders
Income (loss) per common share:
Basic
Diluted
Shares used in computing income per common share:
Basic
Diluted
For the Year Ended December 31,
2011
2012
2013
$
88,960 $
13,609
102,569
96,584 $
14,149
110,733
100,962
26,682
127,644
19,779
4,133
43,967
20,534
1,785
1,707
91,905
10,664
6,094
(3,696)
—
1,360
(485)
3,273
7,391
3,104
4,287
17
4,304
(4,627)
$
$
$
(323) $
(0.01) $
(0.01) $
23,330
3,224
49,701
20,358
2,253
1,177
100,043
10,690
9,108
(1,366)
—
(1,717)
(79)
5,946
4,744
2,223
2,521
226
2,747
—
2,747 $
18,285
2,062
48,701
16,636
2,338
—
88,022
39,622
11,717
(1,942)
(5,041)
—
(1,426)
3,308
36,314
(69,283)
105,597
799
106,396
—
106,396
0.07 $
0.07 $
2.81
2.76
40,133
40,133
39,522
40,337
37,908
38,582
The accompanying notes are an integral part of these financial statements.
56
CALLON PETROLEUM COMPANY
CONSOLIDATE STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
Table of Contents
Net income
Other comprehensive income (loss):
Change in fair value of derivatives designated as hedges, net of tax
Comprehensive income
Preferred stock dividends
Comprehensive income (loss) available to common shareholders
$
$
For the Year Ended December 31,
2012
2013
2011
4,304 $
2,747 $
106,396
—
4,304
(4,627)
(323) $
(1,624)
1,123
—
1,123 $
2,561
108,957
—
108,957
The accompanying notes are an integral part of these consolidated financial statements.
57
CALLON PETROLEUM COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands)
Balance at 12/31/2010
Comprehensive income:
Net income
Other comprehensive income
Total comprehensive income
Shares issued pursuant to employee benefit
plans
Restricted stock
Common stock issued
Reconsolidated subsidiary (See Note 13)
Balance at 12/31/2011
Comprehensive income:
Net income
Other comprehensive loss
Total comprehensive income
Shares issued pursuant to employee benefit
plans
Restricted stock
Balance at 12/31/2012
Comprehensive income:
Net income and comprehensive income
Shares issued pursuant to employee benefit
plans
Restricted stock
Preferred stock issued
Preferred stock dividend
Preferred
Stock
Common
Stock
Capital in
Excess of
Par
Accumulated Other
Comprehensive
Income (Loss)
$
— $
290 $ 248,160 $
(937)
Retained
Earnings
(Deficit)
$ (231,703) $
Total
Stockholders’
Equity
15,810
—
—
—
106,396
$
$
—
—
—
—
— $
—
207
3
101
—
394 $ 324,474 $
2,446
73,661
—
2,561
—
—
—
—
108,957
207
2,449
73,762
17
—
—
—
17
1,624
$ (125,290) $
201,202
—
—
—
2,747
(1,624)
—
—
— $
—
—
—
16
—
235
—
—
4
3,407
398 $ 328,116 $
—
— $ (122,543) $
—
—
—
6
—
243
3,162
70,019
—
4,304
—
—
—
—
(4,627)
1,123
235
3,411
205,971
4,304
243
3,168
70,035
(4,627)
Balance at 12/31/2013
$
16 $
404 $ 401,540 $
— $ (122,866) $
279,094
The accompanying notes are an integral part of these financial statements.
58
CALLON PETROLEUM COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation, depletion and amortization
Accretion expense
Amortization of non-cash debt related items
Amortization of deferred credit
Equity in earnings of Medusa Spar LLC
Deferred income tax expense
Valuation allowance
Net loss (gain) on derivatives, net of settlements
Impairment of other property and equipment
Gain on acquired equipment
Non-cash gain for early debt extinguishment
Non-cash expense related to equity share-based awards
Change in the fair value of liability share-based awards
Payments to settle asset retirement obligations
Changes in current assets and liabilities:
Accounts receivable
Other current assets
Current liabilities
Payments to settle vested liability share-based awards
Change in natural gas balancing receivable
Change in natural gas balancing payable
Change in other long-term liabilities
Change in other assets, net
Net cash provided by operating activities
Cash flows from investing activities:
Capital expenditures
Acquisitions
Proceeds from sale of mineral interests and equipment
Investment in restricted assets related to plugging and abandonment
Distribution from Medusa Spar LLC
Net cash used in investing activities
Cash flows from financing activities:
Borrowings on credit facility
Payments on credit facility
Redemption of 13% Senior Notes
Issuance of preferred stock
Issuance of common stock
Payment of preferred stock dividends
Taxes paid related to exercise of employee stock options
Net cash provided by (used in) financing activities
Net change in cash and cash equivalents
Cash and cash equivalents:
Balance, beginning of period
Balance, end of period
For the Year Ended December 31,
2011
2012
2013
$
4,304 $
2,747 $
106,396
45,393
1,785
471
(3,164)
(17)
2,778
—
2,730
1,707
—
(3,696)
2,092
2,903
(721)
(3,497)
(560)
3,583
(239)
22
(527)
(206)
(812)
54,329
51,043
2,253
402
(3,086)
(226)
2,223
—
(1,683)
1,176
—
(1,366)
1,697
1,620
(1,314)
(883)
100
1,753
(3,383)
51
(102)
205
(1,937)
51,290
49,753
2,338
461
(3,155)
(799)
10,928
(80,211)
—
—
(4,995)
(1,942)
1,337
761
(2,563)
(3,734)
180
4,695
—
252
(115)
100
(520)
79,167
(159,724)
(10,885)
89,992
—
813
(79,804)
(133,299)
(2,075)
39,936
—
1,735
(93,703)
(100,243)
—
7,615
(150)
1,267
(91,511)
80,000
(68,000)
(50,060)
70,035
—
(4,627)
—
27,348
1,873
53,000
(43,000)
(10,225)
—
—
—
(18)
(243)
(42,656)
—
—
(35,062)
—
73,765
—
—
38,703
26,359
1,139
3,012 $
43,795
1,139 $
17,436
43,795
$
The accompanying notes are an integral part of these financial statements.
59
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
Note
1.
2.
3.
4.
5.
Description
Description of Business and Basis of Presentation
Summary of Significant Accounting Policies
Earnings (loss) per Share
Borrowings
Derivative Instruments and Hedging Activities
6.
7.
Fair Value Measurements
Employee Benefit Plans
13.
14.
NOTE 1 – Description of Business and Basis of Presentation
Note
8.
9.
10.
11.
12.
Description
Share-Based Compensation
Equity Transactions
Income Taxes
Asset Retirement Obligations
Supplemental Information on Oil and Natural Gas Operations
(Unaudited)
Other
Summarized Quarterly Financial Information (Unaudited)
Callon Petroleum Company is an independent oil and natural gas company established in 1950, which has been focused on building reserves
and production both onshore and offshore through efficient operations and low finding and development costs. In 2013, the Company
completed the onshore strategic repositioning it initiated in 2009, shifting its operations from the offshore waters in the Gulf of Mexico to
the Permian Basin region in Texas. The Company has built seasoned technical and operational teams with extensive experience in the
Permian Basin to manage and progress its growth plan. In the fourth quarter of 2012, Callon sold its interest in its deepwater Habanero field.
Similarly, in the fourth quarter of 2013, the Company sold its interest in its only remaining deepwater property, the Medusa field, including
the sale of the Medusa Spar facility and substantially all remaining offshore shelf properties. These transactions completed the Company’s
long-term strategic goal of becoming an onshore operator with an asset base concentrated in the Permian Basin.
The Company was incorporated under the laws of the state of Delaware in 1994 and succeeded to the business of a publicly traded limited
partnership, a joint venture with a consortium of European investors and an independent energy company partially owned by a member of
current management. As used herein, the “Company,” “Callon,” “we,” “us,” and “our” refer to Callon Petroleum Company and its
predecessors and subsidiaries unless the context requires otherwise.
The Consolidated Financial Statements include the accounts of the Company, and its subsidiary, Callon Petroleum Operating Company
(“CPOC”). CPOC also includes the subsidiaries Callon Offshore Production, Inc. and Mississippi Marketing, Inc. All intercompany
accounts and transactions have been eliminated. Certain prior year amounts have been reclassified to conform to presentation in the current
year. To the extent these amounts are material, we have either footnoted them within the Company’s disclosures or have noted the items
within this footnote. The Company reclassified on its 2012 and 2011 Consolidated Statements of Operations $3,224 and $2,062,
respectively, from “Lease operating expenses” to “Production taxes” to conform to current year 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.
NOTE 2 – Summary of Significant Accounting Policies
A. Use of
Estimates
The preparation of financial statements in conformity with United States generally accepted accounting principles (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 and the reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
B. Cash
and
Cash
Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
C. Accounts
Receivable
Accounts receivable consists primarily of accrued oil and natural gas production receivables. The balance in the reserve for doubtful
accounts netted within accounts receivable was $73 and $34 at December 31, 2013 and 2012, respectively. During 2013, 2012, and 2011 the
Company recorded $45, $0 and $(281), respectively of bad debt expense. The negative bad debt expense in 2011 relates to the collection of
an amount charged to bad debt expense during 2010.
60
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
D. Revenue Recognition
and Natural Gas
Balancing
The Company recognizes revenue under the entitlement method of accounting. Under this method, revenue is deferred for deliveries in
excess of the Company’s net revenue interest, while revenue is accrued for the undelivered volumes. Production imbalances are generally
recorded at the lower of cost or market. The revenue we receive from the sale of NGLs is included in natural gas sales. Natural gas
balancing receivables were $71 and $93 as of 2013 and 2012, respectively. Natural gas balancing payables were $126 and $653 as of 2013
and 2012, respectively.
E. Major
Customers
The Company’s production is generally sold on month-to-month contracts at prevailing prices. The following table identifies customers to
whom it sold a greater than 10% of its total oil and natural gas production during each of the years ended:
Enterprise Crude Oil, LLC
Shell Trading Company
Plains Marketing, L.P.
Other
Total
For the Year Ended December 31,
2011
2012
2013
38%
31%
15%
16%
100%
32%
39%
15%
14%
100%
16%
45%
17%
22%
100%
Because alternative purchasers of oil and natural gas are readily available, the Company believes that the loss of any of these purchasers
would not result in a material adverse effect on its ability to market future oil and natural gas production.
F. Oil and Natural Gas
Properties
The Company uses the full-cost method of accounting for its exploration and development activities. Under this method of accounting, the
cost of both successful and unsuccessful exploration and development activities are capitalized as property and equipment. Such amounts
include the cost of drilling and equipping productive wells, dry hole costs, lease acquisition costs, delay rentals, interest capitalized on
unevaluated leases, other costs related to exploration and development activities, and site restoration, dismantlement and abandonment costs
capitalized in accordance with asset retirement obligation accounting guidance. Costs capitalized also include any internal costs that are
directly related to exploration and development activities, including salaries and benefits, but do not include any costs related to production,
general corporate overhead or similar activities. The Company capitalized $14,753, $13,331 and $11,857 of these internal costs during
2013, 2012 and 2011, respectively.
When applicable, proceeds from the sale or disposition of oil and natural gas properties are accounted for as a reduction to capitalized costs
unless the sale would significantly alter the relationship between capitalized costs and proved reserves, in which case a gain or loss is
recognized in income.
Costs of oil and natural gas properties, including future development costs, which have proved reserves and properties which have been
determined to be worthless, are depleted using the unit-of-production method based on proved reserves. Excluded from this amortization are
costs associated with unevaluated properties, including capitalized interest on such costs. Unevaluated property costs are transferred to
evaluated property costs at such time as wells are completed on the properties or management determines that these costs have been
impaired.
Under the full-cost accounting rules of the SEC, the Company reviews the carrying value of its proved oil and natural gas properties each
quarter. Under these rules, capitalized costs of oil and natural gas properties, net of accumulated depreciation, depletion and amortization
and deferred income taxes, may not exceed the present value of estimated future net cash flows from proved oil and natural gas reserves,
discounted at 10%, plus the lower of cost or fair value of unevaluated properties, net of related tax effects (the full-cost ceiling
amount). These rules generally require pricing based on the preceding 12-months’ average oil and natural gas prices based on closing prices
on the first day of each month and require a write-down if the “ceiling” is exceeded. See Note 12 for additional information regarding the
Company’s oil and natural gas properties.
Upon the acquisition or discovery of oil and natural gas properties, the Company estimates the future net costs to dismantle, abandon and
restore the property by using available geological, engineering and regulatory data. Such cost estimates are periodically updated for
changes in conditions and requirements. In accordance with asset retirement obligation guidance issued
61
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
by the FASB, such costs are capitalized to the full-cost pool when the related liabilities are incurred. In accordance with SEC’s rules, assets
recorded in connection with the recognition of an asset retirement obligation are included as part of the costs subject to the full-cost ceiling
limitation. The future cash outflows associated with settling the recorded asset retirement obligations are excluded from the computation of
the present value of estimated future net revenues used in determining the full-cost ceiling amount.
G. Other Property and
Equipment
The Company depreciates its other property and equipment of $7,255 and $6,424 at December 31, 2013 and 2012, respectively, using the
straight-line method over estimated useful lives of three to 20 years. Depreciation expense of $750, $760 and $645 relating to other property
and equipment was included in general and administrative expenses in the Company’s consolidated statements of operations for the years
ended December 31, 2013, 2012 and 2011, respectively. The accumulated depreciation on other property and equipment was $13,240 and
$13,238 as of December 31, 2013 and 2012, respectively. As discussed in Note 13, during 2013, the Company recorded an impairment
charge to reduce to zero the carrying values of its assets held for sale. The Company reviews its other property and equipment for
impairment when indicators of impairment exist.
H. Capitalized
Interest
The Company capitalizes interest on expenditures made in connection with exploration and development projects that are not subject to
current amortization (e.g. unevaluated properties). Interest is capitalized only for the period that activities are in progress to bring these
projects to their intended use. Capitalized interest cannot exceed gross interest expense. During the years ended December 31, 2013, 2012
and 2011, the Company capitalized $4,410, $2,109 and $573 of interest expense.
I. Asset Retirement
Obligations
The Company is required to record its estimate of the fair value of liabilities for obligations associated with the retirement of tangible long-
lived assets and the associated asset retirement costs. Interest is accreted on the present value of the asset retirement obligations and reported
as accretion expense within operating expenses in the consolidated statements of operations. See Note 11 for additional information.
J. Derivatives
The Company’s derivative contracts executed prior to 2012 were designated as cash flow hedges, and were recorded at fair market value
with the changes in fair value recorded net of tax through other comprehensive income (loss) (“OCI”) in stockholders’ equity. Ineffective
derivative contracts or ineffective portions of contracts designated as cash flow hedges were recognized as derivative expense (income). The
last of the Company’s derivative contracts designated as cash flow hedges expired on December 31, 2012. Derivative contracts executed
during 2013 and outstanding as of December 31, 2013 were not designated as accounting hedges, and are carried on the balance sheet at
their fair market value. Changes in the fair value of derivative contracts not designated as accounting hedges are reflected in earnings as a
gain or loss on derivative contracts. See Notes 5 and 6 for additional information regarding the Company’s derivative contracts.
K.
Income
Taxes
Provisions for income taxes include deferred taxes resulting primarily from temporary differences due to different reporting methods for oil
and natural gas properties for financial reporting purposes and income tax purposes. GAAP requires the recognition of a deferred tax asset
for net operating loss carryforwards, statutory depletion carryforward and tax credit carryforwards, net of a valuation allowance. A
valuation allowance is provided for that portion, if any, of the asset for which it is deemed more likely than not that it will not be realized.
See Note 10 for additional information.
L. Share-Based
Compensation
The Company grants to directors and employees stock options, restricted stock awards (“RS awards”), and restricted stock unit awards
(“RSU awards”) that may be settled in cash or common stock at the option of the Company and RSU awards that may only be settled in cash
(“Cash-settleable RSU awards”).
Stock Options. For stock options the Company expects to settle in common stock, share-based compensation expense is based on the
grant-date fair value as calculated using the Black-Scholes option pricing model and recognized straight-line over the vesting period
(generally three years).
62
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
RS awards, RSU awards and Cash-settleable RSU awards. For RS and RSU awards that the Company expects to settle in common stock,
share-based compensation expense is based on the grant-date fair value and recognized straight-line over the vesting period (generally
three years). For Cash-settleable RSU awards that the Company expects or is required to settle in cash, share-based compensation
expense is based on the fair value remeasured at each reporting period as calculated using a Monte Carlo pricing model, because vesting
of these awards is subject to a market condition, with the estimated value recognized over the vesting period (generally three years).
M. Statements of Cash Flows Supplemental
Information
During the three year period ended 2013, the Company paid no federal income taxes. During the years ended December 31, 2013, 2012 and
2011, the company made cash interest payments of $13,189, $13,920 and $14,922, respectively.
N.
Investment in Medusa Spar
LLC
During the fourth quarter of 2013, the Company closed on the sale of its 15.0% working interest in the Medusa field, its 10.0% membership
interest in Medusa Spar LLC (“LLC”), and substantially all of its remaining Gulf of Mexico shelf properties. Prior to the sale, the
Company’s ownership interest in the LLC was accounted for under the equity method of accounting for investments. The LLC held a 75%
undivided ownership interest in the deepwater spar production facilities at the Medusa field in the Gulf of Mexico and earned a tariff based
upon production volume throughput from the Medusa area. The Company was obligated to process through the spar production facilities its
share of production from the Medusa field and any future discoveries in the area. The balance of the LLC was owned by Oceaneering
International, Inc. and Murphy Oil Corporation. See Note 12 for additional information on the Medusa divestiture.
O. Consolidation of Variable Interest
Entities
In June 2009, the FASB issued an accounting standard which became effective for and was adopted by the Company on January 1,
2010. Upon adoption, the Company reevaluated its interest in its subsidiary, Callon Entrada. Based on the evaluation performed,
management concluded that a VIE reconsideration event had taken place resulting in the determination that Callon Entrada is a VIE, for
which the Company is not the primary beneficiary. Therefore, effective January 1, 2010, Callon Entrada was deconsolidated from the
consolidated financial statements of the Company. During the second quarter of 2011 and through the formal execution of a wind-down
agreement with its former joint interest partner in the Entrada deepwater project, which resulted in Callon gaining the power to direct the
activities of Callon Entrada, the Company became the primary beneficiary of Callon Entrada. Consequently, effective April 29, 2011,
Callon Entrada was reconsolidated in the Company’s financial statements. Callon Entrada was later dissolved in 2011.
P. Earnings
(EPS)
per
Share
The Company’s basic EPS amounts have been computed based on the weighted-average number of shares of common stock outstanding for
the period. Diluted EPS, using the treasury-stock method, reflects the potential dilution caused by the exercise of all options and vesting of
all restricted stock and restricted stock units settleable in shares.
Q. Recent
Pronouncements
Accounting
From time to time, new accounting pronouncements are issued by FASB that are adopted by the Company as of the specified effective date.
If not discussed, management believes that the impact of recently issued standards, which are not yet effective, will not have a material
impact on the Company’s financial statements upon adoption.
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 and required disclosure of amounts reclassified
out of accumulated other comprehensive income by component. In addition, it requires that the Company present either on the face of its
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 reporting period. For amounts not
reclassified in their entirety to net income, the Company 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.
63
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
NOTE 3 - Earnings (loss) per Share
Basic earnings (loss) per share is computed by dividing income available to common stockholders by the weighted average number of
shares outstanding for the periods presented. The calculation of diluted earnings (loss) per share includes the potential dilutive impact of
non-vested restricted shares and unexercised options outstanding during the periods presented, as calculated using the treasury stock
method, unless their effect is anti-dilutive. A reconciliation of the basic and diluted net income per share computation is as follows (in
thousands, except per share amounts):
Net income
Preferred stock dividends
(a) Income (loss) available to common shareholders
(b) Weighted average shares outstanding
Dilutive impact of stock options
Dilutive impact of restricted stock
(c) Weighted average shares outstanding
for diluted net income (loss) per share (1)
Basic Income (loss) per share (a/b)
Diluted Income (loss) per share (a/c)
$
$
$
$
For the year ended December 31,
2012
2013
4,304 $
(4,627)
(323) $
2,747 $
—
2,747 $
2011
106,396
—
106,396
40,133
—
—
39,522
8
807
37,908
18
656
40,133
40,337
38,582
(0.01) $
(0.01) $
0.07 $
0.07 $
2.81
2.76
67
816
The following were excluded from the diluted EPS calculations because their effect would be anti-dilutive:
52
Stock options
398
Restricted stock
52
123
(1) Because the Company reported a loss for the year ended December 31, 2013, no unvested stock awards were included in computing loss per
share because the effect was anti-dilutive.
NOTE 4 - Borrowings
Principal components:
Credit Facility
13% Senior Notes due 2016, principal
Total principal outstanding
Non-cash components:
13% Senior Notes due 2016 unamortized deferred credit
Total carrying value of borrowings
Senior Secured Revolving Credit Facility (the “Credit Facility”)
For the year ended December 31,
2013
2012
$
$
$
22,000 $
48,481
70,481 $
10,000
96,961
106,961
5,267
75,748 $
13,707
120,668
The Company’s $200,000 Credit Facility, for which Regions Bank serves as the Administrative Agent, matures March 15, 2016 and
includes Citibank, NA, IberiaBank, Whitney Bank and OneWest Bank, FSB as participating lenders. The Company’s Credit Facility had an
approved borrowing base at December 31, 2013 of $83,000. The Credit Facility was secured by mortgages covering the Company’s major
producing fields. As of December 31, 2013, the balance outstanding on the Credit Facility was $22,000 with an interest rate of 2.92%,
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.
Subsequent to December 31, 2013, the Company amended its existing Credit Facility as discussed below. Additionally, the Company
executed the Second Lien Facility also discussed below.
64
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
Amended Credit Facility (“the Amended Credit Facility”)
On March 11, 2014, the Company entered into the Fifth Amended and Restated Credit Agreement million with JPMorgan Chase Bank,
National Association as Administrative Agent.
The Amended Credit Facility includes the following key provisions:
•
$500,000 notional amount, with an initial borrowing base of
$95,000;
• Maturity date of March 11,
•
•
•
•
2019;
First redetermination scheduled with an effective date of May 30, 2014, with subsequent redeterminations occurring every six
months beginning on September 1, 2014;
Pricing grid providing from Eurodollar-based draws ranging from LIBOR plus 1.75%
utilization;
A quarterly commitment fee equal to 0.5% per year of the unused portion of the borrowing base;
and
Secured by mortgages covering all major producing
fields.
to 2.75% depending on
The Amended Credit Facility contains various affirmative and restrictive covenants.
Second Lien Term Loan Facility (the “Second Lien Facility”)
In conjunction with the Amended Credit Facility, the Company entered into the Second Lien Facility in an aggregate amount of up to
$125,000 with JPMorgan Chase Bank, National Association as Administrative Agent. The Second Lien Facility is structured as a multiple
advance term loan facility, with initial commitments of $100,000. If any portion of the committed Second Lien Facility remains undrawn on
the first anniversary of the closing date, then the unfunded commitments under the Second Lien Facility, if any, will terminate on such date.
The Second Lien Facility includes the following key provisions:
•
$125,000 master note, with initial commitments $100,000 and additional availability of $25,000 with consent of 66 2/3% of the
lenders and compliance with financial covenants after giving effect to such increase;
• Maturity date of September 11,
•
•
•
•
•
•
2019;
No mandatory prepayments unless new debt is
issued;
Prepayable at any time. The prepayment premium shall be applicable to the amount of the applicable prepayment multiplied by (i)
102% if such prepayment event occurs prior to the first anniversary of the Closing Date and (ii) 101% if such prepayment event
occurs on or after the first but prior to the second anniversary of the Closing Date. No such prepayment premium shall be payable
for prepayments made on or after the second anniversary of the closing date;
Interest expense at a rate of LIBOR plus 7.75%, calculated on a per annum
basis;
A commitment fee equal to 0.5% calculated on a per annum basis on the unused portion of the initial commitment amount until
March 11, 2015;
The amounts funded on the initial draw date shall be issued with an original issue discount of 1.00% and each subsequent draw
shall be subject to the same 1.00% original issue discount on the drawn amount, applied on the date such draw is funded; and
Secured by junior liens on properties mortgaged under the Amended Credit Facility, subject to an intercreditor
agreement.
The Second Lien Facility contains various affirmative and restrictive covenants.
65
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
13% Senior Notes due 2016 (the “Senior Notes”) and Deferred Credit
As of December 31, 2013, the Company had principal outstanding of $48,481 related to its 13% Senior Notes. The 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 reduced the carrying amount of the Old Notes by the fair value of
the common and preferred stock issued in the amount of $11,527. The $31,507 difference between the adjusted carrying amount of the Old
Notes and the face value of the Senior Notes was recorded as a deferred credit, which is being amortized as a reduction in 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 at December 31, 2013:
Gross Carrying
Amount
$31,507
Accumulated
Amortization at
December 31, 2013
Carrying Value at
December 31, 2013
$26,240
$5,267
Amortization Recorded
during Current Year
(a)
$8,440
Estimated Annual
Amortization Expense
Expected to be
Recognized in
2014
$5,267
(a) Of the amount recorded as amortization during the current year, $3,165 was recorded as a reduction of interest expense and $5,275 (discussed
below) was recorded as a component of the gain on early extinguishment of debt.
Using a portion of the proceeds from the sale of our interest in Medusa on December 17, 2013, the Company redeemed $48,481 of its
Senior Notes, which resulted in a net $3,696 gain on the early extinguishment of debt. The gain represents the difference between the
$50,057 paid (inclusive of $1,576 of redemption expenses, primarily the call premium) for Senior Notes with a carrying value of $53,756
(inclusive of the $5,275 of accelerated deferred credit amortization).
In June 2012, the Company redeemed $10,000 of its Senior Notes, which resulted in a net $1,366 gain on the early extinguishment of debt.
The gain represents the difference between the $10,225 paid (inclusive of $225 of redemption expenses, primarily the call premium) for
Senior Notes with a carrying value of $11,591 (inclusive of the $1,591 of accelerated deferred credit amortization).
In March 2011, the Company redeemed $31,000 of its Senior Notes using proceeds from its February 2011 equity offering, which resulted
in a $1,974 gain on the early extinguishment of debt. The gain represents the difference between the $35,062 paid (inclusive of the$4,062
of redemption expenses, primarily the call premium) for Senior Notes with a carrying value of $37,004 (inclusive of t h e $6,004 of
accelerated deferred credit amortization).
On March 11, the Company provided notice to holders of its outstanding Senior Notes that it expects to redeem those notes on April 11,
2014 using proceeds from the previously discussed Second Lien Facility. The redemption will result in the acceleration of the amortization
of the remaining $5,267 of deferred credit as reflected in the table above.
Restrictive Covenants
The Indenture governing our Senior Notes and the Company’s Credit Facility contains 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 December 31, 2013.
66
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
NOTE 5 – Derivative Instruments and Hedging Activities
Objectives and Strategies for Using Derivative Instruments
The Company is exposed to fluctuations in oil and natural gas prices on the majority of its production. Consequently, the Company believes
it is prudent to manage the variability in cash flows on a portion of its oil and natural gas production. The Company utilizes primarily a mix
of collar, swap, put and call derivative financial instruments to manage fluctuations in cash flows resulting from changes in commodity
prices. The Company does not use these instruments for speculative or trading purposes.
Counterparty risk and offsetting
The use of derivative transactions exposes the Company to the risk that a counterparty will be unable to meet its commitments. 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 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 regarding fair value.
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
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.
Beginning in 2012, the Company elected not to designate its executed derivative contracts, nor does it expect to designate future derivative
contracts, as an accounting hedge under FASB ASC 815. Consequently, any derivative contract not designated as an accounting hedge will
be carried at its fair value on the balance sheet and marked-to-market at the end of each period, with the change in value reflected as a gain
or loss on the statement of operations. Gains and losses on derivatives that are not designated as hedges are recorded in earnings as a
component of gain (loss) on derivative contracts. Within the gain (loss) on derivative contracts line of the statement of operations are gains
(losses) on derivatives, net of settlement and gains (losses) on derivatives, settled.
Prior to 2012, the Company’s derivative contracts recorded on the Consolidated Balance Sheets were designated as cash flow hedges, and
were recorded at fair market value with the changes in fair value recorded net of tax through OCI in stockholders’ equity. The cash
settlements on effective derivative contracts were recorded as an increase or decrease in oil and natural gas sales.
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):
Commodity Classification
Line Description
12/31/13
12/31/12
12/31/13
12/31/12
12/31/13
12/31/12
Balance Sheet Presentation
Asset Fair Value
Liability Fair Value
Net Derivative Fair Value
Derivatives not designated as Hedging Instruments under ASC 815
Natural gas
Natural gas
Oil
Oil
Current
Non-current
Current
Non-current
Fair market value of derivatives
Other long-term liabilities
Fair market value of derivatives
Other long-term assets
$
60 $
—
—
—
— $
—
1,674
250
— $
(72)
(1,036 )
—
(125) $
(116)
—
—
60 $
(72)
(1,036 )
—
(125)
(116)
1,674
250
Totals
$
60 $
1,924 $
(1,108 ) $
(241) $
(1,048 ) $
1,683
67
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
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 December 31, 2013:
Current assets: Fair value of hedging contracts
Long-term assets: Fair value of hedging contracts
Current liabilities: Fair value of hedging contracts
Long-term liabilities: Fair value of hedging contracts
$
$
8
—
1,088
(72 )
$
52
—
(52 )
—
60
—
1,036
(72 )
Presented without
Effects of Netting
Effects of Netting
As Presented with
Effects of Netting
Derivatives not designated as hedging instruments under ASC 815
For the periods indicated, the Company recorded the following related to its derivative instruments that were not designated as accounting
hedges and are recorded in the Statement of Operations as gain or loss on derivative contracts:
For the year ended December 31,
2012
2011
2013
Natural gas derivatives
Net (loss) gain on derivatives, settled
Net gain (loss) on derivatives, net of settlements
Subtotal gain (loss), net
Oil derivatives
Net gain, on derivatives, settled
Net (loss) gain on derivatives, net of settlements
Subtotal (loss) gain, net
Total (loss) gain on derivative instruments included in Statement of Operations
Derivatives designated as hedging instruments under ASC 815
$
$
$
$
$
(147) $
229
82 $
34 $
(241)
(207) $
1,518 $
(2,960)
(1,442) $
— $
1,924
1,924 $
(1,360) $
1,717 $
—
—
—
—
—
—
—
The table below presents the effect of the Company’s derivative financial instruments on the consolidated statements of operations as an
increase (decrease) to oil and natural gas sales for the effective portion and as an increase (decrease) to other (income) expense for the
ineffective portion and amounts excluded from effectiveness testing:
Amount of gain (loss) reclassified from OCI into income (effective portion)
Amount of gain (loss) recognized in income (ineffective portion and amount
excluded from effectiveness testing)
$
— $
1,420 $
(375)
—
—
—
68
For the year ended December 31,
2012
2013
2011
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
Derivative positions
In the first quarter of 2013, the Company monetized the remaining portion of its 2013 oil collar positions (for the period February -
December 2013) 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 oil swap for the period February - December 2013.
Listed in the table below are the outstanding oil and natural gas derivative contracts as of December 31, 2013:
Commodity
Instrument
Natural gas
Call Option
Natural gas
Swap
Natural gas
Call Option
Oil
Oil
Oil
Natural gas
Swap
Put Option
Swap
Swap
Natural gas
Call Option
Natural gas
Call Option
Average Notional
Volumes per
Month
Quantity Type
Put/Call
Price
Fixed-Price
Swap
38
60
38
30
30
9
46
38
37
MMBtu
$
4.75
MMBtu
n/a
$
MMBtu
$
4.75
n/a
4.36
n/a
Bbls
Bbls
Bbls
MMBtu
MMBtu
MMBtu
n/a
$
93.35
$
70.00
n/a
n/a
$
94.58
n/a
$
4.25
$
$
4.75
5.00
n/a
n/a
Period
Jan14 -
Mar14
Jan14 -
Mar14
Jan14 -
Dec14
Jan14 -
Dec14
Jan14 -
Dec14
Jan14 -
Dec14
Apr14 -
Dec14
Apr14 -
Dec14
Jan15 -
Dec15
Designation under
ASC 815
Not Designated
Not Designated
Not Designated
(a)
Not Designated
Not Designated
Not Designated
Not Designated
Not Designated
Not Designated
(a) The short natural gas call option, when combined with the Company’s long production position, represents a “covered call,” and creates a
$4.75/MMbtu ceiling during the covered period.
Subsequent Event Activity:
Derivative contracts executed subsequent to December 31, 2013 include the following:
Commodity
Oil
Oil
Oil
Oil
Instrument
Swap
Swap
Swap
Swap
Average Notional
Volumes per
Month
Quantity Type
Put/Call
Price
Fixed-Price
Swap
15
15
15
15
Bbls
Bbls
Bbls
Bbls
n/a $
n/a $
n/a $
n/a $
94.15
92.80
90.40
88.64
Period
Feb14 - Mar14
Apr14 - Jun14
Jul14 - Sep14
Oct14 - Dec14
Designation under ASC
815
Not Designated
Not Designated
Not Designated
Not Designated
NOTE 6 – Fair Value Measurements
Fair value is defined within the accounting rules as the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. The rules established a fair value hierarchy that prioritizes the inputs to
valuation techniques used to measure fair value. As presented in the tables below, this hierarchy consists of three broad levels:
Level 1 Valuations consist of unadjusted quoted prices in active markets for identical assets and liabilities and has the highest priority.
Level 2 Valuations rely on quoted prices in markets that are not active or observable inputs over the full term of the asset or liability.
Level 3 Valuations are based on prices or third party or internal valuation models that require inputs that are significant to the fair
value measurement and are less observable and thus have the lowest priority.
69
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
Fair Value of Financial Instruments
Cash, Cash Equivalents, and 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:
For the year ended December 31,
2013
2012
Credit Facility
13% Senior Notes due 2016 (a)
Total
$
$
22,000 $
53,748
75,748 $
22,000 $
50,299
72,299 $
Carrying
Value
Fair Value
Carrying
Value
Fair Value
10,000
100,112
110,112
10,000 $
110,668
120,668 $
(a) 2013 and 2012 fair values are calculated only in relation to the $48,481 and $96,961 face value outstanding of the 13% Senior Notes,
respectively. The remaining $5,267 and $13,707, respectively represents the Company’s deferred credits and have been excluded from the
fair value calculation. 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 Callon’s Consolidated Balance
Sheet. The following methods and assumptions were used to estimate the fair values:
Commodity Derivative Instruments. The fair value of commodity derivative instruments 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 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.
The following tables present the Company’s assets and liabilities measured at fair value on a recurring basis for each hierarchy level:
December 31, 2013
Balance Sheet Presentation
Level 1 Level 2 Level 3 Total
Assets
Derivative financial instruments - current Portion
Derivative financial instruments - non-current
Sub-total assets
Liabilities
Derivative financial instruments - current portion
Derivative financial instruments - non-current
Sub-total liabilities
Fair market value of derivatives
Other assets, net
$ — $
—
$ — $
60 $
—
60 $
— $
—
— $
60
—
60
Fair market value of derivatives
Other long-term liabilities
$ — $ 1,036 $
—
72
$ — $ 1,108 $
— $ 1,036
—
72
— $ 1,108
Total
$ — $(1,048) $
— $(1,048)
70
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
December 31, 2012
Balance Sheet Presentation
Level 1 Level 2 Level 3 Total
Assets
Derivative financial instruments - current portion
Derivative financial instruments - non-current
Sub-total assets
Liabilities
Derivative financial instruments - current portion
Derivative financial instruments - non-current
Sub-total liabilities
Fair market value of derivatives
Other assets, net
$ — $ 1,674 $
—
250
$ — $ 1,924 $
— $ 1,674
250
—
— $ 1,924
Fair market value of derivatives
Other long-term liabilities
$ — $
—
$ — $
125 $
116
241 $
— $
—
— $
125
116
241
Total
$ — $1,683 $
— $1,683
The derivative fair values above are based on analysis of each contract. Derivative assets and liabilities with the same counterparty are
presented here on a gross basis, even where the legal right of offset exists. See Note 5 for a discussion of net amounts recorded in the
Consolidated Balance Sheet at December 31, 2013.
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:
Other Property and Equipment. As discussed in Note 13, the Company’s decision to abandon certain of its other property and equipment,
that had been classified as held for sale, resulted in an impairment charge of $1,707 which is included in the Company’s Statement of
Operations for the year ended December 31, 2013. The impairment charge was valued using level 3 inputs.
Acquisition. During the second quarter of 2013, the Company acquired approximately 2,468 gross (2,186 net) acres in Reagan and Upton
Counties, Texas, which is located in the southern portion of the Midland Basin for a purchase price of $11,000. The acquisition also
included seven gross vertical wells and 1,301 barrels of oil equivalent proved reserves. The Company valued the acquired assets in
accordance with the method described below. In accordance with the acquisition method of accounting, the purchase price of 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 purchase price of the
Company’s acquisition during the period was $11,000 with approximately $2,000 allocated to unevaluated oil and gas properties and
approximately $9,000 allocated to evaluated oil and gas properties. Asset retirement obligations assumed in connection with the transaction
were insignificant due to the nature of the properties acquired. The unaudited pro forma results of the properties acquired are immaterial to
the Company’s financial statements. The fair value measurements were based on significant inputs not observable in the market and thus
represent a level 3 measurement.
NOTE 7 – Employee Benefit Plans
The Company utilizes various forms of incentive compensation designed to align the interest of the executives and employees with those of
its stockholders. Tabular disclosures related to the share-based awards are presented in Note 8. The narrative that follows provides a brief
description of each plan, summarizes the overall status of each plan and discusses current year awards under each plan:
Savings and Protection Plan
The Savings and Protection Plan (“401-K Plan”) provides employees with the option to defer receipt of a portion of their compensation, and
the Company may, at its discretion, match a portion of the employee’s deferral with cash. The Company may also elect, at its discretion, to
contribute a non-matching amount in cash and Company Common Stock to employees. The amounts held under the 401-K Plan are
invested in various funds maintained by a third party in accordance with the directions of each employee. An employee is fully vested,
including Company discretionary contributions, immediately upon participation in the 401-K Plan. The total amounts contributed by the
Company, including the value of the common stock contributed, were $923, $918 and $811 in the years 2013, 2012 and 2011, respectively.
71
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
2011 Omnibus Incentive Plan (the “2011 Plan”)
The 2011 Plan, which became effective May 12, 2011 following shareholder approval, authorized and reserved for issuance 2,300 shares of
common stock, which may be issued upon exercise of vested stock options and/or the vesting of any other share-based equity award that is
granted under this plan. The 2011 Plan is the Company’s only active plan, and included a provision at inception whereby all remaining, un-
issued and authorized shares from the Company’s previous share-based incentive plans became issuable under the 2011 Plan. This transfer
provision resulted in the transfer of an additional 841 shares into the plan, increasing the quantity authorized and reserved for issuance
under the Plan to 3,141 at the inception of the plan. Another provision provided that shares which would otherwise become available for
issue under the previous plans as a result of vesting and/or forfeiture of any equity awards existing as of May 12, 2012, would also increase
the authorized shares available to the 2011 Plan. As of December 31, 2013, the 2011 Plan had 1,192 shares remaining and eligible for future
issuance.
Equity awards issued under this plan may be subject to various vesting, accelerated vesting, and forfeiture provisions upon the occurrence of
certain events. Any vested but unexercised options contractually expire 10 years from the date of grant. Equity awards under the 2011 Plan
generally vest over time but may also be subject to attaining a specified performance metrics and may be immediate or cliff vest at a
specified date. The Company will recognize expense on the grant date for all immediately vesting awards, while it will recognize expense
ratably over the requisite service (i.e. vesting) period for both cliff and ratably vesting awards. For performance-based awards, the Company
recognizes expense based on its analysis of the performance criteria, and records or reverses expense as necessary based on its analysis. For
market-based awards, the Company recognizes expense based on its analysis of the market criteria, and records expense as necessary based
on its analysis. Awards with a market-based provision do not allow for the reversal of previously recognized expense, even if the market
metric is not achieved and no shares ultimately vest or are awarded.
Cash-Settleable RSU Awards
Certain of the Company’s RSUs awarded require cash-settlement. Cash-settleable RSU awards are accounted for as liabilities as the
Company is contractually obligated to settle these awards in cash, and are recorded in the Company’s consolidated balance sheet for the
ratable portion of their fair values. The fair value of the Company’s market-based RSU is calculated using a Monte Carlo valuation model,
which considers such inputs as the Company’s and its peer group’s stock prices, a risk-free interest rate, and an estimated volatility for the
Company and its peer group. Changes in the fair value of cash-settleable awards are recorded as adjustments to compensation expense.
Market-based RSUs: A significant portion of the Company’s cash-settleable RSU awards include a market-based vesting condition and may
ultimately vest at a quantity different than the base RSUs awarded. The number of RSUs that cliff-vest is based on a calculation that
compares the Company’s total shareholder return to the same calculated return of a group of peer companies as selected by the Company,
and the number of units that will vest can range between 0% and 200% of the base units awarded.
As of December 31, 2013, the Company had the following cash-settleable RSU awards outstanding (including those that are not based on a
market condition):
Vesting in 2014
Vesting in 2015
Vesting in 2016
Other
Total cash-settleable RSU awards
Base Units
Outstanding at
Potential Minimum Potential Maximum
Units at Vesting at
Units at Vesting at
510
909
66
92
1,577
45
60
66
92
263
975
1,758
66
92
2,891
For the year ended December 31, 2013, 260 market-based cash-settleable RSUs subject to the peer market-based vesting described above
vested at 100% of their issued units, resulting in a cash payment of $1,669. Also during 2013, 65 non-market-based cash settleable RSUs
vested, resulting in a cash payment of $239. During 2012, 364 market-based cash-settleable RSUs vested at 150%, resulting in a cash
payment of $2,626. Also during 2012, 143 non-market-based cash settleable RSUs vested, resulting in a cash payment of $763. See Note 8
for additional information regarding cash-settleable RSUs.
72
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
NOTE 8 - Share-Based Compensation
As discussed in Note 7, the Company grants various forms of share-based compensation awards to employees of the Company and its
subsidiaries and to non-employee members of the Board of Directors. At December 31, 2013, shares available for future share-based
awards, including stock options or restricted stock grants, under the Company’s only active plan, the 2011 Plan, were 1,192.
The following table presents share-based compensation expense for each respective period:
For the year ended December 31,
Share-based compensation expense for:
Options
RSU equity awards
Cash-settleable RSU awards
401(k) contributions in shares
Total share-based compensation expense (a)
$
$
2013
— $
2012
Equity-based Liability-based Equity-based Liability-based Equity-based Liability-based
—
—
1,335
—
1,335
— $
—
2,916
—
2,916 $
— $
—
5,347
—
5,347 $
3,975
—
219
4,194 $
2,832
—
202
3,058 $
4,210
—
218
4,428 $
24 $
— $
2011
(a) The portion of this share-based compensation expense that was included in general and administrative expense totaled $5,751, $4,081 and
$2,502 for the same years respectively, and the portion capitalized to oil and gas properties was $3,791, $3,263 and $1,891, respectively.
The following table presents the specified share-based compensation expense for the indicated periods:
Unrecognized compensation costs related to:
Unvested RSU equity awards
Unvested cash-settleable RSU awards
For the year ended December 31,
2011
2012
2013
5,331
7,669
6,320
2,826
5,748
2,498
The Company’s future expected share-based compensation cost related to unvested RSU and cash-settleable RSU awards is expected to be
recognized over a weighted-average period of 1.4 years.
The following table summarizes the Company’s cash-settleable RSU awards for the periods indicated:
Consolidated Balance Sheets Classification
Accounts payable and accrued liabilities - current portion
Other long-term liabilities - non-current portion
Total cash-settleable RSU awards
2013
2012
2011
$
$
4,173 $
3,409
7,582 $
1,429 $
1,017
2,446 $
604
2,309
2,913
Stock Options
The Company issued no stock options for the past three years and had no options vest or forfeit during 2013. Additionally, no options were
exercised, 15 options expired unexercised during the year. As of December 31, 2013, the Company had 52 options outstanding and
exercisable at a weighted average exercise price per option of $13.75, with no aggregate intrinsic value and with a weighted-average
remaining contract life per unit of 2.3 years.
As of December 31, 2012, the Company had 67 options outstanding and exercisable at a weighted average exercise price per option of
$11.82, with no aggregate intrinsic value and with a weighted-average remaining contract life per unit of 2.7 years. The Company net-share
settles option exercises and therefore receives no cash proceeds from the exercise of stock options.
73
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
Restricted Stock Units
The following table represents unvested restricted stock activity for the year ended December 31, 2013:
Weighted average
Grant-Date Fair
Value per Share
Period over which
expense is expected
to be recognized
Number of Shares
2,295 $
944
(754 )
(223 )
2,262 $
5.58
3.82
5.10
5.37
5.03
1.5
Outstanding at the beginning of the period
Granted
Vested (a)
Forfeited
Outstanding at the end of the period
a.
The fair value of shares vested was
$2,689.
NOTE 9 – Equity Transactions
On May 30, 2013, the Company issued 78,947 of 10.0% Series A Cumulative Preferred Stock (the “Preferred Stock”) and received $70,035
net proceeds after deducting the underwriting commissions and offering expenses. The sale consisted of 1,579 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 $679 for the stub period beginning with the
issuance on May 30, 2013 through the dividend date on June 30, 2013. For the subsequent quarters ended September 30 and December 31,
2013, the Board of Directors declared for each quarter a dividend of $1.25 per share, or a total of $1,974, on the Company’s Preferred Stock,
resulting in total dividend expense recognized in 2013 of $4,627.
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 60,000 authorized shares at December 31, 2013, 16,800 shares were reserved for a
potential conversion. Subsequent to December 31, 2013, via a majority shareholder vote, the number of authorized shares of common stock
was increased from 60,000 to 110,000 with a corresponding increase in the number of common shares reserved for a potential conversion to
a maximum of 42,200 shares. Based on the Company’s closing common stock price of $6.53 per share on December 31, 2013, the Company
reserved 12,090 shares to satisfy the potential conversion.
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.
74
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
During February, 2011, the Company received $73,765 in net proceeds from the public offering of 10.1 million shares of its common stock,
which included the issuance of 1.1 million shares pursuant to the underwriters’ over-allotment option. The Company used $35,062 of the
proceeds to repurchase $31,000 principal amount of its Senior Notes, with the remaining proceeds intended for general corporate purposes
including the planned development of the Company’s Permian basin and other onshore assets.
NOTE 10 – Income Taxes
The following table presents Callon’s net tax benefits relating to its reported net losses and other temporary differences from operations:
Deferred tax asset
Federal net operating loss carryforward
Statutory depletion carryforward
Alternative minimum tax credit carryforward
Asset retirement obligations
Other
Total deferred tax asset
Deferred tax liability
Oil and natural gas properties
Other
Total deferred tax liability
Net deferred tax asset
For the Year Ended December 31
2013
2012
$
$
70,365 $
8,880
208
1,024
7,575
88,052
26,412
32
26,444
61,608 $
87,774
8,184
208
3,357
9,571
109,094
41,336
3,375
44,711
64,383
Prior to 2012, the Company carried a full valuation allowance against its net deferred tax assets. The Company considered both the positive
and negative evidence in determining whether it was more likely than not that its deferred tax assets were recoverable. The Company
incurred a loss in 2008, primarily as a result of a write-down of its oil and natural gas properties following the ceiling test, which created a
loss on an aggregate basis for the three-year period ended December 31, 2008. Primarily as a result of recent cumulative losses, the
Company established a full valuation allowance as of December 31, 2008, and continued to carry the full valuation allowance each
reporting period until December 31, 2011. At December 31, 2011, after considering all available positive and negative evidence, including
the Company’s profitable operations from 2009 to 2011 which resulted in income on an aggregate basis for the three year period ended
December 31, 2011, and future operating results based on proved reserves, the Company determined that it was more likely than not that it
would fully utilize its deferred tax assets recorded at December 31, 2011. Therefore, the Company reversed its valuation allowance at
December 31, 2011.
If not utilized, the Company’s federal operating loss (“NOL”) carryforwards will expire as follows:
Federal NOL carryforwards
$
Total
201,042 $
2014-2019
2020-2022
Year Expiring
2023-2025
2026-2028
— $
48,986 $
65,878 $
32,714 $
2029-2033
53,464
The Company has limited state taxable income. Accordingly, the Company has established a full valuation allowance on the tax benefits
associated with the state net operating loss carryforwards of approximately$167,795 which expire in years through 2033, as the Company
does not anticipate generating taxable state income in the states in which these carryforwards apply. These amounts are not included in the
deferred tax summary table above.
In 2009, the Company began to shift its operational focus from exploration, development and production in the Gulf of Mexico to the
acquisition and development of onshore properties. This shift in exploration and development activity resulted in an increase in Texas
income from production. This, coupled with the Company’s exit from the Gulf of Mexico (the sale of its interest in the Habanero field in
December 2012 and the Medusa field in December 2013), results in a change in the projected future Texas state tax rate beyond 2013 as a
component of overall anticipated future taxes.
75
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
The Company had no significant unrecognized tax benefits at December 31, 2013. Accordingly, the Company does not have any interest or
penalties related to uncertain tax positions. However, if interest or penalties were to be incurred related to uncertain tax positions, such
amounts would be recognized in income tax expense. Tax periods for years 2001 through 2013 remain open to examination by the federal
and state taxing jurisdictions to which the Company is subject.
Below is a reconciliation of the reported amount of income tax expense attributable to continuing operations to the amount of income tax
expense that would result from applying domestic federal statutory tax rates to pretax income from continuing operations.
Component of Income Tax Rate Reconciliation
Income tax expense computed at the statutory federal income tax rate
Change in valuation allowance
Percentage depletion carryforward
State taxes net of federal benefit
Restricted stock and stock options
Section 162(m)
Other
Effective income tax rate
Components of Income Tax Expense
Current federal income tax benefit
Current state income tax expense
Deferred federal income tax expense
Deferred state income tax expense
Valuation allowance
Total income tax expense (benefit)
NOTE 11 – Asset Retirement Obligations
For the Years Ended December 31,
2012
2013
2011
35 %
— %
(8)%
4 %
5 %
6 %
— %
42 %
35 %
— %
(22)%
6 %
2 %
22 %
4 %
47 %
35 %
(227)%
(3)%
— %
— %
— %
4 %
(191)%
For the Years Ended December 31,
2012
2013
2011
$
$
— $
326
2,652
126
—
3,104
$
— $
110
1,777
336
—
2,223
$
—
—
13,176
—
(82,459)
(69,283)
The following table summarizes the activity for the Company’s asset retirement obligations:
Asset retirement obligations at beginning of the period
Accretion expense
Liabilities incurred
Liabilities settled
Liabilities related to oil and gas properties sold
Revisions to estimate
Asset retirement obligations at end of period
Less: current asset retirement obligations
Long-term asset retirement obligations at the end of the period
For the Year Ended
December 31,
2013
2012
13,301 $
1,785
679
(457)
(4,765)
(3,811)
6,732
(4,120)
2,612 $
13,938
2,253
205
(1,073)
(877)
(1,145)
13,301
(2,336)
10,965
$
$
Certain of the Company’s operating agreements require that assets be restricted for future abandonment obligations. Amounts recorded on
the Consolidated Balance Sheets at December 31, 2013 as long-term restricted investments were $3,806. These assets, which primarily
include short-term U.S. Government securities, are held in abandonment trusts dedicated to pay future abandonment costs for several of the
Company’s oil and natural gas properties.
On December 5, 2013, the Company closed on its agreement to sell its interest in the Medusa field, Medusa Spar LLC, and substantially all
of its Gulf of Mexico shelf properties to W&T Offshore, Inc. (“W&T”). Under the agreement, W&T will assume an estimated $4,765 of the
ARO related to these offshore assets.
76
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
The Company’s total revisions to estimates of $3,811 for the year ended December 31, 2013 relate to downward revisions related to the
changes in the expecting timing of the abandonment.
NOTE 12 – Supplemental Information on Oil and Natural Gas Operations (Unaudited)
Oil and Natural Gas Properties
The following table discloses certain financial data relating to the Company’s oil and natural gas activities, all of which are located in the
United States.
Capitalized costs incurred:
Evaluated Properties-
Beginning of period balance
Capitalized G&A
Property acquisition costs
Exploration costs
Development costs
End of period balance
Unevaluated Properties (excluded from amortization):
Beginning of period balance
Acquisitions
Exploration
Capitalized interest
Transfers to evaluated
End of period balance
Accumulated depreciation, depletion and amortization:
Beginning of period balance
Provision charged to expense
Sale of mineral interests
End of period balance
$
$
$
$
$
$
For the Year Ended December 31,
2011
2012
2013
1,497,010 $ 1,421,640 $ 1,316,677
11,205
—
5,473
88,285
1,701,577 $ 1,497,010 $ 1,421,640
10,014
10,885
147,164
36,504
12,148
2,075
22,703
38,444
68,776 $
2,259
10,767
4,410
(42,990)
43,222 $
2,603 $
29,590
34,674
2,109
(200)
68,776 $
8,106
2,422
1,372
573
(9,870)
2,603
1,296,265 $ 1,208,331 $ 1,155,915
52,416
—
1,420,612 $ 1,296,265 $ 1,208,331
48,524
39,410
42,251
82,096
Unevaluated property costs primarily include lease acquisition costs incurred at federal lease sales, unevaluated drilling costs, seismic,
capitalized interest and certain overhead costs related to exploration and development. These costs are directly related to the acquisition and
evaluation of unproved properties and major development projects. The excluded costs and related reserves are included in the amortization
base as the properties are evaluated and proved reserves are established or impairment is determined. The Company expects that the
majority of these costs will be evaluated over the next three but within five years. The Company’s unevaluated property balance decreased
by $25,554 to $43,222 at December 31, 2013 compared to December 31, 2012. A significant portion of this decrease relates to the transfer
of drilling and completion costs from the unevaluated property base to the evaluated property base.
Subsequent to December 31, 2013 and through March 10, 2014, the Company completed six horizontal exploration wells, drilled four
horizontal wells and had two in progress. Additionally, the Company drilled two vertical exploratory wells and will be evaluating the results.
Depletion per unit-of-production (BOE) amounted to $31.12, $31.56 and $26.42 for the years ended December 31, 2013, 2012, and 2011,
respectively. Lease operating expense per unit-of-production (BOE) amounted to $14.00, $14.81, and $9.92 for the years ended
December 31, 2013, 2012, and 2011, respectively.
77
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
Under the full-cost accounting rules of the SEC, the Company reviews the carrying value of its proved oil and natural gas properties each
quarter. Under these rules, capitalized costs of oil and natural gas properties, net of accumulated depreciation, depletion and amortization
and deferred income taxes, may not exceed the present value of estimated future net cash flows from proved oil and natural gas reserves,
discounted at 10%, plus the lower of cost or fair value of unevaluated properties, net of related tax effects (the full-cost ceiling
amount). These rules generally require pricing based on the preceding 12-months’ average oil and natural gas prices based on closing prices
on the first day of each month and require a write-down if the “ceiling” is exceeded. Given the volatility of oil and natural gas prices, it is
reasonably possible that the Company’s estimate of discounted future net cash flows from proved oil and natural gas reserves could change
in the near term. If oil and natural gas prices decline significantly, even if only for a short period of time, it is possible that write-downs of
oil and natural gas properties could occur in the future. For the years ended December 31, 2013, 2012, and 2011, the Company recorded no
impairment charges related to its oil and natural gas properties as a result of this calculation.
Estimated Reserves
The Company’s proved oil and natural gas reserves at December 31, 2013, 2012 and 2011 have been estimated by Huddleston & Co., Inc.,
the Company’s independent petroleum engineers. The reserves were prepared in accordance with guidelines established by the
SEC. Accordingly, the following reserve estimates are based upon existing economic and operating conditions.
There are numerous uncertainties inherent in establishing quantities of proved reserves. The following reserve data represents estimates
only, and should not be deemed exact. In addition, the standardized measure of discounted future net cash flows should not be construed as
the current market value of the Company’s oil and natural gas properties or the cost that would be incurred to obtain equivalent reserves.
78
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
Changes in the estimated net quantities of oil and natural gas reserves, all of which are located onshore within the continental United States
and offshore within the Gulf of Mexico, are as follows:
Reserve Quantities
For the year ended December 31,
2012
2011
2013
Proved developed and undeveloped reserves:
Oil (MBbls):
Beginning of period
Revisions to previous estimates
Purchase of reserves in place
Sale of reserves in place
Extensions and discoveries
Production
End of period
Natural Gas (MMcf):
Beginning of period
Revisions to previous estimates
Purchase of reserves in place
Sale of reserves in place
Extensions and discoveries
Production
End of period
Proved developed reserves:
Oil (MBbls):
Beginning of period
End of period
Natural Gas (MMcf):
Beginning of period
End of period
MBOE:
Beginning of period
End of period
Proved undeveloped reserves:
Oil (MBbls):
Beginning of period
End of period
Natural Gas (MMcf):
Beginning of period
End of period
MBOE
Beginning of period
End of period
10,780
(2,540)
150
(3,294)
7,713
(911)
11,898
19,753
(5,351)
317
(4,576)
10,619
(3,011)
17,751
4,955
5,960
10,680
9,059
6,735
7,470
5,825
5,938
9,073
8,692
7,337
7,387
10,075
(488)
38
(504)
2,636
(977)
10,780
35,118
(10,838 )
115
(4,404)
3,350
(3,588)
19,753
5,069
4,955
11,605
10,680
7,003
6,735
5,006
5,825
23,513
9,073
8,925
7,337
8,149
(110)
—
(30 )
3,062
(996)
10,075
32,957
486
—
(308)
7,064
(5,081)
35,118
4,503
5,069
12,715
11,605
6,622
7,003
3,645
5,006
20,241
23,513
7,019
8,925
Total Proved Reserves: The Company ended 2013 with estimated net proved reserves of 14,857 MBOE, representing a 6% increase over
2012 year-end estimated net proved reserves of 14,072 MBOE. The increase is primarily due the Company’s development of its Permian
basin, on which it drilled a total of 26 oil wells during 2013. The increase is offset by the sale of the Company’s interest in the Medusa field
and due to the Company’s reclassification of certain vertical PUD locations to the horizontal probable and PUD categories.
Extrapolation of performance history and material balance estimates were utilized by the Company’s independent petroleum and geological
firm to project future recoverable reserves for the producing properties where sufficient history existed to suggest performance trends and
where these methods were applicable to the subject reservoirs. The projections for the remaining producing properties were necessarily
based on volumetric calculations and/or analogy to nearby producing completions. Reserves assigned to nonproducing zones and
undeveloped locations were projected on the basis of volumetric calculations and analogy to nearby production, and to a small extent,
horizontal PDP and PUD categories.
79
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
Proved Undeveloped Reserves: The Company annually reviews its proved undeveloped reserves (“PUDs”) to ensure an appropriate plan for
development exists. Generally, reserves for the Company’s onshore properties are booked as PUDs only if the Company has plans to
convert the PUDs into proved developed reserves within five years of the date they are first booked as PUDs. The Company’s PUDs
increased 1% to 7,387 MBOE from 7,337 MBOE at December 31, 2013 and 2012, respectively. The Company added 5,168 MBOE to its
PUDs, primarily from the continued horizontal development of its Permian Basin properties. The increase in Permian Basin PUDs was
partially offset by the reclassification of 3,724 MBOE, or 51%, included in the year-end 2012 PUD reserves related to vertical PUD
locations that were reclassified to the horizontal probable, and to a small extent, horizontal PDP and PUD categories. The reclassified
vertical PUDs include Wolfberry PUD locations that included certain target zones that are now expected to be more efficiently developed by
the Company’s multi-level horizontal drilling programs initiated in 2012. Also offsetting the Permian Basin PUD growth were the sale of
1,297 MBOE, or 18%, included in the year-end 2012 PUD reserves related to our Medusa field and the conversion of a small portion of
2012 PUD reserves to PDPs during 2013 from the drilling of vertical wells.
The Company’s PUDs decreased 18% to 7,337 MBOE from 8,925 MBOE at December 31, 2012 and 2011, respectively. Additions during
the year added 2,344 MBOE to the Company’s PUDs, offset by (1) 557 MBOE primarily comprised of transfers to PDPs as a result of our
development program, (2) 1,148 MBOE related to the sale of Habanero, and (3) 2,227 MBOE related to reductions in our PUD reserves,
primarily related to the Haynesville Shale, by amounts no longer deemed to be economic PUDs at year-end. Of the Company’s year-end
2011 PUD reserves, 6% were converted to proved developed producing reserves by year end 2012, at a total cost of approximately $19
million, net.
Of the Company’s 2012 PUDs, 1,297 MBOE were attributable to the Company’s offshore properties in the Medusa field in the Gulf of
Mexico. As previously noted, the Company sold its interest in the Medusa field during 2013.
Standardized Measure
The following tables present the standardized measure of future net cash flows related to estimated proved oil and natural gas reserves
together with changes therein, including a reduction for estimated plugging and abandonment costs that are also reflected as a liability on the
balance sheet at December 31, 2013. You should not assume that the future net cash flows or the discounted future net cash flows, referred
to in the tables below, represent the fair value of our estimated oil and natural gas reserves. Prices are based on either the preceding 12-
months’ average price based on closing prices on the first day of each month, or prices defined by existing contractual arrangements. The
following table summarizes the average 12-month oil and natural gas prices net of differentials for the respective periods:
Average 12-month price, net of differentials, per Mcf of natural gas
Average 12-month price, net of differentials, per barrel of oil
2013
2012
2011
$
$
5.45 $
92.16
4.81 $
94.68
5.60
98.98
Future production and development costs are based on current costs with no escalations. Estimated future cash flows net of future income
taxes have been discounted to their present values based on a 10% annual discount rate.
Natural gas production from our deepwater and Permian Basin properties has a high Btu content of separator natural gas. The natural gas
Mcf prices of $5.45 and $4.81 used in the 2013 and 2012 reserve estimates include adjustments to reflect the Btu content, transportation
charges and other fees specific to the individual properties. The oil prices of $92.16 and $94.68 used in the 2013 and 2012 reserve estimates
have been adjusted to reflect all wellhead deductions and premiums on a property-by-property basis, including transportation costs, location
differentials and crude quality.
80
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
Future cash inflows
Future costs -
Production
Development and net abandonment
Future net inflows before income taxes
Future income taxes
Future net cash flows
10% discount factor
Standardized measure of discounted future net cash flows
Standardized measure at the beginning of the period
Changes
Sales and transfers, net of production costs
Net change in sales and transfer prices, net of production costs
Net change due to purchases and sales of in place reserves
Extensions, discoveries, and improved recovery, net of future production and
development costs incurred
Changes in future development cost
Revisions of quantity estimates
Accretion of discount
Net change in income taxes
Changes in production rates, timing and other
Aggregate change
Standardized measure at the end of period
NOTE 13 – Other
Standardized Measure
For the year ended December 31,
2013
2012
1,193,299 $ 1,115,570 $ 1,194,079
2011
(357,005)
(155,667)
680,627
(68,239)
612,388
(328,442)
283,946 $
(249,329)
(273,817)
592,424
(55,772)
536,652
(305,504)
231,148 $
(356,653)
(268,628)
568,798
(78,813)
489,985
(219,628)
270,357
Changes in Standardized Measure
For the year ended December 31,
2012
2013
270,357 $
231,148 $
2011
198,916
(78,661)
(46,088)
(145,711)
(84,044)
47,261
(35,665)
(107,297)
125,518
1,275
212,431
153,983
(68,958)
25,010
1,751
(959)
52,798
283,946 $
53,446
39,815
(77,322)
30,989
13,969
(27,658)
(39,209)
231,148 $
22,598
(83,110)
(949)
68,384
(32,918)
77,940
71,441
270,357
$
$
$
$
Commitments and Contingencies: The Company is involved in various claims and lawsuits incidental to its business. In the opinion of
management, the ultimate liability hereunder, if any, will not have a material adverse effect on the financial position or results of operations
of the Company.
The Company’s activities are subject to federal, state and local laws and regulations governing environmental quality and pollution
control. Although no assurances can be made, the Company believes that, absent the occurrence of an extraordinary event, compliance with
existing federal, state and local laws, rules and regulations governing the release of materials into the environment or otherwise relating to
the protection of the environment are not expected to have a material effect upon the capital expenditures, earnings or the competitive
position of the Company with respect to its existing assets and operations. The Company cannot predict what effect additional regulation or
legislation, enforcement policies hereunder, and claims for damages to property, employees, other persons and the environment resulting
from the Company’s operations could have on its activities.
Global Settlement with Joint Interest Partner: During 2011, the Company and a joint interest partner entered into a settlement agreement
related to various disputes. All matters were settled and as result of the settlement agreement the Company received an interest in other
specialized deep water property and equipment. The Company recognized a gain of $5,041 as a result of the settlement and classified the
property and equipment received as held for sale assets, included within other property and equipment since the Company had no use for
this type of equipment in its operations. Since the settlement with its joint interest partner, the Company has sold a portion of these assets
and has continued to actively market the remaining assets throughout 2012 and 2013. During 2012, after selling assets valued at $527 during
the year, the Company determined that certain equipment components were not usable without additional rework and thus recorded an
impairment charge to its Statement of Operations of $1,177 during
81
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
2012. During 2013, after selling assets value at $114 during the year, the Company has made a decision to abandon the equipment. As such
the Company recorded an impairment charge of $1,707 to its Statement of Operations, representing the remaining value of this equipment.
Operating Leases: In April 2012, the Company took delivery of a drilling rig (the “Cactus 1 Rig”) for a term of two years, which it
subsequently renewed on March 6, 2014 for an additional two year term ending April 2016. On August 1, 2013, the Company contracted a
second horizontal drilling rig (the “Patterson Rig”) for a one-year term, though the Company provided notice on February 17, 2014 that it
will cancel its Patterson rig contract on or about March 17, 2014. Under the early termination provisions of the agreement, estimated
termination payments for this rig will be approximately $2,055 in 2014. Should the lessor be able to re-charter the rig, the termination
payments would be reduced. To replace the Patterson Rig, the Company contracted a replacement rig (the “Cactus 2 Rig”) for a term of two
years, which is scheduled to commence operations on April 1, 2014. Similar to the Patterson Rig, the Cactus 1 and 2 Rig lease agreements
also 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. Lease costs recorded during 2013 were $12,860. Lease payments as of December 31,
2013 will approximate $13,954, $9,308 and $2,295 in 2014, 2015 and 2016, respectively. Including the additional lease commitments
executed subsequent to December 31, 2013, the Company’s drilling rig lease commitments as of March 10, 2014 are $19,732, $18,250 and
$4,500 in 2014, 2015, and 2016, respectively.
Property Acquisitions and Dispositions
Acquisitions
During the second quarter of 2013, the Company acquired approximately 2,468 gross (2,186 net) acres in Reagan and Upton Counties,
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 1,301 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).
During the first quarter of 2012, the Company acquired approximately 16,233 gross (14,653 net) acres in Borden County, which is located
in the northern Midland basin. The northern Midland basin has had limited drilling activity compared with the southern Midland basin
(where our current production is located), increasing the economic risk related to these drilling activities. The purchase price of $14,538
was funded from existing cash balances. During the third quarter of 2012, we acquired an additional 8,095 gross acres (6.964 net) in this
area for a total consideration of $4,835.
During the second quarter of 2012, the Company signed a purchase and sale agreement to acquire 2,319 gross (1.762 net) acres in southern
Reagan County, Texas for a total purchase price of $12,012, which was financed with a draw on the Credit Facility. The transaction had an
effective date of May 1, 2012 and closed on July 5, 2012.
Dispositions
During the fourth quarter of 2013, the Company closed on the sale of its 15.0% working interest in the Medusa field (Mississippi Canyon
blocks 582 and 538), our 10.0% membership interest in Medusa Spar LLC, and substantially all of our remaining Gulf of Mexico shelf
properties. The Company sold its interest in Medusa to W&T, an unrelated third-party, for a total net cash consideration of approximately
$88,000 after customary purchase price adjustments. Also during the fourth quarter of 2013, the Company closed on the sale of its 69%
interest in the Swan Lake field for $2,000. This was the Company’s only field in the Haynesville shale. Consistent with the Company’s
accounting policy discussed in Note 2, the proceeds from these sales were accounted for as a reduction to capitalized costs as the sale did
not significantly alter the relationship between capitalized costs and proved reserves.
Effective December 28, 2012, the Company closed on the sale of its 11.25% working interest in the Habanero field (Garden Banks Block
341). The Company sold its interest in Habanero to Shell Offshore Inc., a subsidiary of Royal Dutch Shell Plc, for an estimated net cash
consideration of $39,410 after customary purchase price adjustments. As noted above, the proceeds from this sale were accounted for as a
reduction to capitalized costs as the sale did not significantly alter the relationship between capitalized costs and proved reserves.
82
Callon Petroleum Company
Notes to the Consolidated Financial Statements
(All amounts in thousands, except well, acreage, per-share and per-derivative instrument data)
Table of Contents
NOTE 14 – Summarized Quarterly Financial Information (Unaudited)
2013
Total revenues
Income from operations
Net income (loss)
Income (loss) available to common shares
Income (loss) per common share - basic
Income (loss) per common share - diluted
2012
Total revenues
Income from operations
Income (loss) available to common shares
Income (loss) per common share - basic
Income (loss) per common share - diluted
Second
Quarter
Third
Quarter
Fourth
Quarter
22,760 $
957
758
78
0.00 $
0.00 $
30,797 $
6,345
1,082
(892)
(0.02) $
(0.02) $
26,471
2,464
3,264
1,291
0.03
0.03
Second
Quarter
Third
Quarter
Fourth
Quarter
25,360 $
2,759
3,799
0.10 $
0.09 $
27,402 $
2,563
(1,105)
(0.03) $
(0.03) $
28,677
2,652
(435)
(0.01)
(0.01)
First Quarter
$
22,541 $
898
(800)
(800)
(0.02) $
(0.02) $
$
$
First Quarter
$
29,294 $
2,716
488
0.01 $
0.01 $
$
$
83
ITEM 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
There have been no disagreements with the independent auditors on any matters of accounting principles or practices, financial statement
disclosure, or auditing scope or procedures.
ITEM 9A. Controls and Procedures
Disclosure Controls and Procedures. Disclosure controls and procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Securities Exchange Act of 1934,
as amended (the “Exchange Act”), is accumulated and communicated to the issuer’s management, including its principal executive and
financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. The
Company’s principal executive and principal financial officers have concluded that the Company’s disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective as of December 31, 2013.
Management’s Report on Internal Control over Financial Reporting. Management is responsible for establishing and maintaining adequate
internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control
structure is designed to provide reasonable assurance to our management and Board of Directors regarding the reliability of financial
reporting and the preparation and fair presentation of our financial statements prepared for external purposes in accordance with U.S.
generally accepted accounting principles. Under the supervision and with the participation of our management, including our CEO and
CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2013 based on the
framework in Internal Control – Integrated Framework published by the Committee of Sponsoring Organizations (COSO) of the Treadway
Commission (1992 framework)(the COSO criteria). Based on that evaluation, management concluded that our internal control over
financial reporting was effective as of December 31, 2013.
Because of its inherent limitations, internal control over financial reporting can provide only reasonable assurance that the objectives of the
control system are met and may not prevent or detect misstatements. In addition, any evaluation of the effectiveness of internal controls
over financial reporting in future periods is subject to risk that those internal controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s independent registered public accounting firm has issued an attestation report regarding its assessment of the Company’s
internal control over financial reporting as of December 31, 2013, which follows Part II, Item 9B of this filing. Additionally, the financial
statements for each of the years covered in this Annual Report on Form 10-K have been audited by an independent registered public
accounting firm, Ernst & Young LLP whose report is presented immediately preceding the Company’s financial statements included in Part
II, Item 8 of this Annual Report on Form 10-K.
Changes in Internal Control over Financial Reporting. There were no changes to our internal control over financial reporting during our
last fiscal quarter that have materially affected, or are reasonable likely to materially affect, our internal control over financial reporting.
ITEM 9A (T). Controls and Procedures
See Item 9A.
ITEM 9B. Other Information
Submissions of Matters to a Vote of the Security Holders
None.
84
Report of Independent Registered Public Accounting Firm
Table of Contents
The Board of Directors and Stockholders of
Callon Petroleum Company
We have audited Callon Petroleum Company’s internal control over financial reporting as of December 31, 2013 based on criteria
established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission
(1992 framework)(the COSO criteria). Callon Petroleum Company’s management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying
Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal
control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial
reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on
the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit
provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of
management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of
any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Callon Petroleum Company maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2013, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Callon Petroleum Company as of December 31, 2013 and 2012, and the related statements of operations,
comprehensive income, cash flow, and changes in stockholders’ equity (deficit) for each of the three years in the period ended December
31, 2013, and our report dated March 12, 2014 expressed an unqualified opinion thereon.
/s/Ernst & Young LLP
New Orleans, Louisiana
March 12, 2014
85
ITEM 10. Directors, Executive Officers and Corporate Governance
PART III.
For information concerning Item 10, see the definitive proxy statement of Callon Petroleum Company relating to the Annual Meeting of
Stockholders to be held on May 15, 2014 which will be filed with the Securities and Exchange Commission and is incorporated herein by
reference.
The Company has adopted a code of ethics that applies to the Company’s chief executive officer, chief financial officer and chief
accounting officer. The full text of such code of ethics has been posted on the Company’s website at www.callon.com, and is available free
of charge in print to any shareholder who requests it. Request for copies should be addressed to the Secretary at mailing address Post Office
Box 1287, Natchez, Mississippi 39121.
ITEM 11. Executive Compensation
For information concerning Item 11, see the definitive proxy statement of Callon Petroleum Company relating to the Annual Meeting of
Stockholders to be held on May 15, 2014 which will be filed with the Securities and Exchange Commission and is incorporated herein by
reference.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
For information concerning the security ownership of certain beneficial owners and management, see the definitive proxy statement of
Callon Petroleum Company relating to the Annual Meeting of Stockholders to be held on May 15, 2014 which will be filed with the
Securities and Exchange Commission and is incorporated herein by reference.
ITEM 13. Certain Relationships and Related Transactions and Director Independence
For information concerning Item 13, see the definitive proxy statement of Callon Petroleum Company relating to the Annual Meeting of
Stockholders to be held on May 15, 2014 which will be filed with the Securities and Exchange Commission and is incorporated herein by
reference.
ITEM 14. Principal Accountant Fees and Services
For information concerning Item 14, see the definitive proxy statement of Callon Petroleum Company relating to the Annual Meeting of
Stockholders to be held on May 15, 2014 which will be filed with the Securities and Exchange Commission and is incorporated herein by
reference.
86
ITEM 15. Exhibits
Exhibit
1
2
3
2
3
4
Exhibits
3.1
3.2
3.3
3.4
4.1
4.2
4.3
4.4
4.5
4.6
PART IV.
Description
The following is an index to the financial statements and financial statement schedules that are filed in Part
II, Item 8 of this report on Form 10-K.
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2013 and 2012
Consolidated Statements of Operations for each of the three years in the period ended December 31,
2013
Consolidated Statements of Stockholders’ Equity (Deficit) for each of the three years in the Period
Ended December 31, 2013
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31,
2013
Notes to Consolidated Financial Statements
Schedules other than those listed above are omitted because they are not required, not applicable or the
required information is included in the financial statements or notes thereto.
Plan of acquisition, reorganization, arrangement, liquidation or succession*
Articles of Incorporation and Bylaws
Certificate of Incorporation of the Company, as amended (incorporated by reference to Exhibit 3.1 of
the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, File No. 001-
14039)
Bylaws of the Company (incorporated by reference from Exhibit 3.2 of the Company’s Registration
Statement on Form S-4, filed August 4, 1994, Reg. No. 33-82408)
Certificate of Amendment to Certificate of Incorporation of the Company (incorporated by reference
to Exhibit 3.3 of the Company’s Annual Report on Form 10-K for the year ended December 31,
2003, File No. 001-14039)
Certificate of Amendment to the Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.4 of the Company’s Annual Report on Form 10-K for the
year ended December 31, 2010, File No. 001-14039)
Instruments defining the rights of security holders, including indentures
Specimen Common Stock Certificate (incorporated by reference from Exhibit 4.1 of the Company’s
Registration Statement on Form S-4, filed August 4, 1994, Reg. No. 33-82408)
Rights Agreement between Callon Petroleum Company and American Stock Transfer & Trust
Company, Rights Agent, dated March 30, 2000 (incorporated by reference from Exhibit 99.1 of the
Company’s Registration Statement on Form 8-A, filed April 6, 2000, File No. 001-14039)
Indenture for the Company’s 13.00% Senior Notes due 2016, dated November 24, 2009, between
Callon Petroleum Company, the subsidiary guarantors described therein, Regions Bank and American
Stock Transfer & Trust Company (incorporated by reference to Exhibit T3C to the Company’s Form
T3, filed November 19, 2009, File No. 022-28916)
Certificate of Designations of 10% Cumulative Preferred Stock (incorporated by reference to Exhibit
3.5 of the Company’s Form 8-A filed May 23, 2013)
Certificate for the Company’s 10% Cumulative Preferred Stock (incorporated by reference to Exhibit
4.1 of the Company’s Form 8-A filed May 23, 2013
Amendment to the Certificate of Incorporation increasing the number of authorized shares of
common stock [Filed herewith]
9
10
Voting trust agreement
None
Material contracts
10.1
10.2
Callon Petroleum Company 1994 Stock Incentive Plan (incorporated by reference from Exhibit 10.5
of the Company’s Registration Statement on Form 8-B, filed October 3, 1994)
Callon Petroleum Company 1996 Stock Incentive Plan as amended on May 9, 2000 (incorporated by
reference from Appendix I of the Company’s Definitive Proxy Statement on Schedule 14A, filed
March 28, 2000, File No. 001-14039)
87
10.3
10.4
10.5
10.6
10.7
10.8
10.9
10.10
10.11
10.12
10.13
10.14
10.15
10.16
10.17
10.18
10.19
10.20
10.21
10.22
Callon Petroleum Company 2002 Stock Incentive Plan (incorporated by reference to Exhibit 10.13 of
the Company’s Annual Report on Form 10-K for the year ended December 31, 2001, File No. 001-
14039)
Amendment No. 3 to the Callon Petroleum Company 1996 Stock Incentive Plan (incorporated by
reference from Exhibit 10.1 of the Company’s Current Report on Form 8-K, filed January 5, 2009,
File No. 001-14039)
Amendment No. 1 to the Callon Petroleum Company 2002 Stock Incentive Plan (incorporated by
reference from Exhibit 10.2 of the Company’s Current Report on Form 8-K, filed January 5, 2009,
File No. 001-14039)
Callon Petroleum Company Amended and Restated 2006 Stock Incentive Plan (incorporated by
reference from Exhibit 10.3 of the Company’s Current Report on Form 8-K, filed January 5, 2009,
File No. 001-14039)
Callon Petroleum Company 2009 Stock Incentive Plan effective as of April 30, 2009 (incorporated
by reference from Exhibit A to the Company’s Definitive Proxy Statement on Schedule 14A, filed
March 30, 2009, File No. 001-14039)
Amendment to the Callon Petroleum Company 1996 Stock Incentive Plan effective as of August 7,
2009 (incorporated by reference from Exhibit 10.1 of the Company’s Quarterly Report on Form 10-Q
for the period ended September 30, 2009, File No. 001-14039)
Callon Petroleum Company 2010 Phantom Share Plan, adopted May 4, 2010 (incorporated by
reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on May 7, 2010)
Form of Callon Petroleum Company Phantom Share Award Agreement, adopted May 4, 2010
(incorporated by reference to Exhibit 10.2 of the Company’s current Report on Form 8-K filed on
May 7 , 2010)
Deferred Compensation Plan for Outside Directors; Callon Petroleum Company (effective as of
January 1, 2011) (incorporated by reference to Exhibit 10.17 of the Company’s Annual Report on
Form 10-K for the year ended December 31, 2010, File No. 001-14039)
Amended and Restated Severance Compensation Agreement, dated as of March 15, 2011 and
effective as of January 1, 2011, by and between Fred L. Callon and Callon Petroleum Company
(incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed on
March 18, 2011)
Form of Amended and Restated Severance Compensation Agreement, dated as of March 15, 2011 and
effective as of January 1, 2011, by and between Callon Petroleum Company and its executive officers
(incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed on
March 18, 2011)
Severance Compensation Agreement, dated as of September 21, 2011, by and between Gary A.
Newberry and Callon Petroleum Company (incorporated by reference to Exhibit 10.1 of the
Company’s Current Report on Form 8-K filed on September 21, 2011)
Fourth Amended and Restated Credit Agreement dated as of June 20, 2012, by and among the
Company, the “Lenders” described therein, and Regions Bank as the sole arranger and administrative
agent (incorporated by reference from Exhibit 10.1 on Form 8-K, filed June 25, 2012, File No. 001-
14039)
Fourth Amended and Restated Revolving Promissory Note dated June 20, 2012 (incorporated by
reference from Exhibit 10.1 on Form 8-K, filed June 25, 2012, File No. 001-14039)
Fourth Amended and Restated Guaranty Agreement dated June 20, 2012 (incorporated by reference
from Exhibit 10.1 on Form 8-K, filed June 25, 2012, File No. 001-14039)
Master Assignment, Agreement and Amendment No. 1 to the Fourth Amended and Restated Credit
Agreement (incorporated by reference from Exhibit 10.1 on Form 8-K, filed October 16, 2012, File
No. 001-14039)
Purchase and Sale Agreement by and between Shell Offshore Inc. and Callon Petroleum Operating
Company dated as of November 27, 2012.
Callon Petroleum Company 2011 Omnibus Incentive Plan (incorporated by reference from Exhibit A
of the Company’s Definitive Proxy Statement on Schedule 14A filed March 21, 2011, File No.
14039)
Purchase and Sale Agreement by and between W&T Offshore, Inc. and Callon Petroleum Company
dated as of December 5, 2013
Underwriting Agreement relating to the Company’s 10% Cumulative Preferred Stock (incorporated
by reference to Exhibit 1.1 of the Company’s Form 8-K filed on May 28, 2013).
88
10.23
14.1
Agreement, dated March 9, 2014, among the Company and Lone Star Value Investors, L.P., Lone
Star Value Co-Invest I, L.P., Lone Star Value Investors GP, LLC, Lone Star Value Management,
LLC, Jeffery E. Eberwein and Matthew R. Bob (incorporated by reference from Exhibit 10.1 on Form
8-K, filed on March 10, 2014, File No. 001-14039)
Statement re computation of per share earnings*
Statements re computation of ratios*
Annual Report to security holders, Form 10-Q or quarterly reports*
Code of Ethics
Code of Ethics for Chief Executive Officers and Senior Financial Officers (incorporated by reference
to Exhibit 14.1 of the Company’s Annual Report on Form 10-K for the year ended December 31,
2003, File No. 001-14039)
Letter re change in certifying accountant*
Letter re change in accounting principles*
Subsidiaries of the Company
21.1
Subsidiaries of the Company
23.1
23.2
31.1
31.2
Published report regarding matters submitted to vote of security holders*
Consents of experts and counsel
Consent of Ernst & Young LLP
Consent of Huddleston & Co., Inc.
Power of attorney*
Rule 13a-14(a) Certifications
Certification of Chief Executive Officer pursuant to Rule 13(a)-14(a)
Certification of Chief Financial Officer pursuant to Rule 13(a)-14(a)
Section 1350 Certifications of Chief Executive and Financial Officers pursuant to
Rule 13(a)-14(b)
Additional Exhibits
11
12
13
14
16
18
21
22
23
24
31
32
99
99.1
Reserve Report Summary prepared by Huddleston and Co. as of December 31, 2013
101
Interactive Data Files **
*
**
Not applicable to this filing
Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a
registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or
Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to
liability.
89
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURES
Date:
March 12, 2014
Date:
March 12, 2014
Date:
March 12, 2014
Date:
March 12, 2014
Date:
March 12, 2014
/s/ Fred L. Callon
Fred L. Callon (principal executive officer, director)
/s/ B. F. Weatherly
B. F. Weatherly (principal financial officer, director)
/s/ Rodger W. Smith
Rodger W. Smith (principal accounting officer)
/s/ L. Richard Flury
L. Richard Flury (director)
/s/ John C. Wallace
John C. Wallace (director)
Date:
March 12, 2014
/s/ Anthony J. Nocchiero
Anthony J. Nocchiero (director)
Date:
March 12, 2014
/s/ Larry D. McVay
Larry McVay (director)
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
Date:
March 12, 2014
/s/ B. F. Weatherly
B. F. Weatherly, Executive Vice President and
Chief Financial Officer (Principal Financial Officer)
90
Exhibit 21.1
Subsidiaries of Callon Petroleum Company
Name
State of Incorporation
Callon Offshore Production, Inc.
Callon Petroleum Operating Company
Mississippi Marketing, Inc.
Mississippi
Delaware
Mississippi
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the following Registration Statements:
Registration Statement (Form S-3 No. 333-176811) of Callon Petroleum Company and the related Prospectus, and
Registration Statement (Form S-8 No. 333-109744) pertaining to the Callon Petroleum Company Employee Savings and
Protection Plan, and
Registration Statement (Form S-8 No. 333-176061) pertaining to the Callon Petroleum Company 2011 Omnibus Incentive
Plan, and
Registration Statement (Form S-8 No. 333-188008) pertaining to the Callon Petroleum Company Employee Savings and
Protection Plan;
of our reports dated March 12, 2014, with respect to the consolidated financial statements of Callon Petroleum Company and the
effectiveness of internal control over financial reporting of Callon Petroleum Company, included in this Annual Report (Form 10-
K) of Callon Petroleum Company for the year ended December 31, 2013.
/s/Ernst & Young LLP
New Orleans, Louisiana
March 12, 2014
EXHIBIT 23.2
Huddleston & Co., Inc.
Petroleum and Geological Engineers
1 Houston Center
1221 McKinney, Suite 3700
Houston, Texas 77010
PHONE (713) 209-1100 FAX (713) 752-0828
CONSENT OF HUDDLESTON & CO., INC.
As independent oil and gas consultants, we hereby consent to the references to us and our reserve reports for the years ended December 31,
2013, 2012, and 2011 in Callon's Annual Report on Form 10-K for the year ended December 31, 2013 and the incorporation by reference
of our reports in the following Registration Statements:
Registration Statement (Form S-8 No. 333-109744) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-176061) of Callon Petroleum Company;
Registration Statement (Form S-3 No. 333-176811) of Callon Petroleum Company;
Registration Statement (Form S-8 No. 333-188008) of Callon Petroleum Company;
HUDDLESTON & CO., INC.
Texas Registered Engineering Firm F-1024
/s/Peter D. Huddleston
Peter D. Huddleston, P.E.
President
Houston, Texas
March 12, 2014
Exhibit 31.1
I, Fred L. Callon, certify that:
CERTIFICATIONS
1.
2.
I have reviewed this Annual Report on Form 10-K of Callon Petroleum Company;
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect
to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this
report;
4.
The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in
Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this report is being prepared;
(b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles;
(c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on
such evaluation; and
(d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or
is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the
equivalent function):
(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information;
and
(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal controls over financial reporting;
Date:
March 12, 2014
/s/ Fred L. Callon
Fred L. Callon, President and Chief Executive Officer
(Principal executive officer)
Exhibit 31.2
CERTIFICATIONS
I, B. F. Weatherly, certify that:
1.
I have reviewed this Annual Report on Form 10-K of Callon Petroleum
Company;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with
respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all
material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented
in this report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange
Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a.
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed
under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this report is being prepared;
b.
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles;
c.
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on
such evaluation; and
d.
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or
is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over
financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing
the equivalent function):
a.
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information;
and
b.
Any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal controls over financial reporting;
Date:
March 12, 2014
/s/ B. F. Weatherly
B. F. Weatherly, Executive Vice President and
Chief Financial Officer (Principal Financial Officer)
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
EXHIBIT 32
In connection with the Annual Report on Form 10-K of Callon Petroleum Company. (the “Company”) for the year ended December 31,
2013 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, in the capacities and on the
dates indicated below, each hereby certify pursuant to 18 U.S.C. section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, that the Report fully complies with requirements of Section 13(a) of 15(d) of the Securities Exchange Act of 1934 and the
information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the
Company.
Date:
March 12, 2014
Date:
March 12, 2014
/s/ Fred L. Callon
Fred L. Callon (principal executive officer, director)
/s/ B. F. Weatherly
B. F. Weatherly (principal financial officer, director)
The foregoing certification is being furnished as an exhibit to the Report pursuant to Item 601(b)(32) of Regulation S-K and Section 906 of
the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code) and, accordingly, is
not being filed as part of the Report for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not incorporated
by reference into any filing of the Company, whether made before or after the date hereof, regardless of any general incorporation
language in such filing.
Exhibit 99.1
Huddleston & Co., Inc.
Petroleum and Geological Engineers
1221 McKinney, Suite 3700
Houston, Texas 77010
_________
PHONE (713) 209-1100 FAX (713) 752-0828
January 22, 2014
Re: Callon Petroleum Company
Estimated Future Reserves and Revenues
As of December 31, 2013
Callon Petroleum Company
200 North Canal Street
Natchez, Mississippi 39120
Gentlemen:
Pursuant to your request, we have estimated oil and natural gas reserves and projected revenues for all properties owned by
Callon Petroleum Company. It is our understanding that the Proved reserves estimates shown herein constitute all of the
Proved reserves owned by Callon. The active properties are located in Borden, Crockett, Ector, Midland, Reagan and Upton
Counties, Texas. There are inactive properties remaining to be abandoned which are located in Federal waters of the Gulf of
Mexico.
Our conclusions, as of December 31, 2013, follow:
Constant Product Prices
Estimated Future Net Oil/Cond., Mbbl
Estimated Future Net (Sales) Gas, MMcf
Estimated Future Gross Revenue, $M
Estimated Future Operating Expenses, $M
Estimated Future Production Taxes, $M
Estimated Future Capital Costs, $M
Estimated Future Net Revenue (“FNR”), $M
Estimated FNR Discounted at 10%, $M
Projected Revenues by Year - Constant Product Prices, $M
2014
2015
2016
Thereafter
Total
Estimated 2014 Production
Oil/Cond., Mbbl
Gas (Sales), MMcf
*Numbers subject to rounding.
Net to Callon Petroleum Company*
Proved Developed
Proved
Producing
Nonproducing Undeveloped
Total
Proved
4,840.9
7,781.0
1,120.6
1,277.3
5,938.0
8,692.2
11,899.4
17,750.6
487,483.7
182,262.3
23,623.6
4,847.4
276,750.4
173,466.1
62,307.3
33,002.5
23,972.4
157,468.2
276,750.4
110,174.3
20,299.3
5,259.7
17,766.0
66,849.3
29,607.6
595,656.1 1,193,314.0
82,207.7
284,769.4
28,813.6
57,696.8
147,691.8
170,305.1
336,943.0
680,542.6
98,070.0
301,143.7
5,860.7
6,120.5
5,153.6
49,714.5
66,849.3
(53,180.6)
2,867.7
39,888.2
347,367.7
336,943.0
14,987.5
41,990.7
69,014.2
554,550.2
680,542.6
802.2
1,229.4
201.6
219.1
250.5
378.9
1,254.2
1,827.5
1
Report Preparation
Purpose of Report - The purpose of this report is to provide the management of Callon with a projection of future reserves
and revenues for an assessment of oil and gas properties owned by Callon for inclusion in their public filings. The Proved
reserve and revenue projections shown herein have been prepared in accordance with Securities and Exchange Commission
(“SEC”) requirements for reporting purposes as described below.
Reporting Requirements - SEC Regulation S‑K, Item 102, and Regulation S‑X, Rule 4‑10, require oil and gas reserve
information to be reported by publicly held companies as supplemental financial data. These regulations were revised by the
SEC effective for filings beginning January 1, 2010. The revised regulations provide for certain changes in Proved reserve
definitions, add definitions for Probable and Possible reserves, and require that revenues associated with Proved reserves be
reported on the basis of the average of the preceding 12‑month, first-of-month product prices. Revenues are to be discounted
at 10%, consistent with that required in prior years.
The Proved reserves included herein under "Constant Product Prices" have been prepared in accordance with the
methodologies specified under SEC and Financial Accounting Standards Board guidelines.
Standards of Practice - This report has been prepared in accordance with our understanding of the Standards Pertaining to
the Estimating and Auditing of Oil and Gas Reserve Information as promulgated by the Society of Petroleum Engineers and the
Guidelines for Application of the Definitions for Oil and Gas Reserves prepared by the Society of Petroleum Evaluation
Engineers. However, the projected reserves have been prepared with consideration for reserve classification definitions
specified by the SEC that do not necessarily conform to definitions promulgated by the Society of Petroleum Engineers and the
World Petroleum Congress.
Economic Limits - In some cases the projections have been prepared with consideration for overall field production, resulting
in negative cash flow projections for certain properties. In our opinion, the projections shown herein properly reflect the
expected operations. The projections include consideration for abandonment costs, resulting in negative future revenues and
discounted revenues.
Cash Flow Projections - The cash flow projections were run on the aries computer program utilizing Callon's computer
facilities. However, Huddleston & Co., Inc., supplied all of the input parameters for the reserve projections.
Cash Flow Presentation - The gross and net reserve volume columns in the cash flow projections have been separated into
three different columns: oil (Mbbl), produced gas (MMcf), and sales gas (MMcf). Product prices, net revenues before taxes,
and severance taxes are shown separately for each product.
Reserve Estimates
Extrapolation of performance history was utilized for projecting future recoverable reserves for the producing properties where
sufficient history was available to suggest performance trends. The projections for the remaining producing properties were
necessarily based on analogy to nearby producing completions. Reserves assigned to nonproducing zones and undeveloped
locations were projected on the basis of analogy to nearby production. All of the subject properties are located within the
Permian Basin of West Texas.
Approximately 58% of the future net revenues discounted at 10% are included in the Proved Developed Producing category.
The remaining 42% of discounted net revenues are included in the Nonproducing and Undeveloped classifications. However,
only 41% of estimated future reserves (on an equivalent barrel basis) were included in the Producing category. Reserve
estimates for those properties in the Nonproducing and Undeveloped categories will be subject to a significantly greater level
of variation than estimates for producing properties exhibiting established decline trends.
We have utilized certain geologic and engineering data furnished by Callon. However, in all cases we have exercised the final
judgments for the estimated reserves and future schedules of production.
In our opinion the assumptions, data, methodologies and analytical procedures used in this report are appropriate for SEC
reporting purposes. We have used the methods and procedures that we consider necessary and appropriate to prepare the
estimates of reserves herein.
2
Gas Volumes - Gas volumes are reported at the prevailing pressure base of the state in which the reserves are located and at
60 degrees Fahrenheit. The projections reflect gas streams for production gas and sales gas. The difference between the two
is intended to reflect fuel and lease usage.
Property Discussion
Property Sales - During 2013, Callon divested essentially all of its ownership in properties located in the Gulf of Mexico and
Louisiana. The only remaining such properties are Mobile 864 and High Island A-494, which have no scheduled remaining
reserves. The cash flow projections reflect estimated plugging liabilities. In aggregate the properties sold during 2013
represented approximately 33% of oil reserves and 27.5% of gas reserves shown in our report as of December 31, 2012.
In 2009 Callon acquired ownership in four West Texas fields: Block 5, Carpe Diem, East Bloxom, and Kayleigh, located in
Crockett, Midland, Upton, and Ector Counties, respectively. The subject properties are located within the Wolfberry trend.
During 2011, the Pecan Acres Tract was acquired and in 2012 the Taylor Draw property was acquired. Properties added
during 2013 include Garrison Draw and Borden Fields. On an overall basis the properties include 131 producing wells, 4 wells
to be completed, 4 recompletions, and 41 undeveloped locations. Development activity during 2013 resulted in the addition of
17 vertical completions, 15 horizontal completions, and 4 horizontal wells that are to be completed.
The results of horizontal drilling operations during 2013 resulted in Callon’s decision to focus on horizontal development in all
of the fields with the exception of Pecan Acres. We have therefore eliminated all future vertical undeveloped locations from the
report with the exception of those shown for Pecan Acres. It is noted that multi-level horizontal development in East Bloxom
and Carpe Diem is expected to recover reserves that were previously projected to be recovered from vertical wells in a more
capital efficient manner.
Reserve assignments for the producing completions were assigned on the basis of the extrapolation of performance data.
Analogy was considered in determining hyperbolic exponents for the estimation of future reserves for those completions that
did not have sufficient production history to definitively project the proper decline profile. Reserves for the undeveloped
locations were projected on the basis of analogy to existing completions. In all cases, the undeveloped locations are direct
offsets to existing completions.
Product Prices
As we understand the SEC requirements issued on January 14, 2009, oil and gas prices utilized to determine the Standardized
Measure of discounted cash flows should be based on the trailing twelve-month average of the first-of-the-month prices. The
estimated revenues shown herein reflect the actual average of first-of-the-month prices received by Callon on a property by
property basis which conform with benchmark prices of $96.78 per barrel for West Texas Intermediate, and Henry Hub gas of
$3.67 per MMBtu. All prices were held constant over the producing life of the properties. The projected prices for both oil and
gas were based on our understanding of SEC requirements.
Gas prices have been adjusted to reflect the Btu content, transportation charges, and other fees specific to the individual
properties. Gas prices for certain properties include consideration for processing arrangements and the price shown herein has
been adjusted to reflect such arrangements in comparison to produced gas volumes. On an overall basis, the wellhead gas
prices utilized herein are approximately 4.4% lower than the values utilized as of December 31, 2012. Market level gas prices
are subject to a significant level of variation depending on location and marketing considerations specific to the individual
properties. In our opinion, it is likely that there will be a substantial degree of variation in prices in the future. Spot prices for
natural gas have experienced a large degree of volatility during recent years, which can be attributed to seasonal demands
and other market considerations.
The projected oil prices for individual properties have been adjusted to reflect all wellhead deductions and premiums on a
property by property basis, including transportation costs, location differentials, and crude quality. The weighted average
wellhead prices shown herein are approximately 2.9% higher than those utilized for our report prepared as of
December 31, 2012, which has had a limited impact on estimated future revenues and in some cases has marginally affected
economically recoverable reserves. Variations in oil prices are the result of changes in market conditions and future prices are
likely to be affected by a variety of factors including OPEC actions, political and market considerations, and overall economic
conditions.
3
It is noted that the redistribution of the property base resulting from the sale of the Louisiana and offshore properties materially
affected comparisons to benchmark prices. The variations in pricing from previous years is intended to reflect the impact to
Texas properties only.
All deductions and premiums to individual oil and gas prices were held constant over the life of the properties. Variations in
future product prices may materially affect actual revenues in comparison to the projections shown herein.
Product price hedges, if any, were not considered for the purposes of this report.
A comparison of the average product prices, weighted as a composite for all Proved properties, follows:
Oil, $/bbl
Gas, $/Mcf
Operating Expenses
2014
Maximum
92.20
5.40
92.20
5.50
Average Over Life
92.16
5.45
Operating costs have been scheduled in accordance with an analysis prepared by Callon. The projections reflect three
components of costs: fixed costs applied on a well by well basis, variable well costs, and facilities costs scheduled on a total
field basis. We have reviewed the analysis prepared by Callon and the scheduled costs and believe that the projections are
reasonable with consideration for the character of the properties and the level of operations required. Severance and ad
valorem taxes were calculated at the rates applicable to each property and have been deducted from the cash flow. Operating
costs were held constant over the economic life of the properties.
The projections exclude consideration for COPAS overhead charges for those properties operated by Callon.
Capital Costs
Capital costs necessary to perform recompletions and to drill new wells were supplied by Callon. We have generally reviewed
the projected expenditures and they are consistent with our perception of current costs necessary to perform the intended
operations. Capital costs were held constant over the life of the properties. The capital expenditures have been based on 2013
levels and exclude any anticipated savings until such time that such savings are actually realized.
Other Considerations
Additional Costs - Costs were not deducted for depletion, depreciation, and/or amortization. Consideration has also been
excluded for federal and/or state income taxes, if any.
Abandonment costs for all properties were included in the projections where Callon has determined the total cost associated
with abandoning the wells and facilities will exceed salvage value. The projections reflect a total of $14.980 million in
abandonment costs.
Additional Potential Values - Values were not assigned to nonproducing acreage or to acreage held by production, if any.
Context - The estimated reserves and revenues shown herein should be considered on an overall basis and estimates for
individual properties should not be taken out of context with the total or overall projections.
Development - Callon has assured us of its intent and ability to proceed with the development activities included in this report
and that they are not aware of any legal, regulatory, political or economic obstacles that would significantly alter these plans.
Data Sources - Essentially all data was furnished by Callon, including production statistics, product prices, operating costs,
ownership, and basic well information. In some cases we have considered information from our files or data from publically
available sources. We have accepted the data as represented. Production statistics for the significant Callon-operated
properties and for several of the other more significant properties were available through December 2013.
4
We retain in our files plotted production histories for all properties and certain other information that we believe pertinent. We
have not inspected the properties evaluated in this report nor have we conducted independent well tests.
Report Qualifications
THE REVENUES AND PRESENT WORTH OF FUTURE NET REVENUES ARE NOT REPRESENTED TO BE MARKET
VALUES EITHER FOR INDIVIDUAL PROPERTIES OR ON A TOTAL PROPERTY BASIS.
Reserve estimates are inherently uncertain. The reserves shown in this report are estimates only and should not be construed
as exact quantities. Proved reserves are those quantities of oil and gas which, by analysis of engineering and geoscience data,
can be estimated with reasonable certainty to be economically producible. If the reserves are recovered, the resulting
revenues and the related costs could be more or less than the estimated amounts. As a result of governmental regulations and
policies and uncertainties in supply and demand, the sales rates, the prices received for produced reserves, the ability to
recover the reserves, and the costs incurred in recovering such reserves may vary from the assumptions made in the
preparation of this report. Estimates of reserves may increase or decrease as a result of future operations, market conditions,
and/or changes in governmental regulations or policies.
PDH:klh
Respectfully submitted,
Peter D. Huddleston, P.E.
Texas Registered Engineering Firm F-1024
5