2012 AnnuAl RepoRt
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Perfo r m
400 East Kaliste Saloom Road, Suite 6000
Lafayette, Louisiana 70508
Telephone: (337) 232-7028
Fax: (337) 232-0044
PETROQUEST.COM
Corporate Information
Board of Directors
Charles T. Goodson
Chairman of the Board,
Chief Executive Officer, and President
W.J. Gordon III *#^
Vice President of Strategic Planning,
Franciscan Missionaries of Our Lady Health System
Corporate Address
PetroQuest Energy, Inc.
400 East Kaliste Saloom Road, Suite 6000
Lafayette, Louisiana 70508
Telephone: (337) 232-7028
Fax: (337) 232-0044
Web: www.petroquest.com
Michael L. Finch *#^
Private Investments
Charles F. Mitchell II, M.D. *#^
Physician, Private Investments
E. Wayne Nordberg *#^
Hollow Brook Associates, LLC
William W. Rucks, IV *#^
Private Investments
* Member of the Compensation Committee
# Member of the Audit Committee
^ Member of the Nominating and
Corporate Governance Committee
Senior Management
Charles T. Goodson
Chairman of the Board,
Chief Executive Officer, and President
W. Todd Zehnder
Chief Operating Officer
Daniel G. Fournerat
Executive Vice President, General Counsel,
Chief Administrative Officer, and Secretary
J. Bond Clement
Executive Vice President,
Chief Financial Officer, and Treasurer
Art M. Mixon
Executive Vice President,
Operations and Production
Tracy Price
Executive Vice President,
Business Development & Land
Stephen H. Green
Senior Vice President,
Exploration
Mark K. Castell
Vice President - Oklahoma Assets
Edgar A. Anderson
Vice President - ArkLaTex
Exploration Offices
450 Gears Road, Suite 330
Houston, Texas 77067
Telephone: (713) 784-8300
Fax: (713) 784-8327
1717 S. Boulder, Suite 201
Tulsa, Oklahoma 74119
Telephone: (918) 582-2770
Fax: (918) 582-2778
Transfer Agent and Registrar
American Stock Transfer & Trust Company
59 Maiden Lane
New York, New York 10038
Telephone: (718) 921-8145
Independent Auditors
Ernst & Young LLP
New Orleans, Louisiana 70170
Legal Counsel
Porter & Hedges, LLP
Houston, Texas 77002
Onebane Law Firm
Lafayette, Louisiana 70502
Annual Meeting
The Company’s Annual Meeting of Stockholders
will be held at 9:00 A.M. CDT on May 21, 2013, at
the City Club at River Ranch at 221 Elysian Fields Dr.,
Lafayette, LA, 70508.
Form 10-K
Copies of the Company’s Annual Report on
Form 10-K may be obtained, without charge,
by writing to our Corporate Secretary at our
Corporate Address or on the Company’s website
at www.petroquest.com.
Common Stock Listing
Listed on NYSE as PQ
Table of Contents
Corporate Profile ....................................Inside Front Cover
Financial & Operational Highlights ......2
Letter to Stockholders ............................3
Areas of Operation ................................4
2012 Form 10-K .......................................After Page 8
Corporate Information ..........................Inside Back Cover
Corporate Profile
PetroQuest Energy, Inc. is an independent
energy company engaged in the exploration,
development, acquisition and production of oil
and natural gas reserves in Texas, the Arkoma
Basin, South Louisiana and the shallow waters of
the Gulf of Mexico.
Cover Photos - La Cantera production facilities and Broussard Estates #2 well at the La Cantera Field, Vermilion Parish, LA
2 0 1 2
i o n .
P r o d u c t
f o r m a n c e .
P e r
P E O P L E .
1
1
Financial & Operational Highlights
2007
Annual
2008
Annual
2009
Annual
2010
Annual
2011
Annual
Q1
Q2
Q3
Q4
2012
Production
Natural Gas, MMcf
22,650
27,032
28,065
24,502
24,463
6,729
6,945
6,889
NGL, MMcfe
Crude Oil, MBbl
2,316
1,080
2,676
681
2,533
600
2,470
663
2,288
572
593
141
763
116
894
123
6,903
1,116
141
2012
Annual
27,466
3,367
521
Natural Gas, MMcfe
31,444
33,792
34,199
30,951
30,183
8,170
8,405
8,519
8,863
33,957
Financial ($ Thousands, except per share amounts)
Total Revenues
$ 262,334
$ 313,958
$ 218,684
$ 179,263
$ 160,700
$
36,041 $
33,413 $
33,951 $
38,186 $ 141,591
Net Income (Loss)
40,619
(96,960)
(90,190)
47,126
10,548
(17,326)
(53,232)
(37,354)
(24,167)
(132,079)
Preferred Stock Dividends
1,374
5,140
5,140
5,139
5,139
1,282
1,288
1,285
1,284
5,139
Net Income (Loss) Available to
Common Stockholders
Per Common Share:
Basic
Diluted
$
39,245
$
(102,100) $
(95,330) $
41,987
$
5,409
$
(18,608) $
(54,520) $
(38,639) $
(25,451) $ (137,218)
$
$
0.79
0.78
$
$
(2.08) $
(1.72) $
0.67
(2.08) $
(1.72) $
0.66
$
$
0.08
0.08
$
$
(0.30) $
(0.87) $
(0.62) $
(0.41) $
(2.20)
(0.30) $
(0.87) $
(0.62) $
(0.41) $
(2.20)
Year-Over-Year Review
Reserves ($ Thousands, except per share amounts)
Natural Gas, MMcf
NGL, MMcfe
Crude Oil, MBbl
Natural Gas, MMcfe
Percent Developed
Future Undiscounted Net Cash Flows, $000s
SEC PV-10, Before Taxes, $000s
Commodity Prices
2007
2008
2009
2010
2011
2012
129,154
158,781
156,853
174,566
241,926
192,968
13,314
2,342
13,405
2,201
10,508
1,931
8,373
1,623
15,111
1,395
25,360
1,655
156,520
185,392
178,947
192,677
265,407
228,258
69 %
73 %
62 %
65 %
61 %
74 %
$
$
779,395
540,651
$
$
466,449
327,193
$
$
272,271
176,995
$
$
442,505
255,651
$
$
635,327
341,373
PetroQuest Realized, Natural Gas, $/Mcf
$
7.21
$
8.00
$
5.84
$
4.37
$
Henry Hub Cash Market Average, Natural Gas, $/Mcf
PetroQuest Realized, NGL, $/Mcfe
PetroQuest Realized, Crude Oil, $/Bbl
WTI (Cushing) Spot Average, Crude Oil, $/Bbl
PetroQuest Realized, Natural Gas Equivalent, $/Mcfe
Per Unit Analysis, $/Mcfe
Total Revenues
Lease Operating Expense and Production Taxes
Gas Gathering Costs
Gross Operating Margin
Interest Expense
General and Administrative
Preferred Stock Dividends
Gross Cash Margin
6.97
7.93
70.52
72.23
8.15
8.34
1.27
0.13
6.94
0.43
0.67
0.04
5.80
$
$
8.89
9.76
97.49
99.92
9.13
9.29
1.69
0.07
7.53
0.28
0.69
0.15
6.41
$
$
3.94
5.38
68.57
61.99
6.39
6.40
1.26
0.01
5.13
0.37
0.55
0.15
4.06
$
$
4.37
7.78
79.47
79.51
5.78
5.79
1.42
0.00
4.37
0.32
0.69
0.17
3.19
$
$
$
$
3.22
4.00
9.51
104.99
95.04
5.32
5.32
1.38
0.00
3.94
0.32
0.68
0.17
2.77
2
2
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
406,818
239,269
2.31
2.75
6.32
108.97
94.10
4.17
4.17
1.17
0.00
3.00
0.29
0.68
0.15
1.88
“
I remain as bullish as ever
on PetroQuest’s prospects
in 2013 and beyond.
“
To Our Stockholders
PetroQuest Delivers Asset Diversity:
The Key to Success in Challenging
Commodity Price Environments
For the past several years, my position in
communicating with PetroQuest stockholders has been
that the U.S. gas markets should recover in parallel with
an improving economy and an increase in demand
associated with greater use of natural gas in the power
generation and transportation sectors. I still believe that
ultimately these macro forces will converge and that
an investment in PetroQuest will be rewarded as we
accelerate production to capture additional value
for stockholders in a commodity price recovery.
The question is when.
In previous annual reports, I have had the opportunity
to review and discuss a broad range of economic
factors impacting both the United States and Federal
Reserve District 6, which comprises Alabama, Georgia,
Florida, and parts of Louisiana, Tennessee and
Mississippi. What has become clear to me in reviewing
the broader economic data is that national and
regional economic recovery has been slower than
expected. Further, I thought that larger-scale conversion
to natural gas as a transportation fuel would have been
happening at a faster pace than what we are presently
witnessing. These factors, coupled with the large gas
volumes that continue to be produced, even in “liquids-
rich” hydrocarbon plays, have together contributed
to continued and robust gas production volumes, the
result of which has been low gas prices in the U.S.
As we have said for many years, the strategic
imperative of diversifying our reserves, beginning in 2003,
now provides us with the flexibility to pursue projects
which will create the most value for our stockholders
during this sustained period of low gas prices.
La Cantera Discoveries Represent
Long-Term Opportunities for
PetroQuest Stockholders
Given the reality of the gas markets in 2012 and
into 2013, PetroQuest has to closely scrutinize the
economic returns of each project in order to select the
best well prospects to drill when gas prices remain low
for extended periods of time. I can share the good
news that PetroQuest is better-positioned than many
companies because we have both a fully committed
drilling joint venture partner and a portfolio of very
economic projects in South Louisiana. I am referring
to our La Cantera project.
Big Wells Mean Big Returns In
Low Commodity Price Environments
In recent years we have prioritized our participation in
a number of liquids-rich plays. However, the economics
of these plays are challenging on a well-by-well basis
when gas prices are consistently below $4.00, simply
because liquids-rich wells do still produce meaningful
volumes of dry gas. Given this reality, the Gulf Coast
projects we have in our portfolio produce significant
internal rates of return on a well-by-well basis,
3
because the high flow rates and premium pricing
enable faster returns on allocated capital.
La Cantera was the single largest discovery in the
history of our Company. At December 31, 2012,
gross proved reserves associated with the
La Cantera structure were 112 Bcfe and the project
had a gross PV-10 value of approximately $250
million. To put this single project in context,
the market capitalization of PetroQuest at the end
of 2012 was $310 million.
Wells like La Cantera are truly the proverbial
“game-changers” for this Company. Our Thunder
Bayou prospect, which is located approximately
two miles north of La Cantera, falls within this
category. If successful, this well could materially
add to PetroQuest’s reserve base and production
profile in 2014. It makes intuitive sense for
PetroQuest to prioritize drilling these types of wells
because we would have to drill numerous wells
in our other resource plays to generate similar
production and cash flow as a single La Cantera
type project. Although we remain committed over
the long-term to developing our other resource
prospects, given the potential of lower gas prices
over the next year, the Board and I share the
view that the best interests of our stockholders are
served by allocating more capital to these types of
projects, which will generate large cash flows and
quicker payouts, on a well-by-well basis.
Over the past ten years, our Gulf Coast projects
have generated the cash flow we have redeployed
for drilling in other areas, so on some level the large
Gulf Coast wells like La Cantera have been our
foundation for some time. Now is the right time
to allocate higher capital spending in these areas
to again focus on Gulf-Coast generated cash flow
in 2013. This is value creation for our stockholders in
a low natural gas price environment and highlights
the flexibility the Company has in allocating our
capital where it will produce the best returns.
We intend to allocate approximately 32% of our
2013 capital expenditures to the Gulf Coast.
Evolution of the Woodford Continues
Although the Gulf Coast is a focus area for
us in 2013, our continuing commitment to our
diversification strategy and our mid-continent
4
“
assets is reflected in the fact we are deploying 29%
and 9% of our capital program in the Woodford
and Mississippian Lime plays, respectively. For our
stockholders, the highlight is that the Woodford
continues to evolve as a liquids-rich play, where we
plan to drill 12-15 wells in 2013. We have continued
to add acreage to our Woodford position, and we
grew net production from here
by 28% in 2012. The NGL
production component
from this asset grew
from 0 bbl/d at
the beginning
of the year to
over 900 bbl/d
by year end.
The Woodford
was the original
area of focus for
our joint venture
partnership, in
which PetroQuest has
a drilling carry whereby
its pays 25% of the well cost for
50% ownership. The balance on the drilling carry
at year end 2012 was $71 million. Our Woodford
program remains excellent business for PetroQuest
stockholders even in a low gas price environment
where we are projecting internal rates of return
north of 80% using strip pricing.
The Woodford continues
to evolve as a liquids-rich
play, where we plan to
drill 12-15 wells in 2013.
“
Mississippian Lime Is An Emerging Play
Likewise, we established initial production on eight
of the wells we tested in our Mississippian Lime
acreage in northern Oklahoma in 2012. We intend
to release the rig in order to move into the next
phase of our development, which will entail the
collection and evaluation of 3D seismic data over
our acreage. This data, coupled with our well
results, will form the basis for us to further delineate
our acreage in terms of identifying the best
prospects for the next phase of drilling. Once we
fully appraise the seismic data on our Mississippian
Lime acreage, we will move forward with the next
phase of drilling, so I believe this area remains one
of our focus areas for future oil production growth.
“
Horizontal Cotton Valley – Preserved for
Future Production Growth
Lastly, we remain active in our Cotton Valley play
in East Texas. We grew production in the play by 56%
last year and at year end 2012 we were producing
more than 650 barrels of natural gas liquids per
day with an additional well completion expected
in March 2013. We will allocate 8% of our capital
program for 2013 to East Texas. For the remainder
of the year we will focus on production in this area,
rather than drilling new wells. Our Cotton Valley
acreage is held by production, which means that we
are in a position to slow our activity until later in 2013,
given the expectation that commodity prices will
have begun some level of recovery.
Outlook for 2013
The perennial question in the oil and gas business is the
magnitude and timing of commodity price changes;
this has and will always be the central issue driving
our capital allocation decisions. Because we do not
forecast a sustained recovery in gas prices in 2013,
we plan to allocate 35% less capital than in 2012.
Despite a lower capital program, we will still be able
to deliver modest production growth while drilling
within cash flow. This is a critical point highlighting
the strength of our asset portfolio. We can deliver
production growth, or maintain flat production,
by spending significantly below cash flow. The
advantage is that we can quickly return to a more
aggressive production and reserves growth profile by
increasing our capital spending if and when commodity
prices support such a strategy, while at the same time
remaining well within our estimated cash flow for 2013.
Because we operate the majority of our activity, we
control our capital allocation decisions and will be able
to manage our operations to balance the competing
challenges of production growth and reserve
replacement in a low commodity price environment.
The biggest differentiator in 2013 will be that we
are allocating a larger percentage of our capital
expenditure program to our Gulf Coast properties than
in recent years. This is true because the drilling inventory
we have represents the best opportunity in our portfolio
to generate substantial risk adjusted rates of return, even
at low gas prices. The Board and I remain convinced
that our strategy of diversifying our reserve base is the
right way to proceed for the long-term benefit of our
stockholders. This means that we will also continue to
evaluate non-core acreage for potential divesture as a
way to focus the story and to increase liquidity. We did
this by divesting our Fayetteville and a 50% interest in our
Woodford SWD systems, and will likely consider selling
our Eagle Ford position for the same reasons.
The combination of these factors enables me to
outline our 2013 operational priorities, which I believe
is the best way to position the Company for value
creation over the next few years:
• We will focus on our Gulf Coast and liquids-rich
Woodford projects as we prioritize rates of return;
• We will slow the pace of development in some
of our other asset areas to essentially preserve
our growth profile;
• We will continue to evaluate non-core assets for
potential divestiture;
• We will add acreage in those areas where we
believe we will have higher rate of return projects
in the near term.
PetroQuest’s Employees Are the
Catalysts of Stockholder Value
I have explained our operational rationale for
allocating more capital to the Gulf Coast in 2013. It is
equally important, however, for me to point out that
our dedicated geological and geophysical (G&G)
teams are responsible for identifying and nurturing the
prospects in this basin. These are unique projects within
the E&P business, because the wells can be expensive
and involve risk. For that reason they are not every
company’s operational “cup of tea.” PetroQuest has
over the years demonstrated that technically our teams
are as good as anyone in the business, and our G&G,
engineering and land teams have done superlative
work in quietly developing our Gulf Coast projects.
These employees are responsible for generating more
than $300 million in free cash flow since 2007. This is an
advantage we have because many of our employees
have been with the Company through the ebbs and
flows of the commodity price cycle dating to the very
foundation of the Company in 1985.
5
5
Long-term Employee Relations
Drives Our Success
Each year I make it a priority in this letter to
commend our employees as a group, because
they are responsible for PetroQuest’s success year in
and year out. As we enter our 18th year in business
under the PetroQuest name, I thought I would
highlight the contributions of our longest-serving
employee to illustrate that we are committed to
long-term success within the Company because
the Board and I know this is how we will deliver
long-term value for our stockholders. Every day
each one of our employees goes to work in order
to contribute to PetroQuest’s growth. From our
administrative personnel, to our landmen, technical
staff, field personnel, and our executives, we are
each committed to the Company for the long haul.
PetroQuest’s First Employee is Still
Working For Our Stockholders Today
No one better demonstrates this commitment than
Pat Landry, who was the Company’s first employee
in 1985. Pat graduated from the University of
Southwestern Louisiana with a degree in Geology,
and was hired shortly after receiving his diploma.
Pat has been involved in every major initiative in
PetroQuest’s history, ranging from the La Cantera
project to the Mississippi Lime to the Eagle Ford Shale,
the Woodford, and our legacy offshore shallow Gulf
of Mexico projects. Pat has truly “seen it all” in terms
of PetroQuest’s operations throughout the Company’s
history. He has been a key contributor in our major
acquisition and development projects over the years;
Pat’s insight and expertise in evaluating projects
complements PetroQuest’s strategic programs and
has directly contributed to the flexibility we have
in our project portfolio.
Our Team Produces Positive Results
Although Pat is well-known inside the Company for
his long-term commitment to PetroQuest, he is by
no means alone. As I’ve said many times, our team
is in my view the best in the business and I’m proud
to be associated with Pat and many others like him.
PetroQuest employees have collectively produced
positive results year over year for our Company
during very challenging market conditions because
of their tireless dedication.
Where Do We Go From Here?
I remain as bullish as ever on PetroQuest’s prospects
in 2013 and beyond.
I still believe that the combination of an improving
economy and an increase in natural gas usage
will combine to create a positive trajectory for
natural gas prices. Since the end of 2012, the Henry
Hub spot price for natural gas has increased 15%.
Given the reduction in gas storage from last year,
I am optimistic about the gas markets continuing
to outperform last year’s prices. I also think that
the expectation of growth for the sake of growth,
a sentiment that was enabled by increasing
commodity prices over the past 20 years, will have
to be tempered in the near term. Companies with
longevity, demonstrated performance in a number
of commodity cycles, and a high-quality asset
portfolio will be the companies that will provide the
best returns to investors over the long term. I believe
PetroQuest is one of these companies, because we
are managing our operations by prioritizing projects
on the basis of rates of return.
We will continue to provide growth in a low-price
environment by managing costs and developing
new projects and new drilling inventory. This is why
investors should be reminded of the confidence I have
in our teams, because Pat Landry and others like him
are going to work every day seeking to improve the
Company’s performance on behalf of stockholders,
whether measured over quarters or years.
I am proud to lead the PetroQuest team and
believe that our best years remain ahead.
Charles T. Goodson
Chief Executive Officer
March 21, 2013
6
A p p r o x i m a t e l y 2 0 % o f
e m p l o y e e s h a v e b e e n
t h e C o m p a n y
1 0 y e a r s .
r e n t
c u r
t h
w i
f o r
t h e
o v e r
“
“
“
PetroQuest employees have
collectively produced positive results
year over year for our Company due to
their tireless dedication.
“
7
Texas
8%
Capitalized Interest
& Overhead
22%
a
e
r
A
y
b
X
E
P
A
C
d
e
t
c
e
j
o
r
P
3
1
0
2
Gulf Coast/GOM
32%
Mid-continent
38%
Mid-continent
Texas
Gulf Coast/GOM
8
8
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2012
or
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Commission File Number: 001-32681
PETROQUEST ENERGY, INC.
(Exact name of registrant as specified in its charter)
Delaware
State of incorporation:
72-1440714
I.R.S. Employer Identification No.
400 E. Kaliste Saloom Road, Suite 6000
Lafayette, Louisiana 70508
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (337) 232-7028
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, par value $.001 per share
Name of each exchange on which registered
New York Stock Exchange
Securities registered pursuant to Section 12 (g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes
No
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements
for the past 90 days.
Yes
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
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 registrant’s 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
definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
Non-accelerated filer
Accelerated filer
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes
No
The aggregate market value of the voting common equity held by non-affiliates of the registrant was approximately $261,000,000 as of June 29, 2012 (for
purposes of this disclosure, the registrant assumed its directors, executive officers and beneficial owners of 5% or more of the registrant’s common stock were
affiliates).
As of February 28, 2013, the registrant had outstanding 64,570,864 shares of Common Stock, par value $.001 per share.
Document incorporated by reference: portions of the definitive Proxy Statement of PetroQuest Energy, Inc. relating to the Annual Meeting of Stockholders
to be held on May 21, 2013, which are incorporated by reference into Part III of this Form 10-K.
Table of Contents
Page No.
Items 1 and 2 Business and Properties
PART I
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
PART II
Item 6. Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
Item 10. Directors, Executive Officers and Corporate Governance
PART III
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accounting Fees and Services
Item 15. Exhibits, Financial Statement Schedules
PART IV
Index to Financial Statements
2
4
18
31
31
31
32
33
34
42
43
44
44
46
46
46
46
46
46
47
54
This Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933,
as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
All statements other than statements of historical facts included in and incorporated by reference into this Form 10-K are forward
looking statements. These forward-looking statements are subject to certain risks, trends and uncertainties that could cause actual
results to differ materially from those projected.
Among those risks, trends and uncertainties are:
the volatility of oil and natural gas prices and depressed natural gas prices since the middle of 2008;
our indebtedness and the significant amount of cash required to service our indebtedness;
the recent financial crisis and continuing uncertain economic conditions in the United States and globally;
ceiling test write-downs resulting, and that could result in the future, from lower oil and natural gas prices;
our ability to obtain adequate financing when the need arises to execute our long-term strategy and to fund our planned
capital expenditures;
limits on our growth and our ability to finance our operations, fund our capital needs and respond to changing conditions
imposed by restrictive debt covenants;
our ability to find, develop, produce and acquire additional oil and natural gas reserves that are economically recoverable;
approximately one quarter of our production being exposed to the additional risk of severe weather, including hurricanes
and tropical storms, as well as flooding, coastal erosion and sea level rise;
losses and liabilities from uninsured or underinsured drilling and operating activities;
our ability to market our oil and natural gas production;
changes in laws and governmental regulations, increases in insurance costs or decreases in insurance availability, and
delays in our offshore exploration and drilling activities that may result from the April 22, 2010 sinking of the Deepwater
Horizon and subsequent oil spill in the Gulf of Mexico;
competition from larger oil and natural gas companies;
the likelihood that our actual production, revenues and expenditures related to our reserves will differ from our estimates
of proved reserves;
our ability to identify, execute or efficiently integrate future acquisitions;
losses or limits on potential gains resulting from hedging production;
the loss of key management or technical personnel;
the operating hazards attendant to the oil and gas business;
governmental regulation relating to hydraulic fracturing and environmental compliance costs and environmental
liabilities;
the operation and profitability of non-operated properties; and
potential conflicts of interest resulting from ownership of working interests and overriding royalty interests in certain of
our properties by our officers and directors.
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Although we believe that the expectations reflected in these forward looking statements are reasonable, we cannot assure
you that such expectations reflected in these forward looking statements will prove to have been correct.
3
When used in this Form 10-K, the words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate” and
similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these
identifying words. Because these forward-looking statements involve risks and uncertainties, actual results could differ materially
from those expressed or implied by these forward-looking statements for a number of important reasons, including those discussed
under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Risk Factors” and elsewhere
in this Form 10-K.
You should read these statements carefully because they discuss our expectations about our future performance, contain
projections of our future operating results or our future financial condition, or state other “forward-looking” information. You
should be aware that the occurrence of any of the events described under “Management’s Discussion and Analysis of Financial
Condition and Results of Operations,” “Risk Factors” and elsewhere in this Form 10-K could substantially harm our business,
results of operations and financial condition and that upon the occurrence of any of these events, the trading price of our common
stock could decline, and you could lose all or part of your investment.
We cannot guarantee any future results, levels of activity, performance or achievements. Except as required by law, we
undertake no obligation to update any of the forward-looking statements in this Form 10-K after the date of this Form 10-K.
As used in this Form 10-K, the words “we,” “our,” “us,” “PetroQuest” and the “Company” refer to PetroQuest Energy,
Inc., its predecessors and subsidiaries, except as otherwise specified. We have provided definitions for some of the oil and natural
gas industry terms used in this Form 10-K in “Glossary of Certain Oil and Natural Gas Terms” beginning on page 51.
Part I
Item 1 and 2. Business and Properties
Overview
PetroQuest Energy, Inc. is an independent oil and gas company incorporated in the State of Delaware with operations in
Oklahoma, Texas, the Gulf Coast Basin and Wyoming. We seek to grow our production, proved reserves, cash flow and earnings
at low finding and development costs through a balanced mix of exploration, development and acquisition activities. From the
commencement of our operations in 1985 through 2002, we were focused exclusively in the Gulf Coast Basin with onshore
properties principally in southern Louisiana and offshore properties in the shallow waters of the Gulf of Mexico shelf. During
2003, we began the implementation of our strategic goal of diversifying our reserves and production into longer life and lower
risk onshore properties. As part of the strategic shift to diversify our asset portfolio and lower our geographic and geologic risk
profile, we refocused our opportunity selection processes to reduce our average working interest in higher risk projects, shift
capital to higher probability of success onshore wells and mitigate the risks associated with individual wells by expanding our
drilling program across multiple basins.
We have successfully diversified into onshore, longer life basins in Oklahoma, Wyoming and Texas through a combination
of selective acquisitions and drilling activity. Beginning in 2003 with our acquisition of the Carthage Field in Texas through 2012,
we have invested approximately $998 million into growing our longer life assets. During the nine year period ended December 31,
2012, we have realized a 95% drilling success rate on 878 gross wells drilled. Comparing 2012 metrics with those in 2003, the
year we implemented our diversification strategy, we have grown production by 252% and estimated proved reserves by 174%.
At December 31, 2012, 87% of our estimated proved reserves and 75% of our 2012 production were derived from our longer life
assets.
During late 2008, in response to declining commodity prices and the global financial crisis, we shifted our focus from
increasing reserves and production to building liquidity and strengthening our balance sheet. Because of our significant operational
control, we were able to reduce our capital expenditures from $358 million in 2008 to $59 million in 2009 allowing us to utilize
our cash flow from operations, combined with proceeds from an equity offering, to repay $130 million of bank debt. While we
achieved our goal of strengthening the financial position of the Company, because of the reduced capital investments during 2009,
our production declined by 9% during 2010.
Gas prices have remained weak since late-2008. As a result of the impact of low natural gas prices on our revenues and
cash flow, we have focused on growing our reserves and production through a balanced drilling budget with an increased emphasis
on growing our oil and natural gas liquids production. In May 2010, we entered into the Woodford joint development agreement
("JDA"), which provided us with $85 million in cash during 2010 and 2011, along with a drilling carry that we have utilized since
May 2010 to enhance economic returns by reducing our share of capital expenditures in the Woodford and Mississippian Lime.
As a result of the Woodford JDA and the success of our drilling programs, we have grown our estimated proved reserves by 18%
and production by 10% since 2010, while maintaining our long-term debt 28% below 2008 levels.
4
During February 2012, we amended the JDA to accelerate the entry into Phase 2 of the drilling program effective March 1,
2012 and modify the drilling carry ratio. Under the amended JDA, the Phase 2 drilling carry was expanded to provide for
development in both the Mississippian Lime and Woodford Shale plays whereby we will pay 25% of the cost to drill and complete
wells and receive a 50% ownership interest. The Phase 2 drilling carry is subject to extensions in one-year intervals and as of
December 31, 2012, approximately $70.7 million remained available. See “Liquidity and Capital Resources-Source of Capital:
Joint Ventures”.
Business Strategy
Maintain Our Financial Flexibility. Because we operate approximately 77% of our total estimated proved reserves and
manage the drilling and completion activities on an additional 7% of such reserves, we expect to be able to control the timing of
a substantial portion of our capital investments. Our 2013 capital expenditures, which include capitalized interest and overhead,
are expected to range between $80 million and $100 million, which at the midpoint represents a 33% decrease from our capital
expenditures during 2012. We expect to be able to actively manage our 2013 capital budget in the event commodity prices, or the
health of the global financial markets, do not match our expectations. During 2013, we also plan to maintain our commodity
hedging program and, as in during prior years, we may continue to opportunistically dispose of certain non-core or mature assets
to provide capital for higher potential exploration and development properties that fit our long-term growth strategy. During
December 2012, we sold our non-operated Arkansas assets for $9.2 million. During January 2013, we sold 50% of our saltwater
disposal systems and related surface assets in the Woodford for net proceeds of approximately $10 million.
Pursue Balanced Growth and Portfolio Mix. We plan to pursue a risk-balanced approach to the growth and stability of
our reserves, production, cash flows and earnings. Our goal is to strike a balance between lower risk development activities and
higher risk and higher impact exploration activities. We plan to allocate our 2013 capital investments in a manner that continues
to geographically and operationally diversify our asset base, while focusing on oil and natural gas liquids projects as the pricing
for these products is presently expected to be more attractive than that of natural gas. Through our portfolio diversification efforts,
at December 31, 2012, approximately 87% of our estimated proved reserves were located in longer life and lower risk basins in
Oklahoma, Texas and Wyoming and 13% were located in the shorter life, but higher flow rate reservoirs in the Gulf Coast Basin.
In terms of production diversification, during 2012, 75% of our production was derived from longer life basins versus 66% and
54% in 2011 and 2010, respectively. Our 2012 production was comprised of 81% natural gas, 9% oil and 10% natural gas liquids.
Target Underexploited Properties with Substantial Opportunity for Upside. We plan to maintain a rigorous prospect
selection process that enables us to leverage our operating and technical experience in our core operating areas. During 2013, we
intend to primarily target properties that provide us with exposure to oil or natural gas liquids reserves and production. In evaluating
these targets, we seek properties that provide sufficient acreage for future exploration and development, as well as properties that
may benefit from the latest exploration, drilling, completion and operating techniques to more economically find, produce and
develop oil and gas reserves. During 2012, we expanded our acreage positions targeting the Mississippian Lime, a primarily oil
focused play, located on the border of Oklahoma and Kansas.
Concentrate in Core Operating Areas and Build Scale. We plan to continue focusing on our operations in Oklahoma,
Texas and the Gulf Coast Basin. Operating in concentrated areas helps us better control our overhead by enabling us to manage
a greater amount of acreage with fewer employees and minimize incremental costs of increased drilling and production. We have
substantial geological and reservoir data, operating experience and partner relationships in these regions. We believe that these
factors, combined with the existing infrastructure and favorable geologic conditions with multiple known oil and gas producing
reservoirs in these regions, will provide us with attractive investment opportunities.
Manage Our Risk Exposure. We plan to continue several strategies designed to mitigate our operating risks. We have
adjusted the working interest we are willing to hold based on the risk level and cost exposure of each project. For example, we
typically reduce our working interests in higher risk exploration projects while retaining greater working interests in lower risk
development projects. Our partners often agree to pay a disproportionate share of drilling costs relative to their interests, allowing
us to allocate our capital spending to maximize our return and reduce the inherent risk in exploration and development activities.
We also strive to retain operating control of the majority of our properties to control costs and timing of expenditures and we
expect to continue to actively hedge a portion of our future planned production to mitigate the impact of commodity price fluctuations
and achieve more predictable cash flows.
2012 Financial and Operational Summary
During 2012, we invested $135.2 million in exploratory, development and acquisition activities. We drilled 86 gross
exploratory wells and 21 gross development wells realizing an overall success rate of 98%. These activities were financed through
our cash flow from operations, cash on hand and borrowings under our bank credit facility. During 2012, our production increased
13% to 34.0 Bcfe, as a result of success in our Oklahoma and Texas drilling programs as well as the successful drilling of our La
5
Cantera prospect, partially offset by naturally declining production at our Gulf Coast properties. Our estimated proved reserves
at December 31, 2012 decreased 14.0% from 2011 as discussed in greater detail below.
Oil and Gas Reserves
Our estimated proved reserves at December 31, 2012 decreased 14.0% from 2011 totaling 1.7 MMBbls of oil, 25.4 Bcfe
of natural gas liquids (Ngls) and 193.0 Bcf of natural gas, with a pre-tax present value, discounted at 10%, of the estimated future
net revenues based on average prices during 2012 (“PV-10”) of $239 million. The decline in our estimated proved reserves during
2012 was primarily the result of production and the significant decrease in the historical 12-month average price per Mcf of natural
gas used to calculate our estimated proved reserves, along with the sale of our non-operated Arkansas assets in December 2012.
At December 31, 2012, our standardized measure of discounted cash flows, which includes the estimated impact of future income
taxes, totaled $232 million. See the reconciliation of PV-10 to the standardized measure of discounted cash flows below. Our
standardized measure of discounted cash flows at December 31, 2012 was 24% lower than 2011 as we utilized prices (adjusted
for field differentials) for the years ended December 31, 2012 and 2011 as follows:
Oil per Bbl
Natural gas per Mcf
Ngl per Mcfe
12/31/2012 12/31/2011
$102.81
$101.42
$2.20
$6.07
$3.34
$8.62
Ryder Scott Company, L.P., a nationally recognized independent petroleum engineering firm, prepared the estimates of
our proved reserves and future net cash flows (and present value thereof) attributable to such proved reserves at December 31,
2012. Our internal reservoir engineering staff is managed by an individual with 31 years of industry experience as a reservoir and
production engineer, including ten years as a reservoir engineering manager with PetroQuest. This individual is responsible for
overseeing the estimates prepared by Ryder Scott.
The following table sets forth certain information about our estimated proved reserves as of December 31, 2012:
Proved Developed
Proved Undeveloped
Total Proved
Oil (MBbls) NGL (Mmcfe)
20,608
4,752
25,360
1,225
430
1,655
Natural Gas
(Mmcf)
140,307
52,661
192,968
Total Mmcfe*
168,265
59,993
228,258
*
Oil conversion to Mcfe at one Bbl of crude oil, condensate or natural gas liquids to six Mcf of natural gas
6
As of December 31, 2012, our proved undeveloped reserves (“PUDs”) totaled 60.0 Bcfe, a 42% decrease from our PUD
balance at December 31, 2011. This decrease was due primarily to the 34% decrease in the historical 12-month first day of the
month average natural gas price used in computing our reserves, which was $2.20 per Mcf as of December 31, 2012 as compared
to $3.34 per Mcf as of December 31, 2011. During 2012, we spent $2.9 million converting 15 Bcfe of PUDs at December 31,
2011 to proved developed reserves at December 31, 2012. PUDs added from extensions and discoveries were primarily the result
of successful drilling in our Carthage field in East Texas. Following is an analysis of the change in our PUDs as of December 31,
2012:
PUD Balance at December 31, 2011
PUDs converted to proved developed
PUDs added from revisions or extensions and discoveries
PUDs removed for 5 year rule
PUDs removed due to low commodity prices
PUDs sold
PUD Balance at December 31, 2012
Mmcfe
103,935
(14,997)
19,463
(5,490)
(38,321)
(4,597)
59,993
Approximately 66% of our PUDs at December 31, 2012 were associated with the future development of our Oklahoma
properties. We expect all of our PUDs at December 31, 2012 to be developed over the next five years. At December 31, 2012, we
had no PUDs that had been booked for longer than five years. Estimated future costs related to the development of PUDs are
expected to total $28.4 million in 2013, $29.0 million in 2014 and $26.5 million in 2015. However, because 88% of our PUDs at
December 31, 2012 are comprised of natural gas, the specific timing of the development of PUDs over the next five years is highly
dependent upon the prevailing price of natural gas.
The estimated cash flows from our proved reserves at December 31, 2012 were as follows:
Estimated pre-tax future net cash flows (1)
Discounted pre-tax future net cash flows (PV-10) (1)
Total standardized measure of discounted future net cash flows
$
$
350,284
228,053
$
$
56,534
11,216
Proved Developed
(M$)
Proved
Undeveloped
(M$)
Total Proved
(M$)
$
$
$
406,818
239,269
232,395
(1) Estimated pre-tax future net cash flows and discounted pre-tax future net cash flows (PV-10) are non-GAAP measures
because they exclude income tax effects. Management believes these non-GAAP measures are useful to investors as they
are based on prices, costs and discount factors which are consistent from company to company, while the standardized
measure of discounted future net cash flows is dependent on the unique tax situation of each individual company. As a
result, the Company believes that investors can use these non-GAAP measures as a basis for comparison of the relative
size and value of the Company’s reserves to other companies. The Company also understands that securities analysts and
rating agencies use these non-GAAP measures in similar ways. The following table reconciles undiscounted and discounted
future net cash flows to standardized measure of discounted cash flows as of December 31, 2012:
Estimated pre-tax future net cash flows
10% annual discount
Discounted pre-tax future net cash flows
Future income taxes discounted at 10%
Standardized Measure of discounted future net cash flows
Total Proved (M$)
$
$
406,818
(167,549)
239,269
(6,874)
232,395
We have not filed any reports with other federal agencies that contain an estimate of total proved net oil and gas reserves.
7
Core Areas
The following table sets forth estimated proved reserves and annual production from each of our core areas (in Bcfe) for
the years ended December 31, 2012 and 2011.
Oklahoma Woodford
Oklahoma Miss-Lime
E. Texas
S. Texas
Gulf Coast Basin
Arkansas (1)
Wyoming
2012
2011
Reserves
Production
Reserves
Production
146.4
2.1
46.7
2.8
30.0
—
0.3
228.3
16.3
0.2
6.4
0.4
8.7
2.0
—
34.0
184.1
0.4
30.9
2.2
24.7
22.6
0.5
265.4
12.8
—
4.4
0.1
10.2
2.5
0.2
30.2
(1) On December 31, 2012, we sold our Arkansas assets for a net cash purchase price of $9.2 million.
Oklahoma
During late 2006, we began our initial drilling program to evaluate the Woodford Shale formation on a substantial portion
of our Oklahoma acreage. During 2012, we continued our evaluation of the Woodford Shale as we drilled and participated in 46
gross wells, achieving a 98% success rate. In total, we invested $40.8 million during 2012 acquiring prospective Woodford Shale
acreage and drilling and completing wells. In addition, during 2012 we utilized $28.5 million of drilling carry under the amended
JDA and plan to continue utilizing the drilling carry during 2013 under the second phase of the amended JDA. Average daily
production from our Oklahoma properties during 2012 totaled 45 MMcfe per day, a 28% increase from 2011 average daily
production. We experienced negative revisions to our proved reserves as a result of lower average prices, which resulted in a 20%
decrease in our estimated proved reserves. Partially offsetting this negative impact was the addition of approximately 27 Bcfe of
estimated proved reserves from our drilling program during the year. We have allocated approximately 37% of our 2013 capital
budget to operations in the Woodford Shale as we expect to operate the drilling of approximately 23 gross wells, 15 of which will
target liquids rich gas, as well as obtain 3-D seismic data over acreage recently acquired to target liquids rich gas.
As of December 31, 2012, we had invested $16.5 million to acquire approximately 24,000 net acres of Mississippian
Lime acreage in northern Oklahoma and southern Kansas. During 2012, we invested $26 million as we began evaluating this
prospective acreage through coring and seismic work and the drilling of nine gross exploratory wells, achieving an 89% success
rate. During 2012, we utilized $11.6 million of drilling carry under the amended JDA. We have allocated approximately 10% of
our 2013 capital budget to explore this primarily oil focused trend. We plan to acquire 3-D seismic data over our acreage positions
and drill three gross Mississippian Lime wells in 2013. We expect to be able to utilize the 3-D data later in 2013 to assist in the
future development of this asset.
Gulf Coast Basin
During 2012, we drilled two gross wells in the Gulf Coast Basin, achieving a 100% success rate. In total, we invested
$21.0 million in this area during 2012. Production from this area decreased 16% from 2011 totaling 23.7 MMcfe per day in 2012
due to natural production declines. However, production from our second discovery well in our La Cantera prospect commenced
during September 2012 with a third acceleration well at La Cantera currently drilling. Our estimated proved reserves in this area
increased 21% from 2011 primarily as a result of success in the 2012 drilling program. We have allocated approximately 41% of
our 2013 capital budget to various drilling and re-completion projects in the Gulf Coast Basin.
East Texas
During 2012, we invested $23.7 million in our East Texas properties as we drilled and participated in six gross wells,
achieving a 100% success rate. Net production from our East Texas assets averaged 17.4 MMcfe per day during 2012, a 45%
increase from 2011 average daily production and our estimated proved reserves increased 51% from 2011, primarily as a result
of successful drilling in our Carthage field. We have allocated approximately 11% of our 2013 capital budget to drilling and facility
enhancements in our Carthage field.
8
South Texas
During 2012, we invested $14.7 million in our South Texas properties as we drilled five gross wells, all of which were
successful. Net production from our South Texas assets averaged 175 BOE per day during 2012, a 181% increase as compared
to 2011 and our estimated proved reserves increased 23% from 2011. We are currently evaluating our plans for 2013, including
the possibility of divestment.
Arkansas
During 2012, we participated in 39 gross wells in the Fayetteville Shale, all of which were successful. In total, we invested
$1.2 million in Arkansas during 2012. Production during 2012 totaled 5.4 MMcfe per day, a 20% decrease from 2011. We sold
this non-operated asset on December 31, 2012 for a net cash purchase price of $9.2 million.
Markets and Customers
We sell our oil and natural gas production under fixed or floating market contracts. Customers purchase all of our oil and
natural gas production at current market prices. The terms of the arrangements generally require customers to pay us within 30
days after the production month ends. As a result, if the customers were to default on their payment obligations to us, near-term
earnings and cash flows would be adversely affected. However, due to the availability of other markets and pipeline connections,
we do not believe that the loss of these customers or any other single customer would adversely affect our ability to market
production. Our ability to market oil and natural gas from our wells depends upon numerous factors beyond our control, including:
•
•
•
•
•
•
•
•
the extent of domestic production and imports of oil and natural gas;
the proximity of the natural gas production to pipelines;
the availability of capacity in such pipelines;
the demand for oil and natural gas by utilities and other end users;
the availability of alternative fuel sources;
the effects of inclement weather;
state and federal regulation of oil and natural gas production; and
federal regulation of gas sold or transported in interstate commerce.
We cannot assure you that we will be able to market all of the oil or natural gas we produce or that favorable prices can
be obtained for the oil and natural gas we produce.
A portion of the production that we operate in Oklahoma is committed to a firm transportation agreement. Under the
terms of the agreement we must deliver 7.6 Bcf of natural gas during the period January 1 through October 31, 2013. Based upon
our current proved reserves and production, we expect that this commitment will be met.
In view of the many uncertainties affecting the supply and demand for oil, natural gas and refined petroleum products,
we are unable to predict future oil and natural gas prices and demand or the overall effect such prices and demand will have on
the Company. During 2012, one customer accounted for 30%, one accounted for 17%, and one accounted for 12% of our oil and
natural gas revenue. During 2011, one customer accounted for 20%, one accounted for 18%, one accounted for 15% and one
accounted for 11% of our oil and natural gas revenue. During 2010, one customer accounted for 19%, two accounted for 17%
each and one accounted for 10% of our oil and natural gas revenue. These percentages do not consider the effects of commodity
hedges. We do not believe that the loss of any of our oil or natural gas purchasers would have a material adverse effect on our
operations due to the availability of other purchasers.
9
Production, Pricing and Production Cost Data
The following table sets forth our production, pricing and production cost data during the periods indicated. Only two
core areas, East Texas and Oklahoma, which includes primarily Woodford Shale reserves, represented greater than 15% of our
total estimated proved reserves.
Production:
Oil (Bbls):
East Texas
Oklahoma - Woodford
Other
Total Oil (Bbls)
Gas (Mcf):
East Texas
Oklahoma - Woodford
Other
Total Gas (Mcf)
NGL (Mcfe):
East Texas
Oklahoma - Woodford
Other
Total NGL (Mcfe)
Total Production (Mcfe):
East Texas
Oklahoma - Woodford
Other
Total Production (Mcfe)
Average sales prices (1):
Oil (per Bbl):
East Texas
Oklahoma - Woodford
Other
Total Oil (per Bbl)
Gas (per Mcf)
East Texas
Oklahoma - Woodford
Other
Total Gas (per Mcf)
NGL (per Mcfe)
East Texas
Oklahoma - Woodford
Other
Total NGL (per Mcfe)
Total Per Mcfe:
East Texas
Oklahoma - Woodford
Other
Total Per Mcfe
Average Production Cost per Mcfe (2):
East Texas
Oklahoma - Woodford
Other
Total Average Production Cost per Mcfe
(1) Does not include the effect of hedges.
(2) Production costs do not include production taxes.
10
Year Ended December 31,
2011
2010
2012
87,368
171
433,051
520,590
4,360,290
15,349,219
7,756,719
27,466,228
1,479,441
947,935
939,398
3,366,774
6,363,939
16,298,180
11,294,423
33,956,542
104.42
92.53
106.15
105.85
2.82
1.51
2.73
2.06
5.72
4.49
8.32
6.10
4.69
1.69
6.64
3.90
1.56
0.49
1.86
1.15
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
96,923
145
475,028
572,096
2,871,284
12,736,622
8,855,027
24,462,933
924,668
553
1,362,625
2,287,846
4,377,490
12,738,045
13,067,820
30,183,355
102,410
71
560,821
663,302
2,206,266
10,577,414
11,717,860
24,501,540
632,875
683
1,836,313
2,469,871
3,453,601
10,578,523
16,919,099
30,951,223
101.59
89.61
106.09
105.33
3.92
2.42
3.84
3.11
8.19
5.15
10.41
9.51
6.55
2.42
7.54
5.24
2.12
0.76
1.50
1.28
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
77.61
69.62
79.82
79.47
4.32
2.80
4.31
3.66
6.38
3.79
8.26
7.78
6.23
2.80
6.52
5.22
2.56
0.71
1.34
1.26
Oil and Gas Producing Wells
The following table details the productive wells in which we owned an interest as of December 31, 2012:
Gross
Net
Productive Wells:
Oil:
East Texas
Oklahoma - Woodford
Other
Gas:
East Texas
Oklahoma - Woodford
Other
Total
3
—
47
50
105
172
470
747
797
2.53
—
18.46
20.99
68.73
50.57
132.12
251.42
272.41
Of the 797 gross productive wells at December 31, 2012, 2 had dual completions.
Oil and Gas Drilling Activity
The following table sets forth the wells drilled and completed by us during the periods indicated. All wells were drilled
in the continental United States.
Exploration:
Productive
Non-productive
Total
Development:
Productive
Non-productive
Total
2012
2011
2010
Gross
Net
Gross
Net
Gross
Net
84
2
86
21
—
21
15.87
0.84
16.71
4.88
—
4.88
94
1
95
23
—
23
18.15
0.50
18.65
1.33
—
1.33
82
3
85
17
—
17
9.55
0.76
10.31
1.50
—
1.50
In 2012, 31 gross (7.49 net) exploratory and 15 gross (4.78 net) development wells were drilled in the Woodford Shale.
In 2011, 35 gross (9.94 net) exploratory and one gross (.05 net) development wells were drilled in the Woodford Shale. In 2010,
19 gross (7.32 net) exploratory and 1 gross (.81 net) development wells were drilled in the Woodford Shale. One Woodford Shale
well during 2012 was non-productive.
At December 31, 2012, we had 17 gross (6.61 net) wells in progress in Oklahoma.
11
Leasehold Acreage
The following table shows our approximate developed and undeveloped (gross and net) leasehold acreage as of
December 31, 2012:
Kansas
Louisiana
Mississippi
Oklahoma
Texas
Wyoming
Federal Waters
Total
Leasehold Acreage
Developed
Undeveloped
Gross
Net
Gross
Net
—
4,489
721
69,308
42,000
2,720
39,283
158,521
—
1,455
721
38,646
22,768
680
23,611
87,881
4,091
8,829
—
99,599
8,441
3,319
7,124
131,403
2,046
5,867
—
46,182
4,449
830
7,124
66,498
Leases covering 18% of our net undeveloped acreage are scheduled to expire in 2013, 19% in 2014, 16% in 2015 and
47% thereafter. Of the acreage subject to leases scheduled to expire during 2013, less than 3% relates to undeveloped acreage in
Texas and Wyoming where we do not anticipate any further drilling. We expect to hold the majority of the remaining acreage
scheduled to expire in 2013 through drilling or lease extensions.
Title to Properties
We believe that the title to our oil and 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. Our 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 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, farmout agreements, production sales contracts and other agreements that may affect the properties or their
titles;
back-ins and reversionary interests existing under purchase agreements and leasehold 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.
To the extent that such burdens and obligations affect our rights to production revenues, they have been taken into account
in calculating our net revenue interests and in estimating the size and value of our reserves. We believe that the burdens and
obligations affecting our properties are conventional in the industry for properties of the kind that we own.
Federal Regulations
Sales and Transportation of Natural Gas. Historically, the transportation and sales for resale of natural gas in interstate
commerce have been regulated pursuant to the Natural Gas Act of 1938 (“NGA”), the Natural Gas Policy Act of 1978 (“NGPA”)
and Federal Energy Regulatory Commission (“FERC”) regulations. Effective January 1, 1993, the Natural Gas Wellhead Decontrol
Act deregulated the price for all “first sales” of natural gas. Thus, all of our sales of gas may be made at market prices, subject to
applicable contract provisions. Sales of natural gas are affected by the availability, terms and cost of pipeline transportation. Since
1985, the FERC has implemented regulations intended to make natural gas transportation more accessible to gas buyers and sellers
on an open-access, non-discriminatory basis. We cannot predict what further action the FERC will take on these matters. Some
of the FERC's more recent proposals may, however, adversely affect the availability and reliability of interruptible transportation
12
service on interstate pipelines. We do not believe that we will be affected by any action taken materially differently than other
natural gas producers, gatherers and marketers with which we compete.
The Outer Continental Shelf Lands Act (the “OCSLA”), which was administered by the Bureau of Ocean Energy
Management, Regulation and Enforcement (the “BOEMRE”) and, after October 1, 2011, its successors, the Bureau of Ocean
Energy Management (the “BOEM”) and the Bureau of Safety and Environmental Enforcement (the “BSEE”), and the FERC,
requires that all pipelines operating on or across the shelf provide open-access, non-discriminatory service. There are currently
no regulations implemented by the FERC under its OCSLA authority on gatherers and other entities outside the reach of its NGA
jurisdiction. Therefore, we do not believe that any FERC, BOEM or BSEE action taken under OCSLA will affect us in a way that
materially differs from the way it affects other natural gas producers, gatherers and marketers with which we compete.
Our natural gas sales are generally made at the prevailing market price at the time of sale. Therefore, even though we
sell significant volumes to major purchasers, we believe that other purchasers would be willing to buy our natural gas at comparable
market prices.
Natural gas continues to supply a significant portion of North America's energy needs and we believe the importance of
natural gas in meeting this energy need will continue. The impact of the ongoing economic downturn on natural gas supply and
demand fundamentals has resulted in extremely volatile natural gas prices, which is expected to continue.
On August 8, 2005, the Energy Policy Act of 2005 (the “2005 EPA”) was signed into law. This comprehensive act contains
many provisions that will encourage oil and gas exploration and development in the U.S. The 2005 EPA directs the FERC, BOEM
and other federal agencies to issue regulations that will further the goals set out in the 2005 EPA. The 2005 EPA amends the NGA
to make it unlawful for “any entity”, including otherwise non-jurisdictional producers such as us, to use any deceptive or
manipulative device or contrivance in connection with the purchase or sale of natural gas or the purchase or sale of transportation
services subject to regulation by the FERC, in contravention of rules prescribed by the FERC. On January 20, 2006, the FERC
issued rules implementing this provision. The rules make it unlawful in connection with the purchase or sale of natural gas subject
to the jurisdiction of the FERC, or the purchase or sale of transportation services subject to the jurisdiction of the FERC, for any
entity, directly or indirectly, to use or employ any device, scheme or artifice to defraud; to make any untrue statement of material
fact or omit to make any such statement necessary to make the statements made not misleading; or to engage in any act or practice
that operates as a fraud or deceit upon any person. The new anti-manipulation rule does not apply to activities that relate only to
intrastate or other non-jurisdictional sales or gathering, but does apply to activities of otherwise non-jurisdictional entities to the
extent the activities are conducted “in connection with” gas sales, purchases or transportation subject to FERC jurisdiction. It
therefore reflects a significant expansion of the FERC's enforcement authority. We do not anticipate we will be affected any
differently than other producers of natural gas.
In 2007, the FERC issued a final rule on annual natural gas transaction reporting requirements, as amended by subsequent
orders on rehearing (“Order 704”). Under Order 704, wholesale buyers and sellers of more than 2.2 million MMBtu of physical
natural gas in the previous calendar year, including interstate and intrastate natural gas pipelines, natural gas gatherers, natural
gas processors and natural gas marketers are now required to report, on May 1 of each year, beginning in 2009, aggregate volumes
of natural gas purchased or sold at wholesale in the prior calendar year to the extent such transactions utilize, contribute to, or may
contribute to the formation of price indices. It is the responsibility of the reporting entity to determine which individual transactions
should be reported based on the guidance of Order 704. The monitoring and reporting required by these rules have increased our
administrative costs. We do not anticipate that we will be affected any differently than other producers of natural gas.
Sales and Transportation of Crude Oil. Our sales of crude oil, condensate and natural gas liquids are not currently
regulated, and are subject to applicable contract provisions made at market prices. In a number of instances, however, the ability
to transport and sell such products is dependent on pipelines whose rates, terms and conditions of service are subject to the FERC's
jurisdiction under the Interstate Commerce Act. In other instances, the ability to transport and sell such products is dependent on
pipelines whose rates, terms and conditions of service are subject to regulation by state regulatory bodies under state statutes.
The regulation of pipelines that transport crude oil, condensate and natural gas liquids is generally more light-handed
than the FERC's regulation of gas pipelines under the NGA. Regulated pipelines that transport crude oil, condensate, and natural
gas liquids are subject to common carrier obligations that generally ensure non-discriminatory access. With respect to interstate
pipeline transportation subject to regulation of the FERC under the Interstate Commerce Act, rates generally must be cost-based,
although market-based rates or negotiated settlement rates are permitted in certain circumstances. Pursuant to FERC Order No. 561,
pipeline rates are subject to an indexing methodology. Under this indexing methodology, pipeline rates are subject to changes in
the Producer Price Index for Finished Goods, minus one percent. A pipeline can seek to increase its rates above index levels
provided that the pipeline can establish that there is a substantial divergence between the actual costs experienced by the pipeline
and the rate resulting from application of the index. A pipeline can seek to charge market based rates if it establishes that it lacks
significant market power. In addition, a pipeline can establish rates pursuant to settlement if agreed upon by all current shippers.
13
A pipeline can seek to establish initial rates for new services through a cost-of-service proceeding, a market-based rate proceeding,
or through an agreement between the pipeline and at least one shipper not affiliated with the pipeline.
Federal Leases. We maintain operations located on federal oil and natural gas leases, which are administered by the
BOEMRE, BOEM or BSEE, pursuant to the OCSLA. The BOEMRE and its successors, the BOEM and the BSEE, regulate
offshore operations, including engineering and construction specifications for production facilities, safety procedures, plugging
and abandonment of wells on the Gulf of Mexico shelf, and removal of facilities.
On January 19, 2011, the U.S. Department of the Interior announced that it would divide offshore oil and gas
responsibilities among three separate agencies, with the reorganization to be completed in 2011. The Department of the Interior
first created the Office of Natural Resources Revenue to manage revenue collection on October 1, 2010. Effective October 1,
2011, the remaining functions of BOEMRE were split into two federal bureaus, the BOEM, which handles offshore leasing,
resource evaluation, review and administration of oil and gas exploration and development plans, renewable energy development,
NEPA analysis and environmental studies, and the BSEE, which is responsible for the safety and enforcement functions of offshore
oil and gas operations, including the development and enforcement of safety and environmental regulations, permitting of offshore
exploration, development and production activities, inspections, offshore regulatory programs, oil spill response and newly formed
training and environmental compliance programs. Consequently, after October 1, 2011, we are required to interact with two newly
formed federal bureaus to obtain approval of our exploration and development plans and issuance of drilling permits, which may
result in added plan approval or drilling permit delays as the functions of the former BOEMRE are fully divested and implemented
in the two federal bureaus. At this time, we cannot predict the impact that this reorganization, or future regulations of enforcement
actions taken by the new agencies, may have on our operations. Our federal oil and natural gas leases are awarded based on
competitive bidding and contain relatively standardized terms. These leases require compliance with detailed BOEMRE regulations
and orders that are subject to interpretation and change by the BOEM or BSEE. The BOEMRE has promulgated other regulations
governing the plugging and abandonment of wells located offshore and the installation and removal of all production facilities,
structures and pipelines, and the BOEM or the BSEE may in the future amend these regulations. Please read “Risk Factors”
beginning on page 16 for more information on new regulations.
To cover the various obligations of lessees on the Outer Continental Shelf (the “OCS”), the BOEMRE and its successors
generally require that lessees have substantial net worth or post bonds or other acceptable assurances that such obligations will
be satisfied. The cost of these bonds or assurances can be substantial and there is no assurance that they can be obtained in all
cases. We are currently exempt from supplemental bonding requirements. As many regulations are being reviewed, we may be
subject to supplemental bonding requirements in the future. Under some circumstances, the BOEM may require any of our
operations on federal leases to be suspended or terminated. Any such suspension or termination could materially adversely affect
our financial condition and results of operations.
Hurricanes in the Gulf of Mexico can have a significant impact on oil and gas operations on the OCS. The effects from
past hurricanes have included structural damage to pipelines, wells, fixed production facilities, semi-submersibles and jack-up
drilling rigs. The BOEMRE has been in the past, and the BOEM and the BSEE will be in the future, concerned about the loss of
these facilities and rigs as well as the potential for catastrophic damage to key infrastructure and the resultant pollution from future
storms. In an effort to reduce the potential for future damage, the BOEMRE has periodically issued guidance aimed at improving
platform survivability by taking into account environmental and oceanic conditions in the design of platforms and related structures.
It is possible that similar, if not more stringent, requirements will be issued by the BOEM or the BSEE for future hurricane seasons.
New requirements, if any, could increase our operating costs to future storms.
The Office of Natural Resources Revenue (the “ONRR”) in the U.S. Department of the Interior administers the collection
of royalties under the terms of the OCSLA and the oil and natural gas leases issued thereunder. The amount of royalties due is
based upon the terms of the oil and natural gas leases as well as the regulations promulgated by the ONRR.
Federal, State or American Indian Leases. In the event we conduct operations on federal, state or American Indian oil
and gas leases, such operations must comply with numerous regulatory restrictions, including various nondiscrimination statutes,
and certain of such operations must be conducted pursuant to certain on-site security regulations and other appropriate permits
issued by the Bureau of Land Management (“BLM”) or BOEM or other appropriate federal or state agencies.
The Mineral Leasing Act of 1920 (“Mineral Act”) prohibits direct or indirect ownership of any interest in federal onshore
oil and gas leases by a foreign citizen of a country that denies “similar or like privileges” to citizens of the United States. Such
restrictions on citizens of a “non-reciprocal” country include ownership or holding or controlling stock in a corporation that holds
a federal onshore oil and gas lease. If this restriction is violated, the corporation's lease can be cancelled in a proceeding instituted
by the United States Attorney General. Although the regulations of the BLM (which administers the Mineral Act) provide for
agency designations of non-reciprocal countries, there are presently no such designations in effect. We own interests in numerous
federal onshore oil and gas leases. It is possible that holders of our equity interests may be citizens of foreign countries, which at
some time in the future might be determined to be non-reciprocal under the Mineral Act.
14
State Regulations
Most states regulate the production and sale of oil and natural gas, including:
•
•
•
•
•
requirements for obtaining drilling permits;
the method of developing new fields;
the spacing and operation of wells;
the prevention of waste of oil and gas resources; and
the plugging and abandonment of wells.
The rate of production may be regulated and the maximum daily production allowable from both oil and gas wells may
be established on a market demand or conservation basis or both.
We may enter into agreements relating to the construction or operation of a pipeline system for the transportation of
natural gas. To the extent that such gas is produced, transported and consumed wholly within one state, such operations may, in
certain instances, be subject to the jurisdiction of such state’s administrative authority charged with the responsibility of regulating
intrastate pipelines. In such event, the rates that we could charge for gas, the transportation of gas, and the construction and
operation of such pipeline would be subject to the rules and regulations governing such matters, if any, of such administrative
authority.
Legislative Proposals
In the past, Congress has been very active in the area of natural gas regulation. New legislative proposals in Congress
and the various state legislatures, if enacted, could significantly affect the petroleum industry. At the present time it is impossible
to predict what proposals, if any, might actually be enacted by Congress or the various state legislatures and what effect, if any,
such proposals might have on our operations.
Environmental Regulations
General. Our activities are subject to existing federal, state and local laws and regulations governing environmental
quality and pollution control. Although no assurances can be made, we believe that, absent the occurrence of an extraordinary
event, compliance with existing federal, state and local laws, regulations and rules regulating the release of materials in the
environment or otherwise relating to the protection of human health, safety and the environment will not have a material effect
upon our capital expenditures, earnings or competitive position with respect to our existing assets and operations. We cannot
predict what effect additional regulation or legislation, enforcement policies, and claims for damages to property, employees, other
persons and the environment resulting from our operations could have on our activities.
Our activities with respect to exploration and production of oil and natural gas, including the drilling of wells and the
operation and construction of pipelines, plants and other facilities for extracting, transporting, processing, treating or storing natural
gas and other petroleum products, are subject to stringent environmental regulation by state and federal authorities, including the
United States Environmental Protection Agency (the “USEPA”). Such regulation can increase the cost of planning, designing,
installation and operation of such facilities. Although we believe that compliance with environmental regulations will not have a
material adverse effect on us, risks of substantial costs and liabilities are inherent in oil and gas production operations, and there
can be no assurance that significant costs and liabilities will not be incurred. Moreover it is possible that other developments, such
as spills or other unanticipated releases, stricter environmental laws and regulations, and claims for damages to property or persons
resulting from oil and gas production, would result in substantial costs and liabilities to us.
Solid and Hazardous Waste. We own or lease numerous properties that have been used for production of oil and gas
for many years. Although we have utilized operating and disposal practices standard in the industry at the time, hydrocarbons or
other solid wastes may have been disposed or released on or under these properties. In addition, many of these properties have
been operated by third parties that controlled the treatment of hydrocarbons or other solid wastes and the manner in which such
substances may have been disposed or released. State and federal laws applicable to oil and gas wastes and properties have gradually
become stricter over time. Under these laws, we could be required to remove or remediate previously disposed wastes (including
wastes disposed or released by prior owners or operators) or property contamination (including groundwater contamination by
prior owners or operators) or to perform remedial plugging operations to prevent future contamination.
15
We generate wastes, including hazardous wastes, which are subject to regulation under the federal Resource Conservation
and Recovery Act (“RCRA”) and state statutes. The USEPA has limited the disposal options for certain hazardous wastes.
Furthermore, it is possible that certain wastes generated by our oil and gas operations which are currently exempt from regulation
as “hazardous wastes” may in the future be designated as “hazardous wastes” under RCRA or other applicable statutes, and
therefore be subject to more rigorous and costly disposal requirements.
Naturally Occurring Radioactive Materials (“NORM”) are radioactive materials which precipitate on production
equipment or area soils during oil and natural gas extraction or processing. NORM wastes are regulated under the RCRA framework,
although such wastes may qualify for the oil and gas hazardous waste exclusion. Primary responsibility for NORM regulation
has been a state function. Standards have been developed for worker protection; treatment, storage and disposal of NORM waste;
management of waste piles, containers and tanks; and limitations upon the release of NORM-contaminated land for unrestricted
use. We believe that our operations are in material compliance with all applicable NORM standards.
Superfund. The Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), also known
as the “Superfund” law, imposes liability, without regard to fault or the legality of the original conduct, on certain persons with
respect to the release or threatened release of a “hazardous substance” into the environment. These persons include the owner and
operator of a site and persons that disposed or arranged for the disposal of hazardous substances at a site. CERCLA also authorizes
the USEPA and, in some cases, third parties to take actions in response to threats to the public health or the environment and to
seek to recover from the responsible persons the costs of such action. State statutes impose similar liability.
Under CERCLA, the term “hazardous substance” does not include “petroleum, including crude oil or any fraction thereof,”
unless specifically listed or designated and the term does not include natural gas, Ngls, liquefied natural gas, or synthetic gas
usable for fuel. While this “petroleum exclusion” lessens the significance of CERCLA to our operations, we may generate waste
that may fall within CERCLA's definition of a “hazardous substance” in the course of our ordinary operations. We also currently
own or lease properties that for many years have been used for the exploration and production of oil and natural gas. Although
we and, to our knowledge, our predecessors have used operating and disposal practices that were standard in the industry at the
time, “hazardous substances” may have been disposed or released on, under or from the properties owned or leased by us or on,
under or from other locations where these wastes have been taken for disposal. At this time, we do not believe that we have any
liability associated with any Superfund site, and we have not been notified of any claim, liability or damages under CERCLA.
Oil Pollution Act. The Oil Pollution Act of 1990 (the “OPA”) and regulations thereunder impose a variety of regulations
on “responsible parties” related to the prevention of oil spills and liability for damages resulting from such spills in United States
waters. A “responsible party” includes the owner or operator of a facility or vessel, or the lessee or permittee of the area in which
an offshore facility is located. The OPA assigns liability to each responsible party for oil removal costs and a variety of public and
private damages. While liability limits apply in some circumstances, a party cannot take advantage of liability limits if the spill
was caused by gross negligence or willful misconduct or resulted from violation of a federal safety, construction or operating
regulation. If the party fails to report a spill or to cooperate fully in the cleanup, liability limits likewise do not apply. Few defenses
exist to the liability imposed by the OPA.
The OPA establishes a liability limit for onshore facilities of $350 million and for offshore facilities of all removal costs
plus $75 million, and lesser limits for some vessels depending upon their size. The regulations promulgated under OPA impose
proof of financial responsibility requirements that can be satisfied through insurance, guarantee, indemnity, surety bond, letter of
credit, qualification as a self-insurer, or a combination thereof. The amount of financial responsibility required depends upon a
variety of factors including the type of facility or vessel, its size, storage capacity, oil throughput, proximity to sensitive areas,
type of oil handled, history of discharges and other factors. We carry insurance coverage to meet these obligations, which we
believe is customary for comparable companies in our industry. A failure to comply with OPA's requirements or inadequate
cooperation during a spill response action may subject a responsible party to civil or criminal enforcement actions.
As a result of the explosion and sinking of the Deepwater Horizon drilling rig in the Gulf of Mexico in April 2010, the
U.S. Congress has considered legislation that could increase our obligations and potential liability under the OPA, including by
eliminating the current cap on liability for damages and by increasing minimum levels of financial responsibility. It is uncertain
whether, and in what form, such legislation may ultimately be adopted. We are not aware of the occurrence of any action or event
that would subject us to liability under OPA, and we believe that compliance with OPA's financial responsibility and other operating
requirements will not have a material adverse effect on us.
Discharges. The Clean Water Act (“CWA”) regulates the discharge of pollutants to waters of the United States, including
wetlands, and requires a permit for the discharge of pollutants, including petroleum, to such waters. Certain facilities that store or
otherwise handle oil are required to prepare and implement Spill Prevention, Control and Countermeasure Plans and Facility
Response Plans relating to the possible discharge of oil to surface waters. We are required to prepare and comply with such plans
and to obtain and comply with discharge permits. We believe we are in substantial compliance with these requirements and that
any noncompliance would not have a material adverse effect on us. The CWA also prohibits spills of oil and hazardous substances
16
to waters of the United States in excess of levels set by regulations and imposes liability in the event of a spill. State laws further
provide civil and criminal penalties and liabilities for spills to both surface and groundwaters and require permits that set limits
on discharges to such waters.
Hydraulic Fracturing. Moreover, our exploration and production activities may involve the use of hydraulic fracturing
techniques to stimulate wells and maximize natural gas production. Citing concerns over the potential for hydraulic fracturing to
impact drinking water, human health and the environment, and in response to a congressional directive, the USEPA has
commissioned a study to identify potential risks associated with hydraulic fracturing. The USEPA published a progress report on
this study in December 2012 and a final draft report will be delivered in 2014. Additionally, the Bureau of Land Management
(“BLM”) proposed to regulate the use of hydraulic fracturing on federal and tribal lands, but following extensive public comment
on the proposals, announced it would issue an improved proposal before finalizing new rules. The revised proposal is expected
to address disclosure of fluids used in the fracturing process, integrity of well construction, and the management and disposal of
wastewater that flows back from the drilling process. Some states now regulate utilization of hydraulic fracturing and others are
in the process of developing, or are considering development of, such rules. Depending on the results of the USEPA study and
other developments related to the impact of hydraulic fracturing, our drilling activities could be subjected to new or enhanced
federal, state and/or local regulatory requirements governing hydraulic fracturing.
Air Emissions. Our operations are subject to local, state and federal regulations for the control of emissions from sources
of air pollution. Administrative enforcement actions for failure to comply strictly with air regulations or permits may be resolved
by payment of monetary fines and correction of any identified deficiencies. Alternatively, regulatory agencies could impose civil
and criminal liability for non-compliance. An agency could require us to forego construction or operation of certain air emission
sources. We believe that we are in substantial compliance with air pollution control requirements and that, if a particular permit
application were denied, we would have enough permitted or permittable capacity to continue our operations without a material
adverse effect on any particular producing field.
According to certain scientific studies, emissions of carbon dioxide, methane, nitrous oxide and other gases commonly
known as greenhouse gases (“GHG”) may be contributing to global warming of the earth's atmosphere and to global climate
change. In response to the scientific studies, legislative and regulatory initiatives have been underway to limit GHG emissions.
The U.S. Supreme Court determined that GHG emissions fall within the federal Clean Air Act (“CAA”) definition of an “air
pollutant”, and in response the USEPA promulgated an endangerment finding paving the way for regulation of GHG emissions
under the CAA. The USEPA has also promulgated rules requiring large sources to report their GHG emissions. Sources subject
to these reporting requirements include on- and offshore petroleum and natural gas production and onshore natural gas processing
and distribution facilities that emit 25,000 metric tons or more of carbon dioxide equivalent per year in aggregate emissions from
all site sources. We are not subject to GHG reporting requirements. In addition, the USEPA promulgated rules that significantly
increase the GHG emission threshold that would identify major stationary sources of GHG subject to CAA permitting programs.
As currently written and based on current Company operations, we are not subject to federal GHG permitting requirements.
Regulation of GHG emissions is new and highly controversial, and further regulatory, legislative and judicial developments are
likely to occur. Such developments may affect how these GHG initiatives will impact the Company. Further, apart from these
developments, recent judicial decisions that have not precluded certain state tort claims alleging property damage to proceed
against GHG emissions sources may increase the Company's litigation risk for such claims. Due to the uncertainties surrounding
the regulation of and other risks associated with GHG emissions, the Company cannot predict the financial impact of related
developments on the Company.
USEPA has finalized new rules to limit air emissions from many hydraulically fractured natural gas wells. The new
regulations will require use of equipment to capture gases that come from the well during the drilling process (so-called green
completions) after January 1, 2015. Other new requirements, many effective in 2012, involve tighter standards for emissions
associated with gas production, storage and transport. While these new requirements are expected to increase the cost of natural
gas production, we do not anticipate that we will be affected any differently than other producers of natural gas.
Coastal Coordination. There are various federal and state programs that regulate the conservation and development of
coastal resources. The federal Coastal Zone Management Act (“CZMA”) was passed to preserve and, where possible, restore the
natural resources of the Nation's coastal zone. The CZMA provides for federal grants for state management programs that regulate
land use, water use and coastal development.
The Louisiana Coastal Zone Management Program (“LCZMP”) was established to protect, develop and, where feasible,
restore and enhance coastal resources of the state. Under the LCZMP, coastal use permits are required for certain activities, even
if the activity only partially infringes on the coastal zone. Among other things, projects involving use of state lands and water
bottoms, dredge or fill activities that intersect with more than one body of water, mineral activities, including the exploration and
production of oil and gas, and pipelines for the gathering, transportation or transmission of oil, gas and other minerals require such
permits. General permits, which entail a reduced administrative burden, are available for a number of routine oil and gas
17
activities. The LCZMP and its requirement to obtain coastal use permits may result in additional permitting requirements and
associated project schedule constraints.
The Texas Coastal Coordination Act (“CCA”) provides for coordination among local and state authorities to protect
coastal resources through regulating land use, water, and coastal development and establishes the Texas Coastal Management
Program (“CMP”) that applies in the nineteen counties that border the Gulf of Mexico and its tidal bays. The CCA provides for
the review of state and federal agency rules and agency actions for consistency with the goals and policies of the Coastal Management
Plan. This review may affect agency permitting and may add a further regulatory layer to some of our projects.
OSHA. We are subject to the requirements of the federal Occupational Safety and Health Act (“OSHA”) and comparable
state statutes. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of the
federal Superfund Amendments and Reauthorization Act, and similar state statutes require us to organize and/or disclose
information about hazardous materials used or produced in our operations. Certain of this information must be provided to
employees, state and local governmental authorities and local citizens.
Management believes that we are in substantial compliance with current applicable environmental laws and regulations
and that continued compliance with existing requirements will not have a material adverse impact on us.
Corporate Offices
Our headquarters are located in Lafayette, Louisiana, in approximately 48,400 square feet of leased space, with exploration
offices in Houston, Texas and Tulsa, Oklahoma, in approximately 5,500 square feet and 11,800 square feet, respectively, of leased
space. We also maintain owned or leased field offices in the areas of the major fields in which we operate properties or have a
significant interest. Replacement of any of our leased offices would not result in material expenditures by us as alternative locations
to our leased space are anticipated to be readily available.
Employees
We had 116 full-time employees as of February 7, 2013. In addition to our full time employees, we utilize the services
of independent contractors to perform certain functions. We believe that our relationships with our employees are satisfactory.
None of our employees are covered by a collective bargaining agreement.
Available Information
We make available free of charge, or through the “Investors—SEC Documents” section of our website at
www.petroquest.com, access to our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K,
and amendments to those reports filed pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable
after such material is filed, or furnished to the Securities and Exchange Commission. Our Code of Business Conduct and Ethics,
our Corporate Governance Guidelines and the charters of our Audit, Compensation and Nominating and Corporate Governance
Committees are also available through the “Investors—Corporate Governance” section of our website or in print to any stockholder
who requests them.
Item 1A.
Risk Factors
Risks Related to Our Business, Industry and Strategy
Oil and natural gas prices are volatile, and natural gas prices have been significantly depressed since the middle of 2008. An
extended decline in the prices of oil and natural gas would likely have a material adverse effect on our financial condition,
liquidity, ability to meet our financial obligations and results of operations.
Our future financial condition, revenues, results of operations, profitability and future growth, and the carrying value of
our oil and natural gas properties depend primarily on the prices we receive for our oil and natural gas production. Our ability to
maintain or increase our borrowing capacity and to obtain additional capital on attractive terms also substantially depends upon
oil and natural gas prices. Prices for natural gas have been significantly depressed since the middle of 2008 and future oil and
natural gas prices are subject to large fluctuations in response to a variety of factors beyond our control.
These factors include:
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relatively minor changes in the supply of or the demand for oil and natural gas;
the condition of the United States and worldwide economies;
• market uncertainty;
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the level of consumer product demand;
• weather conditions in the United States, such as hurricanes;
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the actions of the Organization of Petroleum Exporting Countries;
domestic and foreign governmental regulation and taxes, including price controls adopted by the Federal Energy
Regulatory Commission;
political conditions or hostilities in oil and natural gas producing regions, including the Middle East and South
America;
the price and level of foreign imports of oil and natural gas; and
the price and availability of alternate fuel sources.
We cannot predict future oil and natural gas prices and such prices may decline. An extended decline in oil and natural
gas prices may adversely affect our financial condition, liquidity, ability to meet our financial obligations and results of operations.
Lower prices have reduced and may further reduce the amount of oil and natural gas that we can produce economically and has
required and may require us to record additional ceiling test write-downs. Substantially all of our oil and natural gas sales are
made in the spot market or pursuant to contracts based on spot market prices. Our sales are not made pursuant to long-term fixed
price contracts.
To attempt to reduce our price risk, we periodically enter into hedging transactions with respect to a portion of our expected
future production. We cannot assure you that such transactions will reduce the risk or minimize the effect of any decline in oil or
natural gas prices. Any substantial or extended decline in the prices of or demand for oil or natural gas would have a material
adverse effect on our financial condition, liquidity, ability to meet our financial obligations and results of operations.
We have a substantial amount of indebtedness, which may adversely affect our cash flow and our ability to operate our business,
remain in compliance with debt covenants and make payments on our debt.
As of December 31, 2012, the aggregate amount of our outstanding indebtedness, net of cash on hand, was $185.1 million,
which could have important consequences for you, including the following:
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it may be more difficult for us to satisfy our obligations with respect to our outstanding indebtedness, including 10%
senior notes due 2017, which we refer to as our 10% notes, and any failure to comply with the obligations of any
of our debt agreements, including financial and other restrictive covenants, could result in an event of default under
the agreements governing such indebtedness;
the covenants contained in our debt agreements limit our ability to borrow money in the future for acquisitions,
capital expenditures or to meet our operating expenses or other general corporate obligations and may limit our
flexibility in operating our business;
• we will need to use a substantial portion of our cash flows to pay interest on our debt, approximately $15 million
per year for interest on our 10% notes alone, and to pay quarterly dividends, if declared by our Board of Directors,
on our Series B Preferred Stock of approximately $5.1 million per year, which will reduce the amount of money we
have for operations, capital expenditures, expansion, acquisitions or general corporate or other business activities;
•
the amount of our interest expense may increase because certain of our borrowings in the future may be at variable
rates of interest, which, if interest rates increase, could result in higher interest expense;
• we may have a higher level of debt than some of our competitors, which may put us at a competitive disadvantage;
• we may be more vulnerable to economic downturns and adverse developments in our industry or the economy in
general, especially extended or further declines in oil and natural gas prices; and
•
our debt level could limit our flexibility in planning for, or reacting to, changes in our business and the industry in
which we operate.
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Our ability to meet our expenses and debt obligations will depend on our future performance, which will be affected by
financial, business, economic, regulatory and other factors. We will not be able to control many of these factors, such as economic
conditions and governmental regulation. We cannot be certain that our cash flow from operations will be sufficient to allow us to
pay the principal and interest on our debt, including our 10% notes, and meet our other obligations. If we do not have enough cash
to service our debt, we may be required to refinance all or part of our existing debt, including our 10% notes, sell assets, borrow
more money or raise equity. We may not be able to refinance our debt, sell assets, borrow more money or raise equity on terms
acceptable to us, if at all.
To service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors
beyond our control, and any failure to meet our debt obligations could harm our business, financial condition and results of
operations.
Our ability to make payments on and to refinance our indebtedness, including our 10% notes, and to fund planned capital
expenditures will depend on our ability to generate sufficient cash flow from operations in the future. To a certain extent, this is
subject to general economic, financial, competitive, legislative and regulatory conditions and other factors that are beyond our
control, including the prices that we receive for our oil and natural gas production.
We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will
be available to us under our bank credit facility in an amount sufficient to enable us to pay principal and interest on our indebtedness,
including our 10% notes, or to fund our other liquidity needs. If our cash flow and capital resources are insufficient to fund our
debt obligations, we may be forced to reduce our planned capital expenditures, sell assets, seek additional equity or debt capital
or restructure our debt. We cannot assure you that any of these remedies could, if necessary, be affected on commercially reasonable
terms, or at all. In addition, any failure to make scheduled payments of interest and principal on our outstanding indebtedness
would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness on acceptable
terms. Our cash flow and capital resources may be insufficient for payment of interest on and principal of our debt in the future,
including payments on our 10% notes, and any such alternative measures may be unsuccessful or may not permit us to meet
scheduled debt service obligations, which could cause us to default on our obligations and could impair our liquidity.
Declining general economic, business or industry conditions may have a material adverse effect on our results of operations,
liquidity and financial condition.
Concerns over global economic conditions, energy costs, geopolitical issues, inflation, the availability and cost of credit,
the United States mortgage market and a declining real estate market in the United States have contributed to increased economic
uncertainty and diminished expectations for the global economy. These factors, combined with volatile prices of oil and natural
gas, declining business and consumer confidence and increased unemployment, have precipitated an economic slowdown and a
recession. Concerns about global economic growth have had a significant adverse impact on global financial markets and
commodity prices. If the economic climate in the United States or abroad continues to deteriorate, demand for petroleum products
could diminish, which could impact the price at which we can sell our oil, natural gas and natural gas liquids, affect the ability of
our vendors, suppliers and customers to continue operations and ultimately adversely impact our results of operations, liquidity
and financial condition.
Lower oil and natural gas prices may cause us to record ceiling test write-downs, which could negatively impact our results of
operations.
We use the full cost method of accounting to account for our oil and natural gas operations. Accordingly, we capitalize
the cost to acquire, explore for and develop oil and natural gas properties. Under full cost accounting rules, the net capitalized
costs of oil and natural gas properties may not exceed a “full cost ceiling” which is based upon the present value of estimated
future net cash flows from proved reserves, including the effect of hedges in place, discounted at 10%, plus the lower of cost or
fair market value of unproved properties. If at the end of any fiscal period we determine that the net capitalized costs of oil and
natural gas properties exceed the full cost ceiling, we must charge the amount of the excess to earnings in the period then ended.
This is called a “ceiling test write-down.” This charge does not impact cash flow from operating activities, but does reduce our
net income and stockholders' equity. Once incurred, a write-down of oil and natural gas properties is not reversible at a later date.
During 2012 and 2011, we recognized approximately $137.1 million and $18.9 million, respectively, in ceiling test write-downs
as a result of the decline in commodity prices.
We review the net capitalized costs of our properties quarterly, using, effective for fiscal periods ending on or after
December 31, 2009, a single price based on the beginning of the month average of oil and natural gas prices for the prior 12
months. We also assess investments in unproved properties periodically to determine whether impairment has occurred. The risk
that we will be required to further write down the carrying value of our oil and gas properties increases when oil and natural gas
prices are low or volatile. In addition, write-downs may occur if we experience substantial downward adjustments to our estimated
proved reserves or our unproved property values, or if estimated future development costs increase. We may experience further
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ceiling test write-downs or other impairments in the future. In addition, any future ceiling test cushion would be subject to fluctuation
as a result of acquisition or divestiture activity.
We may not be able to obtain adequate financing when the need arises to execute our long-term operating strategy.
Our ability to execute our long-term operating strategy is highly dependent on our having access to capital when the need
arises. We historically have addressed our long-term liquidity needs through bank credit facilities, second lien term credit facilities,
issuances of equity and debt securities, sales of assets, joint ventures and cash provided by operating activities. We will examine
the following alternative sources of long-term capital as dictated by current economic conditions:
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borrowings from banks or other lenders;
the sale of non-core assets;
the issuance of debt securities;
the sale of common stock, preferred stock or other equity securities;
joint venture financing; and
production payments.
The availability of these sources of capital when the need arises will depend upon a number of factors, some of which
are beyond our control. These factors include general economic and financial market conditions, oil and natural gas prices, our
credit ratings, interest rates, market perceptions of us or the oil and gas industry, our market value and our operating performance.
We may be unable to execute our long-term operating strategy if we cannot obtain capital from these sources when the need arises.
Restrictive debt covenants could limit our growth and our ability to finance our operations, fund our capital needs, respond to
changing conditions and engage in other business activities that may be in our best interests.
Our bank credit facility and the indenture governing our 10% notes contain a number of significant covenants that, among
other things, restrict or limit our ability to:
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pay dividends or distributions on our capital stock or issue preferred stock;
repurchase, redeem or retire our capital stock or subordinated debt;
• make certain loans and investments;
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place restrictions on the ability of subsidiaries to make distributions;
sell assets, including the capital stock of subsidiaries;
enter into certain transactions with affiliates;
create or assume certain liens on our assets;
enter into sale and leaseback transactions;
• merge or to enter into other business combination transactions;
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enter into transactions that would result in a change of control of us; or
engage in other corporate activities.
Also, our bank credit facility and the indenture governing our 10% notes require us to maintain compliance with specified
financial ratios and satisfy certain financial condition tests. Our ability to comply with these ratios and financial condition tests
may be affected by events beyond our control, and we cannot assure you that we will meet these ratios and financial condition
tests. These financial ratio restrictions and financial condition tests could limit our ability to obtain future financings, make needed
capital expenditures, withstand a future downturn in our business or the economy in general or otherwise conduct necessary
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corporate activities. We may also be prevented from taking advantage of business opportunities that arise because of the limitations
that the restrictive covenants under our bank credit facility and the indenture governing our 10% notes impose on us.
A breach of any of these covenants or our inability to comply with the required financial ratios or financial condition
tests could result in a default under our bank credit facility and our 10% notes. A default, if not cured or waived, could result in
all indebtedness outstanding under our bank credit facility and our 10% notes to become immediately due and payable. If that
should occur, we may not be able to pay all such debt or borrow sufficient funds to refinance it. Even if new financing were then
available, it may not be on terms that are acceptable to us. If we were unable to repay those amounts, the lenders could accelerate
the maturity of the debt or proceed against any collateral granted to them to secure such defaulted debt.
Our future success depends upon our ability to find, develop, produce and acquire additional oil and natural gas reserves that
are economically recoverable.
As is generally the case in the Gulf Coast Basin where approximately one quarter of our current production is located,
many of our producing properties are characterized by a high initial production rate, followed by a steep decline in production.
In order to maintain or increase our reserves, we must constantly locate and develop or acquire new oil and natural gas reserves
to replace those being depleted by production. We must do this even during periods of low oil and natural gas prices when it is
difficult to raise the capital necessary to finance our exploration, development and acquisition activities. Without successful
exploration, development or acquisition activities, our reserves and revenues will decline rapidly. We may not be able to find and
develop or acquire additional reserves at an acceptable cost or have access to necessary financing for these activities, either of
which would have a material adverse effect on our financial condition.
Approximately one quarter of our production is exposed to the additional risk of severe weather, including hurricanes and
tropical storms, as well as flooding, coastal erosion and sea level rise.
At December 31, 2012, approximately one quarter of our production and approximately 13% of our reserves are located
in the Gulf of Mexico and along the Gulf Coast Basin. Operations in this area are subject to severe weather, including hurricanes
and tropical storms, as well as flooding, coastal erosion and sea level rise. Some of these adverse conditions can be severe enough
to cause substantial damage to facilities and possibly interrupt production. For example, certain of our Gulf Coast Basin properties
have experienced damages and production downtime as a result of storms including Hurricanes Katrina and Rita, and more recently
Hurricanes Gustav and Ike. In addition, according to certain scientific studies, emissions of carbon dioxide, methane, nitrous oxide
and other gases commonly known as greenhouse gases may be contributing to global warming of the earth's atmosphere and to
global climate change, which may exacerbate the severity of these adverse conditions. As a result, such conditions may pose
increased climate-related risks to our assets and operations.
In accordance with customary industry practices, we maintain insurance against some, but not all, of these risks; however,
losses could occur for uninsured risks or in amounts in excess of existing insurance coverage. We cannot assure you that we will
be able to maintain adequate insurance in the future at rates we consider reasonable or that any particular types of coverage will
be available. An event that is not fully covered by insurance could have a material adverse effect on our financial position and
results of operations.
Losses and liabilities from uninsured or underinsured drilling and operating activities could have a material adverse effect on
our financial condition and operations.
We maintain several types of insurance to cover our operations, including worker's compensation, maritime employer's
liability and comprehensive general liability. Amounts over base coverages are provided by primary and excess umbrella liability
policies. We also maintain operator's extra expense coverage, which covers the control of drilling or producing wells as well as
redrilling expenses and pollution coverage for wells out of control.
We may not be able to maintain adequate insurance in the future at rates we consider reasonable, or we could experience
losses that are not insured or that exceed the maximum limits under our insurance policies. If a significant event that is not fully
insured or indemnified occurs, it could materially and adversely affect our financial condition and results of operations.
Factors beyond our control affect our ability to market oil and natural gas.
The availability of markets and the volatility of product prices are beyond our control and represent a significant risk.
The marketability of our production depends upon the availability and capacity of natural gas gathering systems, pipelines and
processing facilities. The unavailability or lack of capacity of these systems and facilities could result in the shut-in of producing
wells or the delay or discontinuance of development plans for properties. Our ability to market oil and natural gas also depends
on other factors beyond our control. These factors include:
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the level of domestic production and imports of oil and natural gas;
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the proximity of natural gas production to natural gas pipelines;
the availability of pipeline capacity;
the demand for oil and natural gas by utilities and other end users;
the availability of alternate fuel sources;
the effect of inclement weather, such as hurricanes;
state and federal regulation of oil and natural gas marketing; and
federal regulation of natural gas sold or transported in interstate commerce.
If these factors were to change dramatically, our ability to market oil and natural gas or obtain favorable prices for our
oil and natural gas could be adversely affected.
The Macondo well explosion and ensuing oil spill could have broad adverse consequences affecting our operations in the Gulf
of Mexico, some of which may be unforeseeable.
In April 2010, there was a fire and explosion aboard the rig drilling the Macondo well operated by another company in
ultra-deep water in the U.S. Gulf of Mexico. As a result of the explosion and ensuing fire, the rig sank, causing loss of life, and
created a major oil spill that produced economic, environmental and natural resource damage in the U.S. Gulf Coast region. In
response to the explosion and spill, there have been many proposals by governmental and private constituencies to address the
direct impact of the disaster and to prevent similar disasters in the future. Beginning in May 2010, the U.S. Department of the
Interior, initially through its federal Minerals Management Service (the “MMS”), which was subsequently renamed the Bureau
of Ocean Energy Management, Regulation and Enforcement (the “BOEMRE”) in June 2010, issued a series of “Notices to Lessees
and Operators” (“NTLs”), imposing a variety of new safety measures and permitting requirements, and implementing a moratorium
on deepwater drilling activities in the U.S. Gulf of Mexico that effectively shut down deepwater drilling activities until the
moratorium was lifted by Secretary of the Interior Ken Salazar in October 2010. Despite the fact that the drilling moratorium was
lifted, this spill and its aftermath have led to delays in obtaining drilling permits from the BOEMRE. Effective October 1, 2011,
the BOEMRE was split into two federal bureaus, the Bureau of Ocean Energy Management (the “BOEM”), which handles offshore
leasing, resource evaluation, review and administration of oil and gas exploration and development plans, renewable energy
development, NEPA analysis and environmental studies, and the Bureau of Safety and Environmental Enforcement (the “BSEE”),
which is responsible for the safety and enforcement functions of offshore oil and gas operations, including the development and
enforcement of safety and environmental regulations, permitting of offshore exploration, development and production activities,
inspections, offshore regulatory programs, oil spill response and newly formed training and environmental compliance programs.
Consequently, after October 1, 2011, we will be required to interact with two newly formed federal bureaus to obtain approval of
our exploration and development plans and issuance of drilling permits, which may result in added plan approval or drilling permit
delays as the functions of the former BOEMRE are fully divested and implemented in the two federal bureaus. While legislation
was introduced and passed in the U.S. House of Representatives to expedite the process for offshore permits including limitations
on the timeframe for environmental and judicial review, there is no guarantee that this or similar legislation will pass in the U.S.
Senate.
In addition to the drilling restrictions, new safety measures and permitting requirements already issued by the BOEMRE,
there have been numerous additional proposed changes in laws, regulations, guidance and policy in response to the Macondo well
explosion and oil spill that could affect our operations and cause us to incur substantial losses or expenditures. Implementation of
any one or more of the various proposed responses to the disaster could materially adversely affect operations in the U.S. Gulf of
Mexico by raising operating costs, increasing insurance premiums, delaying drilling operations and increasing regulatory costs,
and, further, could lead to a wide variety of other unforeseeable consequences that make operations in the U.S. Gulf of Mexico
more difficult, more time consuming, and more costly. For example, during the previous session of Congress, a variety of
amendments to the OPA, were proposed in response to the Macondo well incident. The OPA and regulations adopted pursuant to
the OPA impose a variety of requirements related to the prevention of and response to oil spills into waters of the United States,
including the Outer Continental Shelf, which includes the U.S. Gulf of Mexico where we have offshore operations. The OPA
subjects operators of offshore leases and owners and operators of oil handling facilities to strict joint and several liability for all
containment and cleanup costs and certain other damages arising from a spill, including, but not limited to, the costs of responding
to a release of oil, natural resource damages, and economic damages suffered by persons adversely affected by an oil spill. The
OPA also requires owners and operators of offshore oil production facilities to establish and maintain evidence of financial
responsibility to cover costs that could be incurred in responding to an oil spill. The OPA currently requires a minimum financial
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responsibility demonstration of $35 million for companies operating on the Outer Continental Shelf, although the Secretary of
Interior may increase this amount up to $150 million in certain situations. Legislation was proposed in a previous session of
Congress to amend the OPA to increase the minimum level of financial responsibility to $300 million or more and there exists the
possibility that similar legislation could be introduced and adopted during the current session of Congress. If the OPA is amended
during the current session of Congress to increase the minimum level of financial responsibility to $300 million, we may experience
difficulty in providing financial assurances sufficient to comply with this requirement. If we are unable to provide the level of
financial assurance required by the OPA, we may be forced to sell our properties or operations located on the Outer Continental
Shelf or enter into partnerships with other companies that can meet the increased financial responsibility requirement, and any
such developments could have an adverse effect on the value of our offshore assets and the results of our operations. We cannot
predict at this time whether the OPA will be amended or whether the level of financial responsibility required for companies
operating on the Outer Continental Shelf will be increased.
Regulatory requirements imposed by the BOEMRE, BOEM or BSEE could significantly delay our ability to obtain permits to
drill new wells in offshore waters.
Subsequent to the Macondo well incident in the U.S. Gulf of Mexico, the BOEMRE issued a series of NTLs and other
regulatory requirements imposing new standards and permitting procedures for new wells to be drilled in federal waters of the
Outer Continental Shelf. These requirements include the following:
• The Environmental NTL, which imposes new and more stringent requirements for documenting the environmental
impacts potentially associated with the drilling of a new offshore well and significantly increases oil spill response
requirements.
• The Compliance and Review NTL, which imposes requirements for operators to secure independent reviews of well
design, construction and flow intervention processes, and also requires certifications of compliance from senior
corporate officers.
• The Drilling Safety Rule, which prescribes tighter cementing and casing practices, imposes standards for the use of
drilling fluids to maintain wellbore integrity, and stiffens oversight requirements relating to blowout preventers and
their components, including shear and pipe rams.
• The Workplace Safety Rule, which requires operators to have a comprehensive safety and environmental management
system (“SEMS”) in order to reduce human and organizational errors as root causes of work-related accidents and
offshore spills.
On September 14, 2011, BOEMRE issued proposed rules that would amend the Workplace Safety Rule by requiring the
imposition of certain added safety procedures to a company's SEMS not covered by the original rule and revising existing obligations
that a company's SEMS be audited by requiring the use of an independent third party auditor who has been pre-approved by the
agency to perform the auditing task. These proposed amendments have not yet been implemented. Moreover, effective October 1,
2011, the BOEMRE was split into two separate federal bureaus, the BOEM and the BSEE. As the new standards and procedures
are being integrated into the existing framework of offshore regulatory programs, we anticipate that there may be increased costs
associated with regulatory compliance and delays in obtaining permits for other operations such as recompletions, workovers and
abandonment activities.
We are unsure what long-term effect, if any, the BOEMRE's, BOEM's or BSEE's additional regulatory requirements and
permitting procedures will have on our offshore operations. Consequently, we may be subject to a variety of unforeseen adverse
consequences arising directly or indirectly from the Macondo well incident.
Regulatory requirements imposed by the BOEMRE, BOEM or BSEE could significantly impact our estimates of future asset
retirement obligations from period to period.
We are responsible for plugging and abandoning wellbores and decommissioning associated platforms, pipelines and
facilitates on our oil and natural gas properties. In addition to the NTLs discussed previously, the BOEMRE issued NTL No. 2010-
G05, effective October 15, 2010, which establishes a more stringent regimen for the timely decommissioning of what is known
as “idle iron”-wells, platforms and pipelines that are no longer producing or serving exploration or support functions related to
an operator's lease-in the U.S. Gulf of Mexico. This NTL sets forth more stringent standards for decommissioning timing
requirements by applying the requirement that any well that has not been used during the past five years for exploration or production
on active leases and is no longer capable of producing in paying quantities must be permanently plugged or temporarily abandoned
within three years. Plugging or abandonment of wells may be delayed by two years if all of the well's hydrocarbon and sulphur
zones are appropriately isolated. Similarly, platforms or other facilities that are no longer useful for operations must be removed
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within five years of the cessation of operations. The triggering of these plugging, abandonment and removal activities under what
may be viewed as an accelerated schedule in comparison to the industry's historical decommissioning efforts may serve to increase,
perhaps materially, our future plugging, abandonment and removal costs, which may translate into a need to increase our estimate
of future asset retirement obligations required to meet such increased costs. For additional details relating to our asset retirement
obligations, please read Note 6 to our audited consolidated financial statements.
BSEE has also issued several NTLs imposing or enhancing requirements related to oil spill prevention and reporting.
These NTLs expand guidelines for Oil Spill Response Plans, specify expected content of written oil discharge reports to be
submitted following an incident, and clarify calculations to be made of various anticipated pressures prior to production.
Federal and state legislation and regulatory initiatives relating to oil and natural gas development and hydraulic fracturing
could result in increased costs and additional operating restrictions or delays.
Hydraulic fracturing involves the injection of water, sand and chemicals under pressure into rock formations to enhance
oil and natural gas production. Hydraulic fracturing using fluids other than diesel is currently exempt from regulation under the
federal Safe Drinking Water Act, but opponents of hydraulic fracturing have called for further study of the technique's environmental
effects and, in some cases, a moratorium on the use of the technique. Several proposals have been submitted to Congress that, if
implemented, would subject all hydraulic fracturing to regulation under the Safe Drinking Water Act. Further, the USEPA is
conducting a scientific study to investigate the possible relationships between hydraulic fracturing and drinking water. The USEPA
published a progress report on this study in December 2012, and the final draft report is scheduled for completion by 2014. USEPA
has also finalized new rules to limit air emissions from many hydraulically fractured natural gas wells. The new regulations will
require use of equipment to capture gases that come from the well during the drilling process (so-called green completions) after
January 1, 2015. Other new requirements, many effective in 2012, involve tighter standards for emissions associated with gas
production, storage and transport. Additionally, the Bureau of Land Management (“BLM”) has proposed rules to regulate the use
of hydraulic fracturing on federal and tribal lands, but following extensive public comment on the proposals, announced it would
issue an improved proposal before finalizing new rules. The revised proposal is expected to address disclosure of fluids used in
the fracturing process, integrity of well construction, and the management and disposal of wastewater that flows back from the
drilling process.
A number of states, including Louisiana, Texas and Wyoming, have required operators or service companies to disclose
chemical components in fluids used for hydraulic fracturing. Some states have also imposed, or are considering, more stringent
regulation of oil and natural gas exploration and production activities involving hydraulic fracturing by, among other things,
promulgating well completion requirements, imposing controls on storage, recycling and disposal of flowback fluids, and increasing
reporting obligations. In addition, concerns related to the impacts from hydraulic fracturing have led several states to ban new
natural gas development or to impose moratoria on use of hydraulic fracturing in various sensitive areas, including some areas
overlying the Marcellus Shale. Similar action could be taken to preclude or limit natural gas development in other locations.
Recent seismic events have been observed in some areas (including Oklahoma, Ohio and Texas) where hydraulic fracturing
has taken place. Some scientists believe the increased seismic activity may result from deep well fluid injection associated with
use of hydraulic fracturing. Additional regulatory measures designed to minimize or avoid damage to geologic formations may
be imposed to address such concerns.
Although it is not possible at this time to predict the final outcome of the USEPA's study or the requirements of any
additional federal or state legislation or regulation regarding hydraulic fracturing, management of drilling fluids or well integrity
requirements, any new federal or state restrictions imposed on such activities in areas in which we conduct business could
significantly increase our operating, capital and compliance costs as well as delay our ability to develop oil and natural gas reserves.
In addition to increased regulation of our business, we may also experience an increase in litigation seeking damages as a result
of heightened public concerns related to air quality, water quality, and other environmental impacts.
The adoption and implementation of new statutory and regulatory requirements for derivative transactions could have an
adverse impact on our ability to hedge risks associated with our business and increase the working capital requirements to
conduct these activities.
In July 2010, federal legislation known as the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-
Frank Act, was enacted. The Dodd-Frank Act provides for new statutory and regulatory requirements for derivative transactions,
including oil and natural gas hedging transactions. Among other things, the Dodd-Frank Act provides for the creation of position
limits for certain derivatives transactions, as well as requiring certain transactions to be cleared on exchanges for which cash
collateral will be required. In October 2011, the Commodities Futures Trading Commission, or the CFTC, approved final rules
that establish position limits for futures contracts on 28 physical commodities, including four energy commodities, and swaps,
futures and options that are economically equivalent to those contracts. The rules provide an exemption for “bona fide hedging”
transactions or positions, but this exemption is narrower than the exemption under existing CFTC position limit rules. These newly
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approved CFTC position limits rules were vacated by the United States District Court for the District of Columbia in September
2012, although the CFTC has stated that it will appeal the District Court's decision.
It is not possible at this time to predict with certainty the full effect of the Dodd-Frank Act and CFTC rules on us and the
timing of such effects. The Dodd-Frank Act may require us to comply with margin requirements and with certain clearing and
trade-execution requirements if we do not satisfy certain specific exceptions. The Dodd-Frank Act may also require the
counterparties to our derivatives contracts to transfer or assign some of their derivatives contracts to a separate entity, which may
not be as creditworthy as the current counterparty. Depending on the rules adopted by the CFTC or similar rules that may be
adopted by other regulatory bodies, we might in the future be required to provide cash collateral for our commodities hedging
transactions under circumstances in which we do not currently post cash collateral. Posting of such additional cash collateral could
impact liquidity and reduce our cash available for capital expenditures. A requirement to post cash collateral could therefore reduce
our ability to execute hedges to reduce commodity price uncertainty and thus protect cash flows. If we reduce our use of derivatives
as a result of the Dodd-Frank Act and regulations, our results of operations may become more volatile and our cash flows may be
less predictable.
Proposed changes to U.S. tax laws, if adopted, could have an adverse effect on our business, financial condition, results of
operations and cash flows.
The U.S. President's Fiscal Year 2013 Budget Proposal includes provisions that would, if enacted, make significant
changes to U.S. tax laws applicable to oil and natural gas exploration and production companies. These changes include, but are
not limited to:
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the repeal of the limited percentage depletion allowance for oil and natural gas production in the United States;
the elimination of current deductions for intangible drilling and development costs;
the elimination of the deduction for certain domestic production activities; and
an extension of the amortization period for certain geological and geophysical expenditures.
Members of the U.S. Congress have considered similar changes to the existing federal income tax laws that affect oil
and natural gas exploration and production companies. It is unclear whether these or similar changes will be enacted. The passage
of this legislation or any similar changes in federal income tax laws could eliminate or postpone certain tax deductions that are
currently available with respect to U.S. oil and natural gas exploration and development. Any such changes could have an adverse
effect on our financial position, results of operations and cash flows.
We face strong competition from larger oil and natural gas companies that may negatively affect our ability to carry on
operations.
We operate in the highly competitive areas of oil and natural gas exploration, development and production. Factors that
affect our ability to compete successfully in the marketplace include:
•
•
•
the availability of funds and information relating to a property;
the standards established by us for the minimum projected return on investment; and
the transportation of natural gas.
Our competitors include major integrated oil companies, substantial independent energy companies, affiliates of major
interstate and intrastate pipelines and national and local natural gas gatherers, many of which possess greater financial and other
resources than we do. If we are unable to successfully compete against our competitors, our business, prospects, financial condition
and results of operations may be adversely affected.
Our estimates of proved reserves have been prepared under revised SEC rules which went into effect for fiscal years ending
on or after December 31, 2009, which may make comparisons to prior periods difficult and could limit our ability to book
additional proved undeveloped reserves in the future.
This Form 10-K presents estimates of our proved reserves as of December 31, 2012, which have been prepared and
presented under revised SEC rules. These revised rules were effective for fiscal years ending on or after December 31, 2009, and
require SEC reporting companies to prepare their reserve estimates using revised reserve definitions and revised pricing based on
twelve-month unweighted first-day-of-the-month average pricing. The previous rules required that reserve estimates be calculated
26
using last-day-of-the-year pricing. As a result of these changes, direct comparisons to our reserve amounts reported prior to the
year ending on December 31, 2009 may be more difficult.
Another impact of the revised SEC rules is a general requirement that, subject to limited exceptions, proved undeveloped
reserves may only be booked if they relate to wells scheduled to be drilled within five years of the date of booking. This revised
rule may limit our potential to book additional proved undeveloped reserves as we pursue our drilling program. Moreover, we
may be required to write down our proved undeveloped reserves if we do not drill on those reserves within the required five-year
time frame. We removed approximately 5.5 Bcfe of proved undeveloped reserves in 2012 as a result of the five year rule.
Our actual production, revenues and expenditures related to our reserves are likely to differ from our estimates of proved
reserves. We may experience production that is less than estimated and drilling costs that are greater than estimated in our
reserve report. These differences may be material.
Although the estimates of our oil and natural gas reserves and future net cash flows attributable to those reserves were
prepared by Ryder Scott Company, L.P., our independent petroleum and geological engineers, we are ultimately responsible for
the disclosure of those estimates. Reserve engineering is a complex and subjective process of estimating underground accumulations
of oil and natural gas that cannot be measured in an exact manner. Estimates of economically recoverable oil and natural gas
reserves and of future net cash flows necessarily depend upon a number of variable factors and assumptions, including:
•
•
•
•
historical production from the area compared with production from other similar producing wells;
the assumed effects of regulations by governmental agencies;
assumptions concerning future oil and natural gas prices; and
assumptions concerning future operating costs, severance and excise taxes, development costs and work-over and
remedial costs.
Because all reserve estimates are to some degree subjective, each of the following items may differ materially from those
assumed in estimating proved reserves:
•
•
•
•
the quantities of oil and natural gas that are ultimately recovered;
the production and operating costs incurred;
the amount and timing of future development expenditures; and
future oil and natural gas sales prices.
Furthermore, different reserve engineers may make different estimates of reserves and cash flows based on the same
available data. Historically, the difference between our actual production and the production estimated in a prior year's reserve
report has not been material. Our 2012 production was approximately 7% greater than amounts projected in our 2011 reserve
report. We cannot assure you that these differences will not be material in the future.
Approximately 26% of our estimated proved reserves at December 31, 2012 are undeveloped and 6% were developed,
non-producing. Recovery of undeveloped reserves requires significant capital expenditures and successful drilling operations. The
reserve data assumes that we will make significant capital expenditures to develop and produce our reserves. Although we have
prepared estimates of our oil and natural gas reserves and the costs associated with these reserves in accordance with industry
standards, we cannot assure you that the estimated costs are accurate, that development will occur as scheduled or that the actual
results will be as estimated. In addition, the recovery of undeveloped reserves is generally subject to the approval of development
plans and related activities by applicable state and/or federal agencies. Statutes and regulations may affect both the timing and
quantity of recovery of estimated reserves. Such statutes and regulations, and their enforcement, have changed in the past and may
change in the future, and may result in upward or downward revisions to current estimated proved reserves.
You should not assume that the standardized measure of discounted cash flows is the current market value of our estimated
oil and natural gas reserves. In accordance with SEC requirements, the standardized measure of discounted cash flows from proved
reserves at December 31, 2012 are based on twelve-month average prices and costs as of the date of the estimate. These prices
and costs will change and may be materially higher or lower than the prices and costs as of the date of the estimate. Any changes
in consumption by oil and natural gas purchasers or in governmental regulations or taxation may also affect actual future net cash
flows. The timing of both the production and the expenses from the development and production of oil and natural gas properties
will affect the timing of actual future net cash flows from proved reserves and their present value. In addition, the 10% discount
27
factor we use when calculating standardized measure of discounted cash flows for reporting requirements in compliance with
accounting requirements is not necessarily the most appropriate discount factor. The effective interest rate at various times and
the risks associated with our operations or the oil and natural gas industry in general will affect the accuracy of the 10% discount
factor.
We may be unable to successfully identify, execute or effectively integrate future acquisitions, which may negatively affect our
results of operations.
Acquisitions of oil and gas businesses and properties have been an important element of our business, and we will continue
to pursue acquisitions in the future. In the last several years, we have pursued and consummated acquisitions that have provided
us opportunities to grow our production and reserves. Although we regularly engage in discussions with, and submit proposals to,
acquisition candidates, suitable acquisitions may not be available in the future on reasonable terms. If we do identify an appropriate
acquisition candidate, we may be unable to successfully negotiate the terms of an acquisition, finance the acquisition or, if the
acquisition occurs, effectively integrate the acquired business into our existing business. Negotiations of potential acquisitions
and the integration of acquired business operations may require a disproportionate amount of management's attention and our
resources. Even if we complete additional acquisitions, continued acquisition financing may not be available or available on
reasonable terms, any new businesses may not generate revenues comparable to our existing business, the anticipated cost
efficiencies or synergies may not be realized and these businesses may not be integrated successfully or operated profitably. The
success of any acquisition will depend on a number of factors, including the ability to estimate accurately the recoverable volumes
of reserves, rates of future production and future net revenues attainable from the reserves and to assess possible environmental
liabilities. Our inability to successfully identify, execute or effectively integrate future acquisitions may negatively affect our
results of operations.
Even though we perform due diligence reviews (including a review of title and other records) of the major properties we
seek to acquire that we believe is consistent with industry practices, these reviews are inherently incomplete. It is generally not
feasible for us to perform an in-depth review of every individual property and all records involved in each acquisition. However,
even an in-depth review of records and properties may not necessarily reveal existing or potential problems or permit us to become
familiar enough with the properties to assess fully their deficiencies and potential. Even when problems are identified, we may
assume certain environmental and other risks and liabilities in connection with the acquired businesses and properties. The discovery
of any material liabilities associated with our acquisitions could harm our results of operations.
In addition, acquisitions of businesses may require additional debt or equity financing, resulting in additional leverage
or dilution of ownership. Our bank credit facility contains certain covenants that limit, or which may have the effect of limiting,
among other things acquisitions, capital expenditures, the sale of assets and the incurrence of additional indebtedness.
Hedging production may limit potential gains from increases in commodity prices or result in losses.
We enter into hedging arrangements from time to time to reduce our exposure to fluctuations in oil and natural gas prices
and to achieve more predictable cash flow. Our hedges at December 31, 2012 are in the form of a three-way costless collar and
a straight swap placed with the commodity trading branch of JPMorgan Chase Bank which participates in our bank credit facility.
We cannot assure you that this or future counterparties will not become credit risks in the future. Hedging arrangements expose
us to risks in some circumstances, including situations when the counterparty to the hedging contract defaults on the contractual
obligations or there is a change in the expected differential between the underlying price in the hedging agreement and actual
prices received. These hedging arrangements may limit the benefit we could receive from increases in the market or spot prices
for oil and natural gas. Oil and natural gas hedges increased our total oil and gas sales by approximately $9.1 million, $2.4 million
and $17.5 million during 2012, 2011 and 2010, respectively. We cannot assure you that the hedging transactions we have entered
into, or will enter into, will adequately protect us from fluctuations in oil and natural gas prices.
The loss of key management or technical personnel could adversely affect our ability to operate.
Our operations are dependent upon a diverse group of key senior management and technical personnel. In addition, we
employ numerous other skilled technical personnel, including geologists, geophysicists and engineers that are essential to our
operations. We cannot assure you that such individuals will remain with us for the immediate or foreseeable future. The unexpected
loss of the services of one or more of any of these key management or technical personnel could have an adverse effect on our
operations.
Operating hazards may adversely affect our ability to conduct business.
Our operations are subject to risks inherent in the oil and natural gas industry, such as:
•
unexpected drilling conditions including blowouts, cratering and explosions;
28
•
•
•
•
uncontrollable flows of oil, natural gas or well fluids;
equipment failures, fires or accidents;
pollution and other environmental risks; and
shortages in experienced labor or shortages or delays in the delivery of equipment.
These risks could result in substantial losses to us from injury and loss of life, damage to and destruction of property and
equipment, pollution and other environmental damage and suspension of operations. Our offshore operations are also subject to
a variety of operating risks peculiar to the marine environment, such as hurricanes or other adverse weather conditions and more
extensive governmental regulation. These regulations may, in certain circumstances, impose strict liability for pollution damage
or result in the interruption or termination of operations.
Environmental compliance costs and environmental liabilities could have a material adverse effect on our financial condition
and operations.
Our operations are subject to numerous federal, state and local laws and regulations governing the discharge of materials
into the environment or otherwise relating to environmental protection. These laws and regulations may:
•
•
•
•
•
require the acquisition of permits before drilling commences;
restrict the types, quantities and concentration of various substances that can be released into the environment from
drilling and production activities;
limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas;
require remedial measures to mitigate pollution from former operations, such as plugging abandoned wells; and
impose substantial liabilities for pollution resulting from our operations.
The trend toward stricter standards in environmental legislation and regulation is likely to continue. The enactment of
stricter legislation or the adoption of stricter regulations could have a significant impact on our operating costs, as well as on the
oil and natural gas industry in general.
Our operations could result in liability for personal injuries, property damage, oil spills, discharge of hazardous materials,
remediation and clean-up costs and other environmental damages. We could also be liable for environmental damages caused by
previous property owners. As a result, substantial liabilities to third parties or governmental entities may be incurred which could
have a material adverse effect on our financial condition and results of operations. We maintain insurance coverage for our
operations, including limited coverage for sudden and accidental environmental damages, but this insurance may not extend to
the full potential liability that could be caused by sudden and accidental environmental damages and further may not cover
environmental damages that occur over time. Accordingly, we may be subject to liability or may lose the ability to continue
exploration or production activities upon substantial portions of our properties if certain environmental damages occur.
The Oil Pollution Act of 1990 imposes a variety of regulations on “responsible parties” related to the prevention of oil
spills. The implementation of new, or the modification of existing, environmental laws or regulations, including regulations
promulgated pursuant to the Oil Pollution Act, could have a material adverse impact on us.
We cannot control the activities on properties we do not operate and we are unable to ensure the proper operation and profitability
of these non-operated properties.
We do not operate all of the properties in which we have an interest. As a result, we have limited ability to exercise
influence over, and control the risks associated with, the operation of these properties. The success and timing of drilling and
development activities on our partially owned properties operated by others therefore will depend upon a number of factors outside
of our control, including the operator's:
•
•
•
timing and amount of capital expenditures;
expertise and diligence in adequately performing operations and complying with applicable agreements;
financial resources;
29
•
•
inclusion of other participants in drilling wells; and
use of technology.
As a result of any of the above or an operator's failure to act in ways that are in our best interest, our allocated production
revenues and results of operations could be adversely affected.
Ownership of working interests and overriding royalty interests in certain of our properties by certain of our officers and
directors potentially creates conflicts of interest.
Certain of our executive officers and directors or their respective affiliates are working interest owners or overriding
royalty interest owners in certain properties. In their capacity as working interest owners, they are required to pay their proportionate
share of all costs and are entitled to receive their proportionate share of revenues in the normal course of business. As overriding
royalty interest owners they are entitled to receive their proportionate share of revenues in the normal course of business. There
is a potential conflict of interest between us and such officers and directors with respect to the drilling of additional wells or other
development operations with respect to these properties.
Risks Relating to Our Outstanding Common Stock
Our stock price could be volatile, which could cause you to lose part or all of your investment.
The stock market has from time to time experienced significant price and volume fluctuations that may be unrelated to
the operating performance of particular companies. In particular, the market price of our common stock, like that of the securities
of other energy companies, has been and may continue to be highly volatile. During 2012, the sales price of our stock ranged from
a low of $4.26 per share (on June 4, 2012) to a high of $7.39 per share (on January 5, 2012). Factors such as announcements
concerning changes in prices of oil and natural gas, the success of our acquisition, exploration and development activities, the
availability of capital, and economic and other external factors, as well as period-to-period fluctuations and financial results, may
have a significant effect on the market price of our common stock.
From time to time, there has been limited trading volume in our common stock. In addition, there can be no assurance
that there will continue to be a trading market or that any securities research analysts will continue to provide research coverage
with respect to our common stock. It is possible that such factors will adversely affect the market for our common stock.
Issuance of shares in connection with financing transactions or under stock incentive plans will dilute current stockholders.
We have issued 1,495,000 shares of Series B Preferred Stock, which are presently convertible into 5,147,734 shares of
our common stock. In addition, pursuant to our stock incentive plan, our management is authorized to grant stock awards to our
employees, directors and consultants. You will incur dilution upon the conversion of the Series B Preferred Stock, the exercise of
any outstanding stock awards or the grant of any restricted stock. In addition, if we raise additional funds by issuing additional
common stock, or securities convertible into or exchangeable or exercisable for common stock, further dilution to our existing
stockholders will result, and new investors could have rights superior to existing stockholders.
The number of shares of our common stock eligible for future sale could adversely affect the market price of our stock.
At December 31, 2012, we had reserved approximately 1.9 million shares of common stock for issuance under outstanding
options and approximately 5.1 million shares issuable upon conversion of the Series B Preferred Stock. All of these shares of
common stock are registered for sale or resale on currently effective registration statements. We may issue additional restricted
securities or register additional shares of common stock under the Securities Act in the future. The issuance of a significant number
of shares of common stock upon the exercise of stock options, the granting of restricted stock or the conversion of the Series B
Preferred Stock, or the availability for sale, or sale, of a substantial number of the shares of common stock eligible for future sale
under effective registration statements, under Rule 144 or otherwise, could adversely affect the market price of the common stock.
Provisions in our certificate of incorporation and bylaws could delay or prevent a change in control of our company, even if
that change would be beneficial to our stockholders.
Certain provisions of our certificate of incorporation and bylaws may delay, discourage, prevent or render more difficult
an attempt to obtain control of our company, whether through a tender offer, business combination, proxy contest or otherwise.
These provisions include:
•
•
the charter authorization of “blank check” preferred stock;
provisions that directors may be removed only for cause, and then only on approval of holders of a majority of the
outstanding voting stock;
30
•
•
a restriction on the ability of stockholders to call a special meeting and take actions by written consent; and
provisions regulating the ability of our stockholders to nominate directors for election or to bring matters for action
at annual meetings of our stockholders.
We do not intend to pay dividends on our common stock and our ability to pay dividends on our common stock is restricted.
We have not paid dividends on our common stock, cash or otherwise, and intend to retain our cash flow from operations
for the future operation and development of our business. We are currently restricted from paying dividends on our common stock
by our bank credit facility, the indenture governing the 10% senior notes and, in some circumstances, by the terms of our Series
B Preferred Stock. Any future dividends also may be restricted by our then-existing debt agreements.
Item 1B Unresolved Staff Comments
None
Item 3.
Legal Proceedings
PetroQuest is involved in litigation relating to claims arising out of its operations in the normal course of business,
including worker’s compensation claims, tort claims and contractual disputes. Some of the existing known claims against us are
covered by insurance subject to the limits of such policies and the payment of deductible amounts by us. Management believes
that the ultimate disposition of all uninsured or unindemnified matters resulting from existing litigation will not have a material
adverse effect on PetroQuest’s business or financial position.
Item 4.
Mine Safety Disclosures
Not applicable.
31
PART II
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
The following graph illustrates the yearly percentage change in the cumulative stockholder return on our common stock,
compared with the cumulative total return on the NYSE/AMEX Stock Market (U.S. Companies) Index and the NYSE Stocks—
Crude Petroleum and Natural Gas Index, for the five years ended December 31, 2012.
Comparison of 5 Year Cumulative Total Return
Assumes Initial Investment of $100
December 2012
PetroQuest Energy, Inc.
NYSE/AMEX/NASDAQ Market (US
Companies)
NYSE Stocks (SIC 1310-1319 US
Companies) Crude Petroleum and
Natural Gas
12/31/2007
12/31/2008
12/31/2009
12/31/2010
12/31/2011
12/31/2012
$100.00
47.26
42.86
52.65
46.15
34.61
$100.00
63.85
79.87
94.00
95.01
109.87
$100.00
62.78
92.97
110.35
103.83
98.65
32
Market Price of and Dividends on Common Stock
Our common stock trades on the New York Stock Exchange under the symbol “PQ.” The following table lists high and
low sales prices per share for the periods indicated:
2011
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
2012
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
$
$
High
Low
9.75 $
9.60
8.70
8.11
7.39 $
6.46
7.05
7.00
6.92
6.21
5.48
4.72
5.41
4.26
4.82
4.69
As of February 28, 2013, there were 302 common stockholders of record.
We have never paid a dividend on our common stock, cash or otherwise, and intend to retain our cash flow from operations
for the future operation and development of our business. In addition, under our bank credit facility, the indenture governing the
10% senior notes, and, in some circumstances, the terms of our Series B Preferred Stock, we are restricted from paying cash
dividends on our common stock. The payment of future dividends, if any, will be determined by our Board of Directors in light
of conditions then existing, including our earnings, financial condition, capital requirements, restrictions in financing agreements,
business conditions and other factors. See Item 1A. “Risk Factors – Risks Relating to our Outstanding Common Stock – We do
not intend to pay dividends on our common stock and our ability to pay dividends on our common stock is restricted.”
The following table sets forth certain information with respect to repurchases of our common stock during the quarter
ended December 31, 2012.
Total Number of
Shares
Purchased (1)
Average Price
Paid Per Share
20,669 $
— $
— $
6.86
—
—
Total Number of
Shares Purchased
as Part of
Publicly
Announced Plan
or Program
Maximum Number (or
Approximate Dollar
Value) of Shares that May
be Purchased Under the
Plans or Programs
—
—
—
—
—
—
October 1—October 31, 2012
November 1—November 30, 2012
December 1—December 31, 2012
(1) All shares repurchased were surrendered by employees to pay tax withholding upon the vesting of restricted stock awards.
33
Item 6.
Selected Financial Data
The following table sets forth, as of the dates and for the periods indicated, selected financial information for the Company.
The financial information for each of the five years in the period ended December 31, 2012 has been derived from the audited
Consolidated Financial Statements of the Company 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 future results of the Company. All amounts
are stated in U.S. dollars unless otherwise indicated.
2012 (1)
2011 (2)
2010
2009 (3)
2008 (4)
Year Ended December 31,
Average sales price per Mcfe
Revenues
Net income (loss) available to common stockholders
$
4.17
141,591
(137,218)
Net income (loss) available to common stockholders
per share:
(in thousands except per share and per Mcfe data)
$
$
$
5.32
160,700
5,409
5.78
179,263
41,987
6.39
218,684
(95,330)
$
9.13
311,649
(102,100)
Basic
Diluted
Oil and gas properties, net
Total assets
Long-term debt
Stockholders’ equity
(2.20)
(2.20)
333,946
433,403
200,000
87,591
0.08
0.08
405,351
516,166
150,000
222,390
0.67
0.66
312,940
439,517
150,000
208,162
(1.72)
(1.72)
321,875
410,459
178,267
162,105
(2.08)
(2.08)
512,861
670,249
278,998
237,487
(1) The year ended December 31, 2012 includes a pre-tax ceiling test write-down of $137.1 million.
(2) The year ended December 31, 2011 includes a pre-tax ceiling test write-down of $18.9 million.
(3) The year ended December 31, 2009 includes a pre-tax ceiling test write-down of $156.1 million.
(4) The year ended December 31, 2008 includes a pre-tax ceiling test write-down of $266.2 million.
Item 7.
Overview
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
PetroQuest Energy, Inc. is an independent oil and gas company incorporated in the State of Delaware with operations in
Oklahoma, Texas, the Gulf Coast Basin and Wyoming. We seek to grow our production, proved reserves, cash flow and earnings
at low finding and development costs through a balanced mix of exploration, development and acquisition activities. From the
commencement of our operations in 1985 through 2002, we were focused exclusively in the Gulf Coast Basin with onshore
properties principally in southern Louisiana and offshore properties in the shallow waters of the Gulf of Mexico shelf. During
2003, we began the implementation of our strategic goal of diversifying our reserves and production into longer life and lower
risk onshore properties. As part of the strategic shift to diversify our asset portfolio and lower our geographic and geologic risk
profile, we refocused our opportunity selection processes to reduce our average working interest in higher risk projects, shift
capital to higher probability of success onshore wells and mitigate the risks associated with individual wells by expanding our
drilling program across multiple basins.
We have successfully diversified into onshore, longer life basins in Oklahoma, Wyoming and Texas through a combination
of selective acquisitions and drilling activity. Beginning in 2003 with our acquisition of the Carthage Field in Texas through 2012,
we have invested approximately $998 million into growing our longer life assets. During the nine year period ended December 31,
2012, we have realized a 95% drilling success rate on 878 gross wells drilled. Comparing 2012 metrics with those in 2003, the
year we implemented our diversification strategy, we have grown production by 252% and estimated proved reserves by 174%.
At December 31, 2012, 87% of our estimated proved reserves and 75% of our 2012 production were derived from our longer life
assets.
Gas prices have remained weak since late-2008. As a result of the impact of low natural gas prices on our revenues and
cash flow, we have focused on growing our reserves and production through a balanced drilling budget with an increased emphasis
on growing our oil and natural gas liquids production. In May 2010, we entered into the Woodford joint development agreement
("JDA"), which provided us with $85 million in cash during 2010 and 2011, along with a drilling carry that we have utilized since
May 2010 to enhance economic returns by reducing our share of capital expenditures in the Woodford and Mississippian Lime.
34
As a result of the JDA and the success of our drilling programs, we have grown our estimated proved reserves by 18% and
production by 10% since 2010, while maintaining our long-term debt 28% below 2008 levels.
During February 2012, we amended our JDA to accelerate the entry into Phase 2 of the drilling program effective March 1,
2012 and modify the drilling carry ratio. Under the amended JDA, the Phase 2 drilling carry was expanded to provide for
development in both the Mississippian Lime and Woodford Shale plays whereby we will pay 25% of the cost to drill and complete
wells and receive a 50% ownership interest. The Phase 2 drilling carry is subject to extensions in one-year intervals and as of
December 31, 2012, approximately $70.7 million remained available. See “Liquidity and Capital Resources-Source of Capital:
Joint Ventures”.
Critical Accounting Policies
Reserve Estimates
Our estimates of proved oil and gas reserves constitute those quantities of oil and gas, which, by analysis of geoscience
and engineering data, can be estimated with reasonable certainty to be economically producible from a given date forward, from
known reservoirs, and under existing economic conditions, operating methods, and government regulations prior to the time at
which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of
whether deterministic or probabilistic methods are used for the estimation. At the end of each year, our proved reserves are estimated
by independent petroleum engineers in accordance with guidelines established by the SEC. These estimates, however, represent
projections based on geologic and engineering data. Reserve engineering is a subjective process of estimating underground
accumulations of oil and gas that are difficult to measure. The accuracy of any reserve estimate is a function of the quantity and
quality of available data, engineering and geological interpretation and professional judgment. Estimates of economically
recoverable oil and gas reserves and future net cash flows necessarily depend upon a number of variable factors and assumptions,
such as historical production from the area compared with production from other producing areas, the assumed effect of regulations
by governmental agencies, and assumptions governing future oil and gas prices, future operating costs, severance taxes,
development costs and workover costs. The future drilling costs associated with reserves assigned to proved undeveloped locations
may ultimately increase to the extent that these reserves may be later determined to be uneconomic. Any significant variance in
the assumptions could materially affect the estimated quantity and value of the reserves, which could affect the carrying value of
our oil and gas properties and/or the rate of depletion of such oil and gas properties.
Disclosure requirements under Staff Accounting Bulletin 113 (“SAB 113”) include provisions that permit the use of new
technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions
about reserve volumes. The rules also allow companies the option to disclose probable and possible reserves in addition to the
existing requirement to disclose proved reserves. The disclosure requirements also require companies to report the independence
and qualifications of third party preparers of reserves and file reports when a third party is relied upon to prepare reserves estimates.
Pricing is based on a 12-month average price using beginning of the month pricing during the 12-month period prior to the ending
date of the balance sheet to report oil and natural gas reserves. In addition, the 12-month average is also used to measure ceiling
test impairments and to compute depreciation, depletion and amortization.
Full Cost Method of Accounting
We use the full cost method of accounting for our investments in oil and gas properties. Under this method, all acquisition,
exploration and development costs, including certain related employee costs, incurred for the purpose of exploring for and
developing oil and natural gas are capitalized. Acquisition costs include costs incurred to purchase, lease or otherwise acquire
property. Exploration costs include the costs of drilling exploratory wells, including those in progress and geological and
geophysical service costs in exploration activities. Development costs include the costs of drilling development wells and costs
of completions, platforms, facilities and pipelines. Costs associated with production and general corporate activities are expensed
in the period incurred. Sales of oil and gas properties, whether or not being amortized currently, are accounted for as adjustments
of capitalized costs, with no gain or loss recognized, unless such adjustments would significantly alter the relationship between
capitalized costs and proved reserves of oil and gas.
The costs associated with unevaluated properties are not initially included in the amortization base and primarily relate
to ongoing exploration activities, unevaluated leasehold acreage and delay rentals, seismic data and capitalized interest. These
costs are either transferred to the amortization base with the costs of drilling the related well or are assessed quarterly for possible
impairment or reduction in value.
We compute the provision for depletion of oil and gas properties using the unit-of-production method based upon
production and estimates of proved reserve quantities. Unevaluated costs and related carrying costs are excluded from the
amortization base until the properties associated with these costs are evaluated. In addition to costs associated with evaluated
properties, the amortization base includes estimated future development costs related to non-producing reserves. Our depletion
35
expense is affected by the estimates of future development costs, unevaluated costs and proved reserves, and changes in these
estimates could have an impact on our future earnings.
We capitalize certain internal costs that are directly identified with acquisition, exploration and development activities.
The capitalized internal costs include salaries, employee benefits, costs of consulting services and other related expenses and do
not include costs related to production, general corporate overhead or similar activities. We also capitalize a portion of the interest
costs incurred on our debt. Capitalized interest is calculated using the amount of our unevaluated property and our effective
borrowing rate.
Capitalized costs of oil and gas properties, net of accumulated DD&A and related deferred taxes, are limited to the
estimated future net cash flows from proved oil and gas reserves, including the effect of cash flow hedges in place, discounted at
10 percent, plus the lower of cost or fair value of unproved properties, as adjusted for related income tax effects (the full cost
ceiling). If capitalized costs exceed the full cost ceiling, the excess is charged to write-down of oil and gas properties in the quarter
in which the excess occurs.
At December 31, 2012, the prices used in computing the estimated future net cash flows from our estimated proved
reserves, including the effect of hedges in place at that date, averaged $2.21 per Mcf of natural gas, $102.81 per barrel of oil, and
$6.07 per Mcfe of Ngl. As a result of lower natural gas prices and their negative impact on certain of our longer-lived estimated
proved reserves and estimated future net cash flows, we recognized ceiling test write-downs of $137.1 million and $18.9 million
during the twelve months ended December 31, 2012 and 2011, respectively. Our cash flow hedges in place decreased the ceiling
test write-downs by approximately $2.2 million and $3.9 million during 2012 and 2011, respectively.
Given the volatility of oil and gas prices, it is probable that our estimate of discounted future net cash flows from estimated
proved oil and gas reserves will change in the near term. If oil or gas prices decline, even for only a short period of time, or if we
have downward revisions to our estimated proved reserves, it is possible that further write-downs of oil and gas properties could
occur in the future.
Future Abandonment Costs
Future abandonment costs include costs to dismantle and relocate or dispose of our production platforms, gathering
systems, wells and related structures and restoration costs of land and seabed. We develop estimates of these costs for each of our
properties based upon the type of production structure, depth of water, reservoir characteristics, depth of the reservoir, market
demand for equipment, currently available procedures and consultations with construction and engineering consultants. Because
these costs typically extend many years into the future, estimating these future costs is difficult and requires management to make
estimates and judgments that are subject to future revisions based upon numerous factors, including changing technology, the
timing of estimated costs, the impact of future inflation on current cost estimates and the political and regulatory environment.
Derivative Instruments
We seek to reduce our exposure to commodity price volatility by hedging a portion of our production through commodity
derivative instruments. The estimated fair values of our commodity derivative instruments are recorded in the consolidated balance
sheet. The changes in fair value of those derivative instruments that qualify for hedge accounting treatment are recorded in other
comprehensive income (loss) until the hedged oil or natural gas quantities are produced. If a hedge becomes ineffective because
the hedged production does not occur, or the hedge otherwise does not qualify for hedge accounting treatment, the changes in the
fair value of the derivative are recorded in the income statement as derivative income (expense).
Our hedges are specifically referenced to NYMEX prices for oil and natural gas. We evaluate the effectiveness of our
hedges at the time we enter the contracts, and periodically over the life of the contracts, by analyzing the correlation between
NYMEX prices and the posted prices we receive from our designated production. Through this analysis, we are able to determine
if a high correlation exists between the prices received for the designated production and the NYMEX prices at which the hedges
will be settled. At December 31, 2012, our derivative instruments, with the exception of a three-way collar contract for 2013
natural gas production, were designated effective cash flow hedges.
Estimating the fair value of derivative instruments requires valuation calculations incorporating estimates of future
NYMEX prices, discount rates and price movements. As a result, we calculate the fair value of our commodity derivatives using
an independent third-party’s valuation model that utilizes market-corroborated inputs that are observable over the term of the
derivative contract. Our fair value calculations also incorporate an estimate of the counterparties’ default risk for derivative assets
and an estimate of our default risk for derivative liabilities.
36
Results of Operations
The following table sets forth certain information with respect to our oil and gas operations for the periods noted. These
historical results are not necessarily indicative of results to be expected in future periods.
Production:
Oil (Bbls)
Gas (Mcf)
Ngl (Mcfe)
Total Production (Mcfe)
Sales:
Total oil sales
Total gas sales
Total ngl sales
Total oil and gas sales
Average sales prices:
Oil (per Bbl)
Gas (per Mcf)
Ngl (per Mcfe)
Per Mcfe
Year Ended December 31,
2012
2011
2010
520,590
27,466,228
3,366,774
33,956,542
56,635,786
63,535,262
21,262,236
141,433,284
108.79
2.31
6.32
4.17
$
$
$
572,096
24,462,933
2,287,846
30,183,355
60,064,426
78,664,373
21,756,917
160,485,716
104.99
3.22
9.51
5.32
$
$
$
663,302
24,501,540
2,469,871
30,951,223
52,715,434
107,117,320
19,205,726
179,038,480
79.47
4.37
7.78
5.78
$
$
$
The above sales and average sales prices include increases (reductions) to revenue related to the settlement of gas hedges of
$6,846,000, $2,609,000 and $17,538,000, oil hedges of $1,529,000, ($192,000) and zero and Ngl hedges of $722,000, zero and
zero for the twelve months ended December 31, 2012, 2011 and 2010, respectively.
Comparison of Results of Operations for the Years Ended December 31, 2012 and 2011
Net income (loss) available to common stockholders totaled ($137,218,000) and $5,409,000 for the years ended December 31,
2012 and 2011, respectively. The primary fluctuations were as follows:
Production Total production increased 13% during the year ended December 31, 2012 as compared to the 2011 period. Gas
production during the year ended December 31, 2012 increased 12% from the 2011 period. The increase in gas production was
primarily the result of the success of our drilling programs in the Woodford Shale in Oklahoma, the Carthage field in East Texas,
and the La Cantera field in South Louisiana. Gas production also increased at our West Cameron Block 402 well due to a successful
recompletion during the fourth quarter of 2011. Partially offsetting these increases were normal production declines particularly
in our Gulf Coast region. As a result of our reduced capital expenditures budget in 2013, we expect our average daily gas production
in 2013 to remain stable as compared to 2012.
Oil production during the year ended December 31, 2012 decreased 9% as compared to the 2011 period due primarily to continued
normal production declines in our onshore Louisiana and offshore Gulf of Mexico fields. Partially offsetting these decreases were
increases from the inception of production from our La Cantera field during March 2012, our Eagle Ford Shale field where five
new wells commenced production during the third and fourth quarters of 2012 and at our Mississippian Lime field where initial
oil production from our first wells began during the second quarter of 2012 with four additional wells beginning production during
the fourth quarter. Additionally, oil production increased at our Ship Shoal field as a result of three successful recompletions
performed during the fourth quarter of 2012. As a result of decreased drilling planned for 2013, we expect our average daily oil
production to decrease as compared to 2012.
Ngl production during the year ended December 31, 2012 increased 47% from the 2011 period due to the inception of production
from our La Cantera field, the liquids rich portion of our Oklahoma properties, and an increase in production at our Carthage field
in East Texas. These increases were partially offset by the normal production declines particularly in our Gulf Coast region. As
a result of our drilling success in Texas, Oklahoma and the Gulf Coast region, as well as the large allocation of drilling capital in
2013 to the Woodford Shale in Oklahoma, we expect our daily Ngl production in 2013 to increase as compared to 2012.
Prices Including the effects of our hedges, average gas prices per Mcf for the year ended December 31, 2012 were $2.31 as
compared to $3.22 for the 2011 period. Average oil prices per Bbl for the year ended December 31, 2012 were $108.79 as compared
to $104.99 for the 2011 period and average Ngl prices per Mcfe were $6.32 for the year ended December 31, 2012, as compared
37
to $9.51 for the 2011 period. Stated on an Mcfe basis, unit prices received during the year ended December 31, 2012 were 22%
lower than the prices received during the 2011 period.
Revenue Including the effects of hedges, oil and gas sales during the twelve months ended December 31, 2012 decreased 12%
to $141,433,000, as compared to oil and gas sales of $160,486,000 during the 2011 period. The decreased revenue during 2012
was primarily the result of lower natural gas and Ngl prices as well as reduced oil production during the period.
Expenses Lease operating expenses for the year ended December 31, 2012 totaled $38,890,000 as compared to $38,571,000 during
the 2011 period. Per unit lease operating expenses totaled $1.15 per Mcfe during the twelve month period ended December 31,
2012 as compared to $1.28 during the 2011 period. Per unit lease operating expenses decreased primarily due to the increase in
overall produced volumes during the period.
Production taxes for the year ended December 31, 2012 totaled $885,000 as compared to $3,100,000 during the 2011 period. The
significant decrease during the 2012 period was the result of recording a receivable of $2,717,000 during June 2012 for refunds
relative to severance tax previously paid on our Oklahoma horizontal wells that we expect to receive over the next three years.
Beginning in July 2012, we are no longer required to submit the full rate of Oklahoma severance tax on those wells qualifying for
the horizontal tax credit. As a result of the refund receivable recorded in 2012, we expect 2013 production taxes to be higher than
2012, and may approximate the taxes incurred in 2011.
General and administrative expenses during the year ended December 31, 2012 totaled $22,957,000 as compared to $20,436,000
during the 2011 period. Included in general and administrative expenses was non-cash share-based compensation expense as
follows (in thousands):
Stock options:
Incentive Stock Options
Non-Qualified Stock Options
Restricted stock
Share based compensation
Year Ended December 31,
2012
2011
$
$
786
660
5,464
6,910
$
$
493
703
3,637
4,833
General and administrative expenses increased 12% during the year ended December 31, 2012 as compared to the comparable
period of 2011 primarily due to increased non-cash share-based compensation expense during 2012. We capitalized $11,925,000
of general and administrative costs during the year ended December 31, 2012 as compared to $11,176,000 during the comparable
2011 period. General and administrative expenses in 2013 are expected to approximate 2012 results.
Depreciation, depletion and amortization (“DD&A”) expense on oil and gas properties for the year ended December 31, 2012
totaled $59,496,000, or $1.75 per Mcfe, as compared to $57,143,000, or $1.89 per Mcfe, during the comparable 2011 period. The
decrease in the per unit DD&A rate is primarily the result of a decrease in the depletable base due to the ceiling test write-downs
recognized during 2012.
At December 31, 2012, the prices used in computing the estimated future net cash flows from our estimated proved reserves,
including the effect of hedges in place at that date, averaged $2.21 per Mcf of natural gas, $102.81 per barrel of oil, and $6.07 per
Mcfe of Ngl. As a result of lower natural gas prices and their negative impact on certain of our longer-lived estimated proved
reserves and estimated future net cash flows, we recognized ceiling test write-downs of $137,100,000 during the year ended
December 31, 2012. We also recognized a ceiling test write-down of $18,907,000 during the twelve months ended December 31,
2011.
Interest expense, net of amounts capitalized on unevaluated properties, totaled $9,808,000 during the year ended December 31,
2012, as compared to $9,648,000 during 2011. During the year ended December 31, 2012, our capitalized interest totaled $7,036,000
as compared to $7,034,000 during the 2011 period.
Income tax expense (benefit) during the year ended December 31, 2012 totaled $1,636,000, as compared to ($1,810,000) during
the 2011 period. We typically provide for income taxes at a statutory rate of 35% adjusted for permanent differences expected to
be realized, primarily statutory depletion, non-deductible stock compensation expenses and state income taxes.
As a result of the ceiling test write-downs recognized, we have incurred a cumulative three-year loss. Because of the impact the
cumulative loss has on the determination of the recoverability of deferred tax assets through future earnings, we assessed the
realizability of our deferred tax assets based on the future reversals of existing deferred tax liabilities. Accordingly, we established
a valuation allowance for a portion of our deferred tax asset. The valuation allowance was $50,866,000 as of December 31, 2012.
38
Comparison of Results of Operations for the Years Ended December 31, 2011 and 2010
Net income available to common stockholders totaled $5,409,000 and $41,987,000 for the years ended December 31, 2011 and
2010, respectively. The primary reasons for the fluctuations were as follows:
Production Total production decreased 2% during the year ended December 31, 2011 as compared to the 2010 period. However,
total production in the fourth quarter of 2011 increased 8% as compared to the third quarter of 2011. Gas production during the
year ended December 31, 2011 decreased less than one percent from the comparable period in 2010. The decrease in gas production
was primarily the result of normal production declines in the Gulf Coast Basin, offset by increases in gas production from our
longer-life basins.
Oil production during the twelve month period ended December 31, 2011 decreased 14% from the comparable 2010 period. The
decrease in oil production is primarily the result of normal production declines in the Gulf Coast Basin. Partially offsetting this
decrease were increases due to the inception of production in the Niobrara Shale, where our first well began production in the
fourth quarter of 2010 and three subsequent wells began production during 2011, and in the Eagle Ford Shale, where our first five
wells began production in the third quarter of 2011. These Niobrara and Eagle Ford Shale wells represented 8% of our total oil
production during 2011.
Ngl production during the twelve months ended December 31, 2011 decreased 7% from the comparable 2010 period due to the
general decline in Gulf Coast gas production.
Prices Including the effects of our hedges, average gas prices per Mcf for the twelve months ended December 31, 2011 were $3.22
as compared to $4.37 for the 2010 period. Average oil prices per Bbl for the twelve months ended December 31, 2011 were $104.99
as compared to $79.47 for the 2010 period. Average Ngl prices per Mcfe for the twelve months ended December 31, 2011 were
$9.51 compared to $7.78 during the 2010 period. Stated on an Mcfe basis, unit prices received during the twelve month period
ended December 31, 2011 were 8% lower than the prices received during the comparable 2010 period.
Revenue Including the effects of hedges, oil and gas sales during the twelve months ended December 31, 2011 decreased 10% to
$160,486,000 as compared to oil and gas sales of $179,038,000 during the 2010 period. The decreased revenue during 2011 was
primarily the result of lower gas prices and decreased oil production partially offset by higher oil prices.
Expenses Lease operating expenses for the twelve months ended December 31, 2011 decreased to $38,571,000 as compared to
$39,012,000 during the 2010 period. Per unit lease operating expenses totaled $1.28 per Mcfe during the twelve month period
ended December 31, 2011 as compared to $1.26 per Mcfe during the 2010 period.
Production taxes decreased during the twelve months ended December 31, 2011 to $3,100,000 from $4,917,000 during the
comparable 2010 period. The decrease was primarily the result of refunds received totaling $2,934,000 during 2011 with respect
to severance tax previously paid on Oklahoma and East Texas wells as compared to $1,887,000 received during 2010.
General and administrative expenses during the twelve months ended December 31, 2011 totaled $20,436,000 as compared to
expenses of $21,341,000 during the 2010 period. Included in general and administrative expenses was share-based compensation
expense related to ASC Topic 718, as follows (in thousands):
Stock options:
Incentive Stock Options
Non-Qualified Stock Options
Restricted stock
Share-based compensation
Years Ended December 31,
2011
2010
$
$
493
703
3,637
4,833
$
$
793
2,081
4,263
7,137
We capitalized $11,176,000 of general and administrative costs during the twelve month period ended December 31, 2011 and
$11,894,000 of such costs during the comparable 2010 period.
Depreciation, depletion and amortization (“DD&A”) expense on oil and gas properties for the twelve months ended December 31,
2011 totaled $57,143,000, or $1.89 per Mcfe, as compared to $58,172,000, or $1.88 per Mcfe, during the comparable 2010 period.
As a result of higher estimated future development costs and low natural gas prices and their negative impact on certain of our
longer-lived estimated proved reserves and estimated future net cash flows, we recorded non-cash ceiling test write-downs of our
oil and gas properties of $18,907,000 during the year ended December 31, 2011. There were no ceiling test write-downs of our
oil and gas properties in the 2010 period. See Note 11, “Ceiling Test” for further discussion of the ceiling test write-downs.
39
Interest expense, net of amounts capitalized on unevaluated properties, totaled $9,648,000 during the twelve months ended
December 31, 2011 as compared to $9,952,000 during the 2010 period. We capitalized $7,034,000 of interest during the twelve
month period of 2011, and $7,771,000 during the respective 2010 period. The decrease in capitalized interest during the year ended
December 31, 2011 was due to the sale of a portion of our unevaluated properties pursuant to the Woodford joint development
agreement during the second quarter of 2010. Total interest costs were 6% lower during the twelve months ended December 31,
2011 as compared to the same period in 2010 as a result of the refinancing of our 10 3/8% Senior Notes due 2012 with our 10%
Senior Notes due 2017 in August 2010.
In January 2010, we recorded a gain relative to a $9,000,000 cash settlement received from a lawsuit filed by us in 2008 relating
to disputed interests in certain oil and gas assets purchased in 2007. In addition to the cash proceeds received, we were assigned
additional working interests in certain producing properties. We recorded an additional $4,164,000 gain representing the estimated
fair market value of those interests on the effective date of the settlement.
As a result of the early redemption of our 10 3/8% Senior Notes due 2012, we incurred a loss during 2010 totaling $5,973,000.
Approximately $1,785,000 of the loss related to non-cash amortization of deferred financing costs and discount associated with
the 10 3/8% Senior Notes due 2012.
Income tax expense (benefit) during the twelve months ended December 31, 2011 totaled ($1,810,000) as compared to $1,630,000
during the 2010 period. We provide for income taxes at a statutory rate of 35% adjusted for permanent differences expected to be
realized, primarily statutory depletion, non-deductible stock compensation expenses and state income taxes.
As a result of the ceiling test write-downs recognized during prior years, we incurred a cumulative three-year loss. Because of the
impact the cumulative loss has on the determination of the recoverability of deferred tax assets through future earnings, we assessed
the realizability of our deferred tax assets based on future reversals of existing deferred tax liabilities. Accordingly, we established
a valuation allowance for a portion of the deferred tax asset in prior periods. During 2011, we reversed the remaining valuation
allowance as future reversals of existing deferred tax liabilities were sufficient to realize the entire deferred tax asset and we had
a net deferred tax liability of $551,000 at December 31, 2011.
Liquidity and Capital Resources
We have financed our acquisition, exploration and development activities to date principally through cash flow from
operations, bank borrowings, second lien term credit facilities, issuances of equity and debt securities, joint ventures and sales of
assets. At December 31, 2012, we had a working capital deficit of $31.3 million compared to a deficit of $14.0 million at
December 31, 2011. The increase in our working capital deficit is primarily the result of our increased operational activities as
our capital expenditures during 2012 exceeded our cash flow from operations. Since we operate the majority of our drilling
activities, we have the ability to reduce our capital expenditures to manage our working capital deficit and liquidity position. To
the extent our capital expenditures in 2013 exceed our cash flow and cash on hand, we plan to utilize available borrowings under
the bank credit facility or proceeds from the potential sale of non-core assets to fund a portion of our drilling budget.
Prices for oil and natural gas are subject to many factors beyond our control such as weather, the overall condition of the
global financial markets and economies, relatively minor changes in the outlook of supply and demand, and the actions of OPEC.
Oil and natural gas prices have a significant impact on our cash flows available for capital expenditures and our ability to borrow
and raise additional capital. The amount we can borrow under our bank credit facility is subject to periodic re-determination based
in part on changing expectations of future prices. Lower prices may also reduce the amount of oil and natural gas that we can
economically produce. Lower prices and/or lower production may decrease revenues, cash flows and the borrowing base under
the bank credit facility, thus reducing the amount of financial resources available to meet our capital requirements. Lower prices
and reduced cash flow may also make it difficult to incur debt, including under our bank credit facility, because of the restrictive
covenants in the indenture governing the Notes. See “Source of Capital: Debt” below. Our ability to comply with the covenants
in our debt agreements is dependent upon the success of our exploration and development program and upon factors beyond our
control, such as oil and natural gas prices.
Source of Capital: Operations
Net cash flow from operations decreased from $119.2 million during the twelve months ended December 31, 2011 to
$88.6 million during the 2012 period. The decrease in operating cash flow during 2012 as compared to 2011 was primarily
attributable to the decrease in oil and gas revenues during the period due to lower natural gas prices and lower oil production.
Source of Capital: Debt
On August 19, 2010, we issued $150 million in principal amount of 10% Senior Notes due 2017 (the “Notes”) in a public
offering. At December 31, 2012, the estimated fair value of the Notes was $155.3 million, based upon a market quote provided
by an independent broker. The Notes have numerous covenants including restrictions on liens, incurrence of indebtedness, asset
40
sales, dividend payments and other restricted payments. Interest is payable semi-annually on March 1 and September 1. At
December 31, 2012, $5.0 million had been accrued in connection with the March 1, 2013 interest payment and we were in
compliance with all of the covenants contained in the Notes.
We have a Credit Agreement (as amended, the “Credit Agreement”) with JPMorgan Chase Bank, N.A., Wells Fargo Bank,
N.A., Capital One, N.A., IberiaBank and Whitney Bank. The Credit Agreement provides us with a $300 million revolving credit
facility that permits borrowings based on the commitments of the lenders and the available borrowing base as determined in
accordance with the Credit Agreement. The Credit Agreement also allows us to use up to $25 million of the borrowing base for
letters of credit. The credit facility matures on October 3, 2016. As of December 31, 2012 we had $50 million of borrowings
outstanding under (and no letters of credit issued pursuant to) the Credit Agreement.
The borrowing base under the Credit Agreement is based upon the valuation of the reserves attributable to our oil and
gas properties as of January 1 and July 1 of each year. The current borrowing base is $130 million (subject to the aggregate
commitments of the lenders then in effect). The aggregate commitments of the lenders is currently $100 million and can be increased
to up to $300 million by either adding new lenders or increasing the commitments of existing lenders, subject to certain conditions.
The next borrowing base redetermination is scheduled to occur by March 31, 2013. We or the lenders may request two additional
borrowing base redeterminations each year. Each time the borrowing base is to be re-determined, the administrative agent under
the Credit Agreement will propose a new borrowing base as it deems appropriate in its sole discretion, which must be approved
by all lenders if the borrowing base is to be increased, or by lenders holding two-thirds of the amounts outstanding under the Credit
Agreement if the borrowing base remains the same or is reduced.
The Credit Agreement is secured by a first priority lien on substantially all of our assets, including a lien on all equipment
and at least 80% of the aggregate total value of our oil and gas properties. Outstanding balances under the Credit Agreement bear
interest at the alternate base rate (“ABR”) plus a margin (based on a sliding scale of 0.5% to 1.5% depending on total commitments)
or the adjusted LIBO rate (“Eurodollar”) plus a margin (based on a sliding scale of 1.5% to 2.5% depending on total commitments).
The alternate base rate is equal to the highest of (i) the JPMorgan Chase prime rate, (ii) the Federal Funds Effective Rate plus
0.5% or (iii) the adjusted LIBO rate plus 1%. For the purposes of the definition of alternative base rate only, the adjusted LIBO
rate is equal to the rate at which dollar deposits of $5,000,000 with a one month maturity are offered by the principal London
office of JPMorgan Chase Bank, N.A. in immediately available funds in the London interbank market. For all other purposes, the
adjusted LIBO rate is equal to the rate at which Eurodollar deposits in the London interbank market for one, two, three or six
months (as selected by us) are quoted, as adjusted for statutory reserve requirements for Eurocurrency liabilities. Outstanding
letters of credit are charged a participation fee at a per annum rate equal to the margin applicable to Eurodollar loans, a fronting
fee and customary administrative fees. In addition, we pay commitment fees based on a sliding scale of 0.375% to 0.5% depending
on total commitments.
We are subject to certain restrictive financial covenants under the Credit Agreement, including a maximum ratio of total
debt to EBITDAX, determined on a rolling four quarter basis, of 3.0 to 1.0 and a minimum ratio of consolidated current assets
to consolidated current liabilities of 1.0 to 1.0, all as defined in the Credit Agreement. The Credit Agreement also includes customary
restrictions with respect to debt, liens, dividends, distributions and redemptions, investments, loans and advances, nature of business,
international operations and foreign subsidiaries, leases, sale or discount of receivables, mergers or consolidations, sales of
properties, transactions with affiliates, negative pledge agreements, gas imbalances and swap agreements. However, the Credit
Agreement permits us to repurchase up to $10 million of our common stock during the term of the Credit Agreement, so long as
after giving effect to such repurchase our Liquidity (as defined therein) is greater than 20% of the total commitments of the lenders
at such time. As of December 31, 2012, we were in compliance with all of the covenants contained in the Credit Agreement.
Source of Capital: Issuance of Securities
During October 2010, our shelf registration statement was declared effective, which allows us to publicly offer and sell
up to $250 million of any combination of debt securities, shares of common and preferred stock, depositary shares and warrants.
The registration statement does not provide any assurance that we will or could sell any such securities.
Source of Capital: Joint Ventures
In May 2010, we entered into a joint development agreement with WSGP Gas Producing, LLC ("WSGP"), a subsidiary
of NextEra Energy Resources, LLC, whereby WSGP acquired approximately 29 Bcfe of our Woodford proved undeveloped
reserves as well as the right to earn 50% of our undeveloped Woodford acreage position through a two phase drilling program.
We received approximately $57.4 million in cash at closing, net of $2.6 million in transaction fees, and an additional $14 million
on November 30, 2011. In addition, since May 2010, WSGP has funded a share of our drilling costs under a drilling program. We
achieved certain production performance metrics, as outlined in the joint development agreement, relative to the first 18 wells
drilled under the drilling program. As a result, we received an additional $14 million during December 2011.
41
During February 2012, we amended the joint development agreement with WSGP to provide additional funding for a
share of our drilling costs relative to our drilling programs in both our Woodford Shale and Mississippian Lime project areas.
WSGP will continue to earn 50% of our undeveloped Woodford Shale acreage as they continue to fund a share of our drilling
costs. As of December 31, 2012, approximately $70.7 million of drilling carry remained available.
Source of Capital: Divestitures
We do not budget property divestitures; however, we are continuously evaluating our property base to determine if there
are assets in our portfolio that no longer meet our strategic objectives. From time to time we may divest certain non-strategic assets
in order to provide liquidity to strengthen our balance sheet or capital to be reinvested in higher rate of return projects. We are
currently exploring divestment opportunities for our Wyoming and South Texas assets. We cannot assure you that we will be able
to sell any of our assets in the future.
On December 31, 2012, we sold our non-operated Arkansas assets for a net cash purchase price of $9.2 million. In
January 2013, we sold 50% of our saltwater disposal systems and related surface assets in the Woodford for net proceeds of
approximately $10 million.
Use of Capital: Exploration and Development
Our 2013 capital budget, which includes capitalized interest and general and administrative costs, is expected to range
between $80 million and $100 million. Because we operate most of our 2013 activities, we expect to be able to manage the timing
of our capital expenditures in the event commodity prices or costs do not meet our expectations. We plan to fund our capital
expenditures with cash flow from operations and cash on hand. To the extent our capital expenditures during 2013 exceed these
sources, we plan to utilize available borrowings under the bank credit facility or proceeds from the potential sale of non-core
assets. To the extent additional capital is required, we may utilize sales of equity or debt securities or we may reduce our capital
expenditures to manage our liquidity position.
Use of Capital: Acquisitions
We do not budget acquisitions; however, we are continuously evaluating opportunities to expand our existing asset base
or establish positions in new core areas.
We expect to finance our future acquisition activities, if consummated, through cash on hand or available borrowings
under our bank credit facility. We may also utilize sales of equity or debt securities, sales of properties or assets or joint venture
arrangements with industry partners, if necessary. We cannot assure you that such additional financings will be available on
acceptable terms, if at all.
Contractual Obligations
The following
table summarizes our contractual obligations as of December 31, 2012 (in
thousands):
Total
2013
2014
2015
2016
2017
After 2017
10% Senior Notes (1)
$ 220,000
$ 15,000
$ 15,000
$ 15,000
$ 15,000
$ 160,000
$
Bank debt (1)
Operating leases (2)
Asset retirement obligations (3)
Purchase commitments (4)
54,865
5,155
27,259
5,784
1,120
1,211
2,351
5,784
1,245
1,032
3,825
—
1,370
1,026
975
—
51,130
988
932
—
—
898
—
—
—
—
—
19,176
—
Total
$ 313,063
$ 25,466
$ 21,102
$ 18,371
$ 68,050
$ 160,898
$
19,176
(1) Includes principal and estimated interest.
(2) Consists primarily of leases for office space and office equipment.
(3) Consists of estimated future obligations to abandon our oil and gas properties.
(4) Consists of certain drilling rig contracts.
Item 7A
Quantitative and Qualitative Disclosure About Market Risk
We experience market risks primarily in two areas: interest rates and commodity prices. Because all of our properties are
located within the United States, we believe that our business operations are not exposed to significant market risks relating to
foreign currency exchange risk.
42
Our revenues are derived from the sale of our crude oil and natural gas production. Based on projected annual sales
volumes for 2013, a 10% decline in the estimated average prices we expect to receive for our crude oil and natural gas production
would have an approximate $14.5 million impact on our 2013 revenues.
We periodically seek to reduce our exposure to commodity price volatility by hedging a portion of production through
commodity derivative instruments. In the settlement of a typical hedge transaction, we will have the right to receive from the
counterparties 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 counterparties this
difference multiplied by the quantity hedged. During 2012, we received approximately $9.1 million from the counterparties to
our derivative instruments in connection with net hedge settlements.
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. Hedging will also prevent us from receiving the full advantage
of increases in oil or gas prices above the fixed amount specified in the hedge.
Our Credit Agreement requires that the counterparties to our hedge contracts be lenders under the Credit Agreement or,
if not a lender under the Credit Agreement, rated A/A2 or higher by S&P or Moody’s. Currently, the counterparties to our existing
hedge contracts are JPMorgan Chase Bank and Wells Fargo Bank, both of whom are lenders under the Credit Agreement. To the
extent we enter into additional hedge contracts, we would expect that certain of the lenders under the Credit Agreement would
serve as counterparties.
As of December 31, 2012, we had entered into the following gas hedge contracts:
Production Period
Natural Gas:
2013
2013
Instrument
Type
3-way collar
Swap
Daily Volumes
Weighted
Average Price
10,000 Mmbtu
$2.00-$3.00-$4.09
5,000 Mmbtu
$4.00
At December 31, 2012, we recognized a net asset of approximately $0.6 million related to the estimated fair value of
these derivative instruments. Based on estimated future commodity prices as of December 31, 2012, we would realize a $0.4
million gain, net of taxes, as an increase to oil and gas sales during the next 12 months. This gain is expected to be reclassified
based on the schedule of gas volumes stipulated in the derivative contracts.
During January and February 2013, we entered into the following additional hedge contracts accounted for as cash flow
hedges:
Production Period
Crude Oil:
February - December 2013
Natural Gas:
February - December 2013
March - December 2013
April - December 2013
January - December 2014
Instrument
Type
Daily Volumes
Weighted
Average Price
Swap
Swap
Swap
Swap
Swap
250 Bbls
$104.75
10,000 Mmbtu
5,000 Mmbtu
5,000 Mmbtu
10,000 Mmbtu
$3.71
$3.50
$3.74
$4.08
After executing the above transactions, the Company has approximately 11.7 Bcf of gas volumes, at an average price of
$3.51 per Mcf, and approximately 84,000 barrels of oil volumes at $104.75 per barrel, hedged for 2013 and 3.7 Bcf of gas volumes
at an average price of $4.08 per Mcf hedged in 2014.
Debt outstanding under our bank credit facility is subject to a floating interest rate and represents 25% of our total debt
as of December 31, 2012. Based upon an analysis, utilizing the actual interest rate in effect and balances outstanding as of December
31, 2012, and assuming a 10% increase in interest rates and no changes in the amount of debt outstanding, the potential effect on
interest expense for 2013 is $0.1 million.
43
Item 8.
Financial Statements and Supplementary Data
Information concerning this Item begins on page F-1.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, the Company’s management, including its Chief Executive Officer
and Chief Financial Officer, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures
pursuant to Rule 13a-15 of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”). Based on that evaluation,
the Chief Executive Officer and Chief Financial Officer concluded the following:
i.
that the Company’s disclosure controls and procedures are designed to ensure (a) that information required to be
disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed,
summarized and reported, within the time periods specified in the SEC’s rules and forms, and (b) that such
information is accumulated and communicated to the Company’s management, including the Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure; and
ii.
that the Company’s disclosure controls and procedures are effective.
Notwithstanding the foregoing, there can be no assurance that the Company’s disclosure controls and procedures will
detect or uncover all failures of persons within the Company and its consolidated subsidiaries to disclose material information
otherwise required to be set forth in the Company’s periodic reports. There are inherent limitations to the effectiveness of any
system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the
controls and procedures.
Changes in Internal Control Over Financial Reporting
There have been no changes in the Company’s internal control over financial reporting during the quarter ended
December 31, 2012 that have materially affected, or that are reasonably likely to materially affect, the Company’s internal control
over financial reporting.
44
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, and for
performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2012. 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. Our
system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
(ii) 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 (iii) 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.
Projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management performed an assessment of the effectiveness of our internal control over financial reporting as of
December 31, 2012 based upon criteria in Internal Control – Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on our assessment, management believes that our internal control over financial
reporting was effective as of December 31, 2012 based on these criteria.
Ernst & Young LLP, our independent registered public accounting firm, has issued their report on the effectiveness of
the Company's internal control over financial reporting as of December 31, 2012.
March 11, 2013
/s/ Charles T. Goodson
Charles T. Goodson
Chairman and
Chief Executive Officer
/s/ J. Bond Clement
J. Bond Clement
Executive Vice President-
Chief Financial Officer
45
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
PetroQuest Energy, Inc.
We have audited PetroQuest Energy, Inc.’s internal control over financial reporting as of December 31, 2012, based on
criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the COSO criteria). PetroQuest Energy, Inc.’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, PetroQuest Energy, Inc. maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2012, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the accompanying consolidated balance sheets of PetroQuest Energy, Inc. as of December 31, 2012 and 2011, and the
related consolidated statements of operations, comprehensive income, cash flows, and stockholders’ equity for each of the three
years in the period ended December 31, 2012 and our report dated March 11, 2013 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
New Orleans, Louisiana
March 11, 2013
Item 9B.
Other Information
NONE
Item 10, 11, 12, 13, & 14.
PART III
Pursuant to General Instruction G of Form 10-K, the information concerning Item 10. Directors, Executive Officers
and Corporate Governance, Item 11. Executive Compensation, Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters, Item 13. Certain Relationships and Related Transactions, and Director
Independence and Item 14. Principal Accounting Fees and Services, is incorporated by reference to the information set forth in
the definitive Proxy Statement of PetroQuest Energy, Inc. relating to the Annual Meeting of Stockholders to be held May 21, 2013,
to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934 with the Securities and Exchange Commission.
46
Item 15.
Exhibits, Financial Statement Schedules
(a) 1. FINANCIAL STATEMENTS
PART IV
The following financial statements of the Company and the Report of the Company’s Independent Registered Public
Accounting Firm thereon are included on pages F-1 through F-27 of this Form 10-K:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2012 and 2011
Consolidated Statements of Operations for the three years ended December 31, 2012
Consolidated Statements of Comprehensive Income for the three years ended December 31, 2012
Consolidated Statements of Cash Flows for the three years ended December 31, 2012
Consolidated Statements of Stockholders’ Equity for the three years ended December 31, 2012
Notes to Consolidated Financial Statements
2.
FINANCIAL STATEMENT SCHEDULES:
All schedules are omitted because the required information is inapplicable or the information is presented in the Financial
Statements or the notes thereto.
3.
EXHIBITS:
2.1
3.1
3.2
3.3
3.4
3.5
3.6
4.1
4.2
Plan and Agreement of Merger by and among Optima Petroleum Corporation, Optima Energy
(U.S.) Corporation, its wholly-owned subsidiary, and Goodson Exploration Company, NAB
Financial L.L.C., Dexco Energy, Inc., American Explorer, L.L.C. (incorporated herein by reference
to Appendix G of the Proxy Statement on Schedule 14A filed July 22, 1998).
Certificate of Incorporation of PetroQuest Energy, Inc. (incorporated herein by reference to Exhibit
4.1 to Form 8-K filed September 16, 1998).
Certificate of Amendment to Certificate of Incorporation dated May 14, 2008 (incorporated herein
by reference to Exhibit 3.1 to Form 8-K filed June 23, 2009).
Bylaws of PetroQuest Energy, Inc., as amended of December 20, 2007 (incorporated herein by
reference to Exhibit 3.1 to Form 8-K filed December 21, 2007).
Certificate of Domestication of Optima Petroleum Corporation (incorporated herein by reference to
Exhibit 4.4 to Form 8-K filed September 16, 1998).
Certificate of Designations, Preferences, Limitations and Relative Rights of The Series a Junior
Participating Preferred Stock of PetroQuest Energy, Inc. (incorporated herein by reference to
Exhibit A of the Rights Agreement attached as Exhibit 1 to Form 8-A filed November 9, 2001).
Certificate of Designations establishing the 6.875% Series B cumulative convertible perpetual
preferred stock, dated September 24, 2007 (incorporated herein by reference to Exhibit 3.1 to Form
8-K filed on September 24, 2007).
Rights Agreement dated as of November 7, 2001 between PetroQuest Energy, Inc. and American
Stock Transfer & Trust Company, as Rights Agent, including exhibits thereto (incorporated herein
by reference to Exhibit 1 to Form 8-A filed November 9, 2001).
Form of Rights Certificate (incorporated herein by reference to Exhibit C of the Rights Agreement
attached as Exhibit 1 to Form 8-A filed November 9, 2001).
47
4.3
4.4
4.5
4.6
†10.1
†10.2
†10.3
†10.4
†10.5
†10.6
10.7
10.8
10.9
10.10
10.11
10.12
Indenture, dated May 11, 2005, among PetroQuest Energy, Inc., PetroQuest Energy, LLC, the
Subsidiary Guarantors identified therein, and the Bank of New York Trust Company, N.A.
(incorporated herein by reference to Exhibit 4.1 to Form 8-K filed May 11, 2005).
First Supplemental Indenture, dated August 19, 2010, among PetroQuest Energy, Inc., the
Subsidiary Guarantors identified therein, and The Bank of New York Mellon Trust Company, N.A.
(incorporated herein by reference to Exhibit 4.1 to Form 8-K filed on August 19, 2010).
Indenture, dated August 19, 2010, between PetroQuest Energy, Inc. and The Bank of New York
Mellon Trust Company, N.A. (incorporated herein by reference to Exhibit 4.2 to Form 8-K filed on
August 19, 2010).
First Supplemental Indenture, dated August 19, 2010, among PetroQuest Energy, Inc., the
Subsidiary Guarantors identified therein, and The Bank of New York Mellon Trust Company, N.A.
(incorporated herein by reference to Exhibit 4.3 to Form 8-K filed on August 19, 2010).
PetroQuest Energy, Inc. 1998 Incentive Plan, as amended and restated effective May 14, 2008 (the
“Incentive Plan”) (incorporated herein by reference to Appendix A of the Proxy Statement on
Schedule 14A filed April 9, 2008).
Form of Incentive Stock Option Agreement for executive officers (including Charles T. Goodson,
W. Todd Zehnder, Arthur M. Mixon, III, Daniel G. Fournerat, Mark K. Stover, J. Bond Clement,
and Tracy Price) under the Incentive Plan (incorporated herein by reference to Exhibit 10.2 to Form
10-K filed February 27, 2009).
Form of Nonstatutory Stock Option Agreement under the Incentive Plan (incorporated herein by
reference to Exhibit 10.3 to Form 10-K filed February 27, 2009).
Form of Restricted Stock Agreement for executive officers (including Charles T. Goodson, W. Todd
Zehnder, Arthur M. Mixon, III, Daniel G. Fournerat, Mark K. Stover, J. Bond Clement, and Tracy
Price) under the Incentive Plan (incorporated herein by reference to Exhibit 10.4 to Form 10-K filed
February 27, 2009).
PetroQuest Energy, Inc. Annual Incentive Plan (incorporated herein by reference to Exhibit 10.1 to
Form 8-K filed on May 13, 2010).
PetroQuest Energy, Inc. Annual Incentive Plan, as amended and restated (incorporated herein by
reference to Exhibit 10.1 to Form 8-K filed on June 8, 2010).
PetroQuest Energy, Inc. 2012 Employee Stock Purchase Plan (incorporated herein by reference to
Appendix A to Schedule 14A filed March 28, 2012).
PetroQuest Energy, Inc. Long-Term Cash Incentive Plan (incorporated herein by reference to
Exhibit 10.1 to Form 8-K filed November 15, 2012).
Form of Award Notice of Restricted Stock Units - Employees (including Charles T. Goodson, W.
Todd Zehnder, Arthur M. Mixon, III, Daniel G. Fournerat, Mark K. Stover, J. Bond Clement and
Tracy Price) (incorporated herein by reference to Exhibit 10.2 to Form 8-K filed November 15,
2012).
Form of Award Notice of Restricted Stock Units - Outside Director/Consultant (incorporated herein
by reference to Exhibit 10.3 to Form 8-K filed November 15, 2012).
Form of Restricted Stock Agreement - Executive Officers (including Charles T. Goodson, W. Todd
Zehnder, Arthur M. Mixon, III, Daniel G. Fournerat, Mark K. Stover, J. Bond Clement and Tracy
Price) (incorporated herein by reference to Exhibit 10.4 to Form 8-K filed November 15, 2012).
Credit Agreement dated as of October 2, 2008, among PetroQuest Energy, L.L.C., PetroQuest
Energy, Inc., JPMorgan Chase Bank, N.A., Calyon New York Branch, Bank of America, N.A.,
Wells Fargo Bank, N.A., and Whitney National Bank (incorporated herein by reference to Exhibit
10.1 to Form 8-K filed October 6, 2008).
48
10.13
10.14
10.15
10.16
†10.17
†10.18
†10.19
†10.20
†10.21
†10.22
†10.23
†10.24
†10.25
†10.26
First Amendment to Credit Agreement dated as of March 24, 2009, among PetroQuest Energy, Inc.,
PetroQuest Energy, L.L.C., TDC Energy LLC, JPMorgan Chase Bank, N.A., Calyon New York
Branch, Bank of America, N.A., Wells Fargo Bank, N.A. and Whitney National Bank (incorporated
herein by reference to Exhibit 10.1 to Form 8-K filed March 24, 2009).
Second Amendment to Credit Agreement dated as of September 30, 2009, among PetroQuest
Energy, Inc., PetroQuest Energy, L.L.C., TDC Energy LLC, JPMorgan Chase Bank, N.A., Calyon
New York Branch, Bank of America, N.A., Wells Fargo Bank, N.A. and Whitney National Bank
(incorporated herein by reference to Exhibit 10.1 to Form 8-K filed October 1, 2009).
Third Amendment to Credit Agreement dated as of August 5, 2010, among PetroQuest Energy, Inc.,
PetroQuest Energy, L.L.C., TDC Energy LLC, JPMorgan Chase Bank, N.A., Credit Agricole
Corporate and Investment Bank, Bank of America, N.A., Wells Fargo Bank, N.A. and Whitney
National Bank (incorporated herein by reference to Exhibit 10.1 to Form 8-K filed on August 6,
2010).
Fourth Amendment to Credit Agreement dated as of October 3, 2011, among PetroQuest Energy,
Inc., PetroQuest Energy, L.L.C., TDC Energy LLC, JPMorgan Chase Bank, N.A., Wells Fargo
Bank, N.A., Capital One, N.A., Iberiabank and Whitney Bank (incorporated herein by reference to
Exhibit 10.1 to the Form 8-K filed on October 4, 2011).
Amended Executive Employment Agreement dated effective as of December 31, 2008, between
Charles T. Goodson and PetroQuest Energy, Inc. (incorporated herein by reference to Exhibit 10.1
to Form 8-K filed January 6, 2009).
Amended Executive Employment Agreement dated effective as of December 31, 2008, between W.
Todd Zehnder and PetroQuest Energy, Inc. (incorporated herein by reference to Exhibit 10.2 to
Form 8-K filed January 6, 2009).
Amended Executive Employment Agreement dated effective as of December 31, 2008, between
Arthur M. Mixon, III and PetroQuest Energy, Inc. (incorporated herein by reference to Exhibit 10.3
to Form 8-K filed January 6, 2009).
Amended Executive Employment Agreement dated effective as of December 31, 2008, between
Daniel G. Fournerat and PetroQuest Energy, Inc. (incorporated herein by reference to Exhibit 10.4
to Form 8-K filed January 6, 2009).
Amended Executive Employment Agreement dated effective as of December 31, 2008, between
Mark
K. Stover and PetroQuest Energy, Inc. (incorporated herein by reference to Exhibit 10.19 to Form
10-K filed February 27, 2009).
Amended Executive Employment Agreement dated effective as of December 31, 2008, between J.
Bond Clement and PetroQuest Energy, Inc. (incorporated herein by reference to Exhibit 10.20 to
Form 10-K filed February 27, 2009).
Executive Employment Agreement dated May 8, 2012 between PetroQuest Energy, Inc. and Tracy
Price (incorporated herein by reference to Exhibit 10.1 to Form 8-K filed May 10, 2012).
Form of Amended Termination Agreement between the Company and each of its executive officers,
including Charles T. Goodson, W. Todd Zehnder, Arthur M. Mixon, III, Daniel G. Fournerat, Mark
K. Stover, and J. Bond Clement (incorporated herein by reference to Exhibit 10.6 to Form 8-K filed
January 6, 2009).
Termination Agreement dated May 8, 2012 between PetroQuest Energy, Inc. and Tracy Price
(incorporated herein by reference to Exhibit 10.2 to Form 8-K filed May 10, 2012).
Form of Indemnification Agreement between PetroQuest Energy, Inc. and each of its directors and
executive officers, including Charles T. Goodson, W. Todd Zehnder, Arthur M. Mixon, III, Daniel
G. Fournerat, Mark K. Stover, J. Bond Clement, Tracy Price, William W. Rucks, IV, E. Wayne
Nordberg, Michael L. Finch, W.J. Gordon, III and Charles F. Mitchell, II (incorporated herein by
reference to Exhibit 10.21 to Form 10-K filed March 13, 2002).
49
10.27
10.28
10.29
Form of Surrender and Cancellation Agreement for Directors and Executive Officers (incorporated
herein by reference to Exhibit 10.1 to Form 8-K filed on September 16, 2010).
Joint Development Agreement dated May 17, 2010, among PetroQuest Energy, L.L.C., a Louisiana
limited liability company, WSGP Gas Producing, LLC, a Delaware limited liability company, and
NextEra Energy Gas Producing, LLC, a Delaware limited liability company (incorporated herein
by reference to Exhibit 10.2 to Form 10-Q filed on August 5, 2010).
Second Amendment to the Joint Development Agreement dated February 24, 2012, among
PetroQuest Energy, L.L.C., a Louisiana limited liability company, WSGP Gas Producing, LLC, a
Delaware limited liability company, and NextEra Energy Gas Producing, LLC, a Delaware limited
liability company (incorporated herein by reference to Exhibit 10.22 to Form 10-K filed March 5,
2012).
14.1
Code of Business Conduct and Ethics (incorporated herein by reference to Exhibit 14.1 to Form
10-K filed March 8, 2006).
*21.1
Subsidiaries of the Company.
*23.1
Consent of Independent Registered Public Accounting Firm.
*23.2
Consent of Ryder Scott Company, L.P.
*31.1
*31.2
*32.1
*32.2
Certification of Chief Executive Officer pursuant to Rule 13-a-14(a) / Rule 15d-14(a),
promulgated under the Securities Exchange Act of 1934, as amended.
Certification of Chief Financial Officer pursuant to Rule 13-a-14(a) / Rule 15d-14(a), promulgated
under the Securities Exchange Act of 1934, as amended.
Certification pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, of Chief Executive Officer.
Certification pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, of Chief Financial Officer.
*99.1
Reserve report letter as of December 31, 2012, as prepared by Ryder Scott Company, L.P.
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema Document.
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF
XBRL Taxonomy Definitions Linkbase Document
101.LAB
XBRL Taxonomy Extension Label Linkbase Document.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document.
*
†
Filed herewith.
Management contract or compensatory plan or arrangement
(b) Exhibits. See Item 15 (a) (3) above.
(c) Financial Statement Schedules. None
50
GLOSSARY OF CERTAIN OIL AND NATURAL GAS TERMS
The following is a description of the meanings of some of the oil and natural gas used in this Form 10-K.
Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, of crude oil or other liquid hydrocarbons.
Bcf. Billion cubic feet of natural gas.
Bcfe. Billion cubic feet equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of crude oil, condensate
or natural gas liquids.
Block. A block depicted on the Outer Continental Shelf Leasing and Official Protraction Diagrams issued by the U.S.
Minerals Management Service or a similar depiction on official protraction or similar diagrams issued by a state bordering on the
Gulf of Mexico.
Btu or British Thermal Unit. The quantity of heat required to raise the temperature of one pound of water by one degree
Fahrenheit.
Completion. The installation of permanent equipment for the production of natural gas or oil, or in the case of a dry hole,
the reporting of abandonment to the appropriate agency.
Condensate. A mixture of hydrocarbons that exists in the gaseous phase at original reservoir temperature and pressure,
but that, when produced, is in the liquid phase at surface pressure and temperature.
Deterministic estimate. The method of estimating reserves or resources is called deterministic when a single value for
each parameter (from the geoscience, engineering, or economic data) in the reserves calculation is used in the reserves estimation
procedure.
Developed acreage. The number of acres that are allocated or assignable to productive wells or wells capable of production.
Development well. A well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon
known to be productive.
Dry hole. A well found to be incapable of producing hydrocarbons in sufficient quantities such that proceeds from the
sale of such production exceed production expenses and taxes.
Exploratory well. A well drilled to find a new field or to find a new reservoir in a field previously found to be productive
of oil or gas in another reservoir. Generally, an exploratory well is any well that is not a development well, an extension well, a
service well, or a stratigraphic test well as those items are defined in this section.
Extension well. A well drilled to extend the limits of a known reservoir.
Farm-in or farm-out. An agreement under which the owner of a working interest in a natural gas and oil lease assigns
the working interest or a portion of the working interest to another party who desires to drill on the leased acreage. Generally, the
assignee is required to drill one or more wells in order to earn its interest in the acreage. The assignor usually retains a royalty or
reversionary interest in the lease. The interest received by an assignee is a "farm-in" while the interest transferred by the assignor
is a "farm-out."
Field. An area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual
geological structural feature and/or stratigraphic condition.
Gross acres or gross wells. The total acres or wells, as the case may be, in which a working interest is owned.
Lead. A specific geographic area which, based on supporting geological, geophysical or other data, is deemed to have
potential for the discovery of commercial hydrocarbons.
MBbls. Thousand barrels of crude oil or other liquid hydrocarbons.
Mcf. Thousand cubic feet of natural gas.
Mcfe. Thousand cubic feet equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of crude oil,
condensate or natural gas liquids.
MMBls. Million barrels of crude oil or other liquid hydrocarbons.
MMBtu. Million British Thermal Units.
51
MMcf. Million cubic feet of natural gas.
MMcfe. Million cubic feet equivalent, determined using the ratio of six Mcf of natural gas to one Bbl of crude oil,
condensate or natural gas liquids.
Ngl. Natural gas liquid.
Net acres or net wells. The sum of the fractional working interest owned in gross acres or wells, as the case may be.
Possible reserves. Those additional reserves that are less certain to be recovered than probable reserves.
Probabilistic estimate. The method of estimation of reserves or resources is called probabilistic when the full range of
values that could reasonably occur for each unknown parameter (from the geoscience and engineering data) is used to generate a
full range of possible outcomes and their associated probabilities of occurrence.
Probable reserves. Those additional reserves that are less certain to be recovered than proved reserves but which, together
with proved reserves, are as likely as not to be recovered.
Productive well. A well that is found to be capable of producing hydrocarbons in sufficient quantities such that proceeds
from the sale of such production exceed production expenses and taxes.
Prospect. A specific geographic area which, based on supporting geological, geophysical or other data and also preliminary
economic analysis using reasonably anticipated prices and costs, is deemed to have potential for the discovery of commercial
hydrocarbons.
Proved area. The part of a property to which proved reserves have been specifically attributed.
Proved oil and gas reserves. Those quantities of oil and gas, which, by analysis of geoscience and engineering data, can
be estimated with reasonable certainty to be economically producible—from a given date forward, from known reservoirs, and
under existing economic conditions, operating methods, and government regulations—prior to the time at which contracts providing
the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or
probabilistic methods are used for the estimation.
Proved properties. Properties with proved reserves.
Reasonable certainty. If deterministic methods are used, reasonable certainty means a high degree of confidence that the
quantities will be recovered. If probabilistic methods are used, there should be at least a 90% probability that the quantities actually
recovered will equal or exceed the estimate. A high degree of confidence exists if the quantity is much more likely to be achieved
than not, and, as changes due to increased availability of geoscience (geological, geophysical, and geochemical), engineering, and
economic data are made to estimated ultimate recovery (EUR) with time, reasonably certain EUR is much more likely to increase
or remain constant than to decrease.
Reliable technology. A grouping of one or more technologies (including computational methods) that has been field tested
and has been demonstrated to provide reasonably certain results with consistency and repeatability in the formation being evaluated
or in an analogous formation.
Reserves. Estimated remaining quantities of oil and gas and related substances anticipated to be economically producible,
as of a given date, by application of development projects to known accumulations.
Reservoir. A porous and permeable underground formation containing a natural accumulation of producible oil and/or
gas that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs.
Resources. Quantities of oil and gas estimated to exist in naturally occurring accumulations. A portion of the resources
may be estimated to be recoverable, and another portion may be considered to be unrecoverable. Resources include both discovered
and undiscovered accumulations.
Service well. A well drilled or completed for the purpose of supporting production in an existing field. Specific purposes
of service wells include gas injection, water injection, steam injection, air injection, salt-water disposal, water supply for injection,
observation, or injection for in-situ combustion.
Stratigraphic test well. A drilling effort, geologically directed, to obtain information pertaining to a specific geologic
condition. Such wells customarily are drilled without the intent of being completed for hydrocarbon production.
52
Undeveloped oil and gas reserves. Undeveloped oil and gas reserves are reserves of any category that are expected to be
recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for
recompletion.
Undeveloped acreage. Lease acreage on which wells have not been drilled or completed to a point that would permit the
production of commercial quantities of natural gas and oil regardless of whether such acreage contains proved reserves.
Unproved properties. Properties with no proved reserves
Working interest. The operating interest that gives the owner the right to drill, produce and conduct operating activities
on the property and receive a share of production.
53
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, on March 11, 2013.
SIGNATURES
PETROQUEST ENERGY, INC.
By:
/s/ Charles T. Goodson
CHARLES T. GOODSON
Chairman of the Board, President and Chief
Executive Officer
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 indicated on March 11, 2013.
By:
By:
By:
By:
By:
By:
By:
/s/ Charles T. Goodson
CHARLES T. GOODSON
Chairman of the Board, President, Chief Executive Officer and
Director
(Principal Executive Officer)
/s/ J. Bond Clement
J. BOND CLEMENT
Executive Vice President, Chief Financial Officer, Treasurer
(Principal Financial and Accounting Officer)
/s/ W.J. Gordon, III
W.J. GORDON, III
/s/ Michael L. Finch
MICHAEL L. FINCH
Director
Director
/s/ Charles F. Mitchell, II, M.D.
CHARLES F. MITCHELL, II, M.D.
Director
/s/ E. Wayne Nordberg
E. WAYNE NORDBERG
/s/ William W. Rucks, IV
WILLIAM W. RUCKS, IV
Director
Director
54
INDEX TO FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets of PetroQuest Energy, Inc.
Consolidated Statements of Operations of PetroQuest Energy, Inc.
Consolidated Statements of Comprehensive Income of PetroQuest Energy,
Inc.
Consolidated Statements of Cash Flows of PetroQuest Energy, Inc.
Consolidated Statements of Stockholders’ Equity of PetroQuest Energy,
Inc.
Notes to Consolidated Financial Statements
F-1
F-2
F-3
F-4
F-5
F-6
F-6
55
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
PetroQuest Energy, Inc.
We have audited the accompanying consolidated balance sheets of PetroQuest Energy, Inc. as of December 31, 2012 and 2011,
and the related consolidated statements of operations, comprehensive income, cash flows and stockholders’ equity for each of the
three years in the period ended December 31, 2012. 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 PetroQuest Energy, Inc. at December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for
each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States),
PetroQuest Energy, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal
Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated March 11, 2013 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
New Orleans, Louisiana
March 11, 2013
F-1
PETROQUEST ENERGY, INC.
Consolidated Balance Sheets
(Amounts in Thousands)
ASSETS
Current assets:
Cash and cash equivalents
Revenue receivable
Joint interest billing receivable
Other receivable
Derivative asset
Prepaid drilling costs
Drilling pipe inventory
Other current assets
Total current assets
Property and equipment:
Oil and gas properties:
Oil and gas properties, full cost method
Unevaluated oil and gas properties
Accumulated depreciation, depletion and amortization
Oil and gas properties, net
Other property and equipment
Accumulated depreciation of other property and equipment
Total property and equipment
Other assets, net of accumulated amortization of $4,240 and $3,446, respectively
Total assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable to vendors
Advances from co-owners
Oil and gas revenue payable
Accrued interest and preferred stock dividend
Asset retirement obligation
Derivative liability
Other accrued liabilities
Total current liabilities
Bank debt
10% Senior Notes
Asset retirement obligation
Deferred income taxes
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $.001 par value; authorized 5,000 shares; issued and outstanding 1,495
shares
Common stock, $.001 par value; authorized 150,000 shares; issued and outstanding 62,768
and 62,148 shares, respectively
Paid-in capital
Accumulated other comprehensive income
Accumulated deficit
Total stockholders’ equity
Total liabilities and stockholders’ equity
See accompanying Notes to Consolidated Financial Statements.
F-2
December 31,
2012
December 31,
2011
$
$
$
14,904
17,742
42,595
9,208
830
1,698
707
1,900
89,584
1,734,477
71,713
(1,472,244)
333,946
12,370
(7,607)
338,709
5,110
433,403
58,960
20,459
26,175
6,190
2,351
233
6,535
120,903
50,000
150,000
24,909
—
$
$
$
22,263
15,860
47,445
—
6,418
2,900
4,070
2,965
101,921
1,600,546
70,408
(1,265,603)
405,351
10,627
(6,414)
409,564
4,681
516,166
50,750
33,867
13,764
6,167
3,110
—
8,250
115,908
—
150,000
27,317
551
1
1
63
276,534
521
(189,528)
87,591
433,403
$
62
270,606
4,031
(52,310)
222,390
516,166
$
PETROQUEST ENERGY, INC.
Consolidated Statements of Operations
(Amounts in Thousands, Except Per Share Data)
Revenues:
Oil and gas sales
Gas gathering revenue
Expenses:
Lease operating expenses
Production taxes
Depreciation, depletion and amortization
Ceiling test write-down
General and administrative
Accretion of asset retirement obligation
Interest expense
Other income (expense):
Gain on legal settlement
Loss on early extinguishment of debt
Other income (expense)
Derivative income (expense)
Income (loss) from operations
Income tax expense (benefit)
Net income (loss)
Preferred stock dividend
Net income (loss) available to common stockholders
Earnings per common share:
Basic
Net income (loss) per share
Diluted
Net income (loss) per share
Weighted average number of common shares:
Basic
Diluted
Year Ended
December 31,
2012
2011
2010
$
$
141,433
158
141,591
160,486
214
160,700
$
179,038
225
179,263
38,890
885
60,689
137,100
22,957
2,078
9,808
272,407
—
—
606
(233)
373
(130,443)
1,636
(132,079)
5,139
$ (137,218) $
38,571
3,100
58,243
18,907
20,436
2,049
9,648
150,954
—
—
(1,008)
—
(1,008)
8,738
(1,810)
10,548
5,139
5,409
$
$
(2.20) $
0.08
(2.20) $
0.08
39,012
4,917
59,326
—
21,341
1,306
9,952
135,854
12,400
(5,973)
(1,080)
—
5,347
48,756
1,630
47,126
5,139
41,987
0.67
0.66
$
$
$
62,459
62,459
61,937
62,325
61,415
61,789
See accompanying Notes to Consolidated Financial Statements.
F-3
PETROQUEST ENERGY, INC.
Consolidated Statements of Comprehensive Income
(Amounts in Thousands)
Net income (loss)
Change in fair value of derivatives, net of income tax (expense)
benefit of $2,079, ($2,388), and $1,028, respectively
Comprehensive income (loss)
Year Ended
December 31,
2012
$ (132,079) $
2011
10,548
(3,510)
$ (135,589) $
5,120
15,668
2010
47,126
(2,857)
44,269
$
$
See accompanying Notes to Consolidated Financial Statements.
F-4
PETROQUEST ENERGY, INC.
Consolidated Statements of Cash Flows
(Amounts in Thousands)
Cash flows from operating activities:
Net income (loss)
Adjustments to reconcile net income (loss) to net cash provided by operating
activities:
Deferred tax expense (benefit)
Depreciation, depletion and amortization
Ceiling test write-down
Non-cash gain on legal settlement
Loss on early extinguishment of debt
Accretion of asset retirement obligation
Share based compensation expense
Amortization costs and other
Non-cash derivative expense
Payments to settle asset retirement obligations
Changes in working capital accounts:
Revenue receivable
Prepaid drilling and pipe costs
Joint interest billing and other receivable
Accounts payable and accrued liabilities
Advances from co-owners
Other
Net cash provided by operating activities
Cash flows used in investing activities:
Investment in oil and gas properties
Investment in other property and equipment
Sale of oil and gas properties
Sale of unevaluated oil and gas properties
Net cash used in investing activities
Cash flows used in financing activities:
Net payments for share based compensation
Deferred financing costs
Payment of preferred stock dividend
Proceeds from bank borrowings
Repayment of bank borrowings
Redemption of 10 3/8% Senior Notes
Costs to redeem 10 3/8% Senior Notes
Proceeds from issuance of 10% Senior Notes
Costs to issue 10% Senior Notes
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, beginning of period
Cash and cash equivalents, end of period
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest
Income taxes
Year Ended
December 31,
2012
2011
2010
$ (132,079) $ 10,548
$
47,126
1,636
60,689
137,100
—
—
2,078
6,910
881
233
(2,627)
(1,882)
4,479
3,981
20,916
(13,408)
(316)
88,591
(1,810)
58,243
18,907
—
—
2,049
4,833
625
—
(905)
(2,474)
5,530
(35,252)
34,599
25,904
(1,621)
119,176
(147,771)
(1,743)
837
8,889
(139,788)
(194,536)
(1,286)
14,000
28,461
(153,361)
(981)
(42)
(5,139)
102,500
(52,500)
—
—
—
—
43,838
(7,359)
22,263
14,904
(1,133)
(517)
(5,139)
22,000
(22,000)
—
—
—
—
(6,789)
(40,974)
63,237
$ 22,263
16,026
105
$ 16,017
51
$
$
$
$
$
$
$
1,630
59,326
—
(4,164)
5,973
1,306
7,137
1,334
—
(6,274)
3,071
9,180
(401)
3,368
4,301
(227)
132,686
(103,926)
(1,042)
35,000
22,473
(47,495)
(210)
(12)
(5,137)
—
(29,000)
(150,000)
(4,187)
150,000
(4,180)
(42,726)
42,465
20,772
63,237
11,195
192
See accompanying Notes to Consolidated Financial Statements.
F-5
PetroQuest Energy Inc.
Consolidated Statements of Stockholders’ Equity
(Amounts in Thousands)
December 31, 2009
Options exercised
Retirement of shares upon
vesting of restricted stock
Share-based compensation
expense
Derivative fair value
adjustment, net of tax
Preferred stock dividend
Net income
December 31, 2010
Options exercised
Retirement of shares upon
vesting of restricted stock
Share-based compensation
expense
Derivative fair value
adjustment, net of tax
Preferred stock dividend
Net income
December 31, 2011
Options exercised
Retirement of shares upon
vesting of restricted stock
Share-based compensation
expense
Derivative fair value
adjustment, net of tax
Preferred stock dividend
Net loss
December 31, 2012
Common
Stock
Preferred
Stock
$
$
$
$
61
1
—
—
—
—
—
62
—
—
—
—
—
—
62
—
1
—
—
—
—
63
$
$
$
$
1
—
—
—
—
—
—
1
—
—
—
—
—
—
1
—
—
—
—
—
—
1
Paid-In
Capital
$ 259,981
296
Other
Comprehensive
Income (Loss)
1,768
$
—
Accumulated
Deficit
Total
Stockholders’
Equity
$
(99,706) $ 162,105
297
—
(507)
7,137
—
—
—
$ 266,907
234
(1,368)
4,833
—
—
—
$ 270,606
260
(1,242)
6,910
—
—
—
$ 276,534
$
$
$
—
—
—
—
(507)
7,137
(2,857)
—
—
(1,089) $
—
(2,857)
—
(5,139)
(5,139)
47,126
47,126
(57,719) $ 208,162
234
—
—
—
5,120
—
—
4,031
—
—
—
—
—
(1,368)
4,833
5,120
—
(5,139)
(5,139)
10,548
10,548
(52,310) $ 222,390
260
—
$
—
—
(1,241)
6,910
(3,510)
—
—
521
—
(5,139)
(132,079)
$ (189,528) $
(3,510)
(5,139)
(132,079)
87,591
See accompanying Notes to Consolidated Financial Statements.
F-6
PETROQUEST ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1—Organization and Summary of Significant Accounting Policies
PetroQuest Energy, Inc. (a Delaware Corporation) (“PetroQuest”) is an independent oil and gas company headquartered
in Lafayette, Louisiana with exploration offices in Houston, Texas and Tulsa, Oklahoma. It is engaged in the exploration,
development, acquisition and operation of oil and gas properties in Oklahoma, Wyoming and Texas as well as onshore and in the
shallow waters offshore the Gulf Coast Basin.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of PetroQuest and its subsidiaries, PetroQuest Energy, L.L.C.,
PetroQuest Oil & Gas, L.L.C, Pittrans, Inc. and TDC Energy LLC (collectively, the "Company"). All intercompany accounts and
transactions have been eliminated. Certain prior period amounts have been reclassified to conform to current year presentation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States
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.
Oil and Gas Properties
The Company utilizes the full cost method of accounting, which involves capitalizing all acquisition, exploration and
development costs incurred for the purpose of finding oil and gas reserves including the costs of drilling and equipping productive
wells, dry hole costs, lease acquisition costs and delay rentals. The Company also capitalizes the portion of general and
administrative costs that can be directly identified with acquisition, exploration or development of oil and gas properties.
Unevaluated property costs are transferred to evaluated property costs at such time as wells are completed on the properties, the
properties are sold, or management determines these costs to have been impaired. Interest is capitalized on unevaluated property
costs. Transactions involving sales of reserves in place, unless significant, are recorded as adjustments to accumulated depreciation,
depletion and amortization with no gain or loss recognized.
Depreciation, depletion and amortization of oil and gas properties is computed using the unit-of-production method based
on estimated proved reserves. All costs associated with evaluated oil and gas properties, including an estimate of future development
costs associated therewith, are included in the depreciable base. The costs of investments in unevaluated properties are excluded
from this calculation until the related properties are evaluated, proved reserves are established or the properties are determined to
be impaired. Proved oil and gas reserves are estimated annually by independent petroleum engineers.
The capitalized costs of proved oil and gas properties cannot exceed the present value of the estimated net future cash
flows from proved reserves based on historical first of the month average twelve-month oil, gas and natural gas liquid prices,
including the effect of hedges in place (the full cost ceiling). If the capitalized costs of proved oil and gas properties exceed the
full cost ceiling, the Company is required to write-down the value of its oil and gas properties to the full cost ceiling amount. The
Company follows the provisions of Staff Accounting Bulletin (“SAB”) No. 106, regarding the application of ASC Topic 410-20
by companies following the full cost accounting method. SAB No. 106 indicates that estimated future dismantlement and
abandonment costs that are recorded on the balance sheet are to be included in the costs subject to the full cost ceiling limitation.
The estimated future cash outflows associated with settling the recorded asset retirement obligations should be excluded from the
computation of the present value of estimated future net revenues used in applying the ceiling test.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a stated maturity of three months or less to be cash and cash
equivalents. The majority of the Company’s cash and cash equivalents are in overnight securities made through its commercial
bank accounts, which result in available funds the next business day.
Accounts Receivable
In its capacity as operator, the Company incurs drilling and operating costs that are billed to its partners based on their
respective working interests. As of December 31, 2012 and 2011, the Company had $0.1 million and $1.0 million, respectively,
recorded related to an allowance for doubtful accounts. At December 31, 2012, $9.2 million was recorded as an other receivable
relative to net proceeds from the sale of the Company's non-operated Arkansas assets, which were collected in January 2013.
F-7
Other Property and Equipment
During 2006, the Company acquired an interest in a gas gathering system used in the transportation of natural gas. The
costs related to this system are depreciated on a straight line basis over the estimated remaining useful life, generally 14 years.
During 2012, the Company acquired well service equipment to be used on its oil and gas related activities. The costs related to
these assets and other furniture and fixtures are depreciated on a straight line basis over estimated useful lives ranging from 3-8
years. During 2012, a field office servicing the Company's Oklahoma assets was built and is being depreciated over 39 years.
Other Assets
Other assets includes deferred financing costs, which are amortized over the life of the related debt, and the long-term
portion of a severance tax receivable from the state of Oklahoma, which is payable over the next 2.5 years.
Drilling Pipe Inventory
Drilling pipe inventory, which is included in current assets, consists of tubular goods and pipe that the Company either
utilizes in its ongoing exploration and development activities or has available for sale. The cost basis of drilling pipe inventory to
be utilized is depreciated as a component of oil and gas properties once the inventory is used in drilling or other capitalized
operations.
Other Accrued Liabilities
Other accrued liabilities at December 31, 2012 and 2011 included $5.7 million and $7.0 million, respectively, related to
accrued incentive compensation costs.
Income Taxes
The Company accounts for income taxes in accordance with ASC Topic 740. Provisions for income taxes include deferred
taxes resulting primarily from temporary differences due to different reporting methods for oil and gas properties for financial
reporting purposes and income tax purposes. For financial reporting purposes, all exploratory and development expenditures are
capitalized and depreciated, depleted and amortized on the unit-of-production method. For income tax purposes, only the equipment
and leasehold costs relative to successful wells are capitalized and recovered through depreciation or depletion. Generally, most
other exploratory and development costs are charged to expense as incurred; however, the Company may use certain provisions
of the Internal Revenue Code which allow capitalization of intangible drilling costs. Other financial and income tax reporting
differences occur primarily as a result of statutory depletion. Deferred tax assets are assessed for realizabilty and a valuation
allowance is established for any portion of the asset for which it is more likely than not will not be realized.
Revenue Recognition
The Company records natural gas and oil revenue under the sales method of accounting. Under the sales method, the
Company recognizes revenues based on the amount of natural gas or oil sold to purchasers, which may differ from the amounts
to which the Company is entitled based on its interest in the properties. Gas balancing obligations as of December 31, 2012 and
2011 were not significant.
Certain Concentrations
The Company’s production is sold on month to month contracts at prevailing prices. The Company attempts to diversify
its sales among multiple purchasers and obtain credit protection such as letters of credit and parental guarantees when necessary.
The following table identifies customers from whom the Company derived 10% or more of its net oil and gas revenues
during the years presented. Based on the availability of other customers, the Company does not believe the loss of any of these
customers would have a significant effect on its business or financial condition.
Shell Trading Co.
Laclede Energy
JP Morgan Ventures Energy
Texon LP
Gary Williams
(a) Less than 10 percent
F-8
Year Ended December 31,
2012
2011
2010
30%
17%
12%
(a)
(a)
18%
20%
(a)
15%
11%
19%
17%
(a)
17%
10%
Derivative Instruments
Under ASC Topic 815, the nature of a derivative instrument must be evaluated to determine if it qualifies for hedge
accounting treatment. Instruments qualifying for hedge accounting treatment are recorded as an asset or liability measured at fair
value and subsequent changes in fair value are recognized in stockholders’ equity through other comprehensive income (loss), net
of related taxes, to the extent the hedge is effective. If a hedge becomes ineffective because the hedged production does not occur,
or the hedge otherwise does not qualify for hedge accounting treatment, the cash settlements and changes in the fair value of the
derivative are recorded in the income statement as derivative income (expense). The Company does not offset fair value amounts
recognized for derivative instruments. The cash settlements of effective hedges are recorded as adjustments to oil and gas sales.
Oil and gas revenues include additions related to the net settlement of hedges totaling $9.1 million, $2.4 million and $17.5 million
during 2012, 2011 and 2010, respectively.
The Company’s hedges are specifically referenced to NYMEX prices for oil and natural gas. The effectiveness of hedges
is evaluated at the time the contracts are entered into, as well as periodically over the life of the contracts, by analyzing the
correlation between NYMEX prices and the posted prices received from the designated production. Through this analysis, the
Company is able to determine if a high correlation exists between the prices received for its designated production and the NYMEX
prices at which the hedges will be settled. At December 31, 2012, the Company’s derivative instruments, with the exception of a
three-way collar contract for 2013 natural gas production, were designated effective cash flow hedges. See Note 7 for further
discussion of the Company’s derivative instruments.
Note 2—Convertible Preferred Stock
The Company has 1,495,000 shares of 6.875% Series B cumulative convertible perpetual preferred stock (the “Series B
Preferred Stock”) outstanding.
The following is a summary of certain terms of the Series B Preferred Stock:
Dividends. The Series B Preferred Stock accumulates dividends at an annual rate of 6.875% for each share of Series B
Preferred Stock. Dividends are cumulative from the date of first issuance and, to the extent payment of dividends is not prohibited
by the Company’s debt agreements, assets are legally available to pay dividends and the Company’s board of directors or an
authorized committee of the board declares a dividend payable, the Company pays dividends in cash, every quarter.
Mandatory conversion. The Company may, at its option, cause shares of the Series B Preferred Stock to be automatically
converted at the applicable conversion rate, but only if the closing sale price of the Company’s common stock for 20 trading days
within a period of 30 consecutive trading days ending on the trading day immediately preceding the date the Company gives the
conversion notice equals or exceeds 130% of the conversion price in effect on each such trading day.
Conversion rights. Each share of Series B Preferred Stock may be converted at any time, at the option of the holder, into
3.4433 shares of the Company’s common stock (which is based on an initial conversion price of approximately $14.52 per share
of common stock, subject to adjustment) plus cash in lieu of fractional shares, subject to the Company’s right to settle all or a
portion of any such conversion in cash or shares of the Company’s common stock. If the Company elects to settle all or any portion
of its conversion obligation in cash, the conversion value and the number of shares of the Company’s common stock it will deliver
upon conversion (if any) will be based upon a 20 trading day averaging period.
Upon any conversion, the holder will not receive any cash payment representing accumulated and unpaid dividends on
the Series B Preferred Stock, whether or not in arrears, except in limited circumstances. The conversion rate is equal to $50 divided
by the conversion price at the time. The conversion price is subject to adjustment upon the occurrence of certain events. The
conversion price on the conversion date and the number of shares of the Company’s common stock, as applicable, to be delivered
upon conversion may be adjusted if certain events occur.
Note 3—Woodford Joint Development Agreement
In May 2010, PetroQuest Energy, L.L.C. entered into a joint development agreement (“JDA”) with WSGP Gas Producing
LLC (WSGP), a subsidiary of NextEra Energy Resources, LLC, whereby WSGP acquired approximately 29 Bcfe of the Company’s
Woodford proved undeveloped reserves (PUDs) as well as the right to earn 50% of the Company’s undeveloped Woodford acreage
position through a two phase drilling program. The Company received $57.4 million in cash at closing, net of $2.6 million in fees
incurred in relation to the transaction, and recorded a $14.0 million receivable for a contractual payment that was to be received
in 2011. The Company received the $14.0 million contractual payment on November 30, 2011. The Company recorded the total
consideration of approximately $71.0 million during 2010 as an adjustment to capitalized costs with no gain or loss recognized.
Certain defined production performance metrics were achieved during the fourth quarter of 2011 and the Company received an
additional $14 million during December 2011, which was also recorded as a reduction of capitalized costs. Additionally, since
May 2010, WSGP has funded a share of the Company’s drilling costs under a long-term drilling program.
F-9
During February 2012, the Company amended its Woodford Shale JDA to accelerate the entry into Phase 2 of the drilling
program and modify the drilling carry ratio effective March 1, 2012. Under the amended JDA, the Phase 2 drilling carry has been
expanded to provide for development in both the Mississippian Lime and Woodford Shale plays whereby the Company will pay
25% of the cost to drill and complete wells and receive a 50% ownership interest. The Phase 2 drilling carry totals approximately
$93 million and will be subject to extensions in one-year intervals.
F-10
Note 4—Earnings Per Share
A reconciliation between the basic and diluted earnings per share computations (in thousands, except per share
amounts) is as follows:
For the Year Ended December 31, 2012
BASIC EPS
Net loss available to common stockholders
Effect of dilutive securities:
Stock options
Restricted stock
DILUTED EPS
For the Year Ended December 31, 2011
Net income available to common stockholders
Attributable to participating securities
BASIC EPS
Net income available to common stockholders
Effect of dilutive securities:
Stock options
Attributable to participating securities
DILUTED EPS
For the Year Ended December 31, 2010
Net income available to common stockholders
Attributable to participating securities
BASIC EPS
Net income available to common stockholders
Effect of dilutive securities:
Stock options
Attributable to participating securities
DILUTED EPS
Loss
(Numerator)
Shares
(Denominator)
Per
Share Amount
(137,218)
62,459
$
(2.20)
—
—
(137,218)
—
—
62,459
$
Shares
(Denominator)
Per
Share Amount
$
$
$
$
$
Income
(Numerator)
$
$
$
$
5,409
(154)
5,255
5,409
—
(153)
5,256
Income
(Numerator)
$
41,987
(1,029)
40,958
41,987
—
(1,023)
40,964
(2.20)
0.08
0.08
Per
Share Amount
0.67
0.66
61,937
—
61,937
61,937
388
—
62,325
Shares
(Denominator)
61,415
—
61,415
61,415
374
—
61,789
$
$
$
$
An aggregate of 0.9 million shares of common stock representing options to purchase common stock and unvested shares
of restricted common stock and common shares issuable upon the assumed conversion of the Series B preferred stock totaling 5.1
million shares were not included in the computation of diluted earnings per share for the year ended December 31, 2012, because
the inclusion would have been anti-dilutive as a result of the net loss reported for the period.
Common shares issuable upon the assumed conversion of the Series B preferred stock totaling 5.1 million shares during
2011 and 2010 were not included in the computation of diluted earnings per share because the inclusion would have been anti-
dilutive. Options to purchase 1.1 million, 0.1 million and 1.7 million shares of common stock were outstanding during the year
ended December 31, 2012, 2011 and 2010, respectively, and were not included in the computation of diluted earnings per share
because the options' exercise prices were in excess of the average market price of the common shares.
F-11
Note 5—Share-Based Compensation
Share-based compensation expense is reflected as a component of the Company’s general and administrative expense.
A detail of share-based compensation expense for the periods ended December 31, 2012, 2011 and 2010 is as follows (in thousands):
Year Ended December 31,
2011
2010
2012
Stock options:
Incentive Stock Options
Non-Qualified Stock Options
Restricted stock
Restricted stock units
Share based compensation
$
$
786
660
5,464
277
7,187
$
$
493
703
3,637
—
4,833
$
$
793
2,081
4,263
—
7,137
During the years ended December 31, 2012, 2011 and 2010, the Company recorded income tax benefits of approximately
$2.3 million, $1.6 million and $2.4 million, respectively, related to share-based compensation expense recognized during those
periods. Share-based compensation expense for the year ended December 31, 2010 included a charge of approximately $0.5 million
related to the voluntary early cancellation of certain stock options and accelerated recognition of associated compensation expense.
Any excess tax benefits from the vesting of restricted stock and the exercise of stock options will not be recognized in paid-in
capital until the Company is in a current tax paying position. Presently, all of the Company’s income taxes are deferred and the
Company has net operating losses available to carryover to future periods. Accordingly, no excess tax benefits have been recognized
for any periods presented.
At December 31, 2012, the Company had $6.7 million of unrecognized compensation cost related to granted restricted
stock and stock options. This amount will be recognized as compensation expense over a weighted average period of approximately
two years.
Stock Options
Stock options generally vest equally over a three-year period, must be exercised within 10 years of the grant date and
may be granted only to employees, directors and consultants. The exercise price of each option may not be less than 100% of the
fair market value of a share of Common Stock on the date of grant. Upon a change in control of the Company, all outstanding
options become immediately exercisable.
The Company computes the fair value of its stock options using the Black-Scholes option-pricing model assuming a
stock option forfeiture rate and expected term based on historical activity and expected volatility computed using historical stock
price fluctuations on a weekly basis for a period of time equal to the expected term of the option. The Company recognizes
compensation expense using the accelerated expense attribution method over the vesting period. Periodically, the Company adjusts
compensation expense based on the difference between actual and estimated forfeitures.
The following table outlines the assumptions used in computing the fair value of stock options granted during 2012, 2011
and 2010:
2012
—%
Years Ended December 31,
2011
—%
79.2% - 79.6% 78.5% - 79.7% 78.2% - 80.3%
1.5% - 3.0%
1.1% - 2.2%
0.8% - 1.1%
6 years
6 years
6 years
5.0%
5.0%
5.0%
2010
—%
125,487
3.71
465,000
$
$
395,280
5.09
2,011,000
$
$
69,500
4.21
293,000
$
$
Dividend yield
Expected volatility
Risk-free rate
Expected term
Forfeiture rate
Stock options granted (1)
Wgtd. avg. grant date fair value per share
Fair value of grants (1)
(1) Prior to applying estimated forfeiture rate
F-12
The following table details stock option activity during the year ended December 31, 2012:
Outstanding at beginning of year
Granted
Expired/cancelled/forfeited
Exercised
Outstanding at end of year
Options exercisable at end of year
Options expected to vest
Wgtd. Avg.
Remaining
Life
Aggregate
Intrinsic Value
(000’s)
Number of
Options
1,922,408
125,487
(44,554)
(78,400)
1,924,941
Wgtd. Avg.
Exercise Price
5.56
$
5.51
6.71
3.32
5.61
1,534,311
371,098
$
5.31
6.79
4.1 years
8.8 years
5.0 years
$
$
$
1,114
1,114
48
The total fair value of stock options that vested during the years ended December 31, 2012, 2011 and 2010 was $1.7
million, $1.1 million and $3.6 million, respectively. The intrinsic value of stock options exercised was immaterial for all periods
presented.
The following table summarizes information regarding stock options outstanding at December 31, 2012:
Range of
Exercise
Price
$0.0—$3.17
$3.17—$5.91
$5.91—$7.08
$7.08—$9.99
Restricted Stock
Options
Outstanding
12/31/2012
450,667
422,818
672,862
378,594
1,924,941
Wgtd. Avg.
Remaining
Contractual Life
1.0 years
4.1 years
6.4 years
8.4 years
5.0 years
Wgtd. Avg.
Exercise
Price
$2.92
$4.53
$6.98
$7.59
$5.61
Options
Exercisable
12/31/2012
450,667
308,831
639,195
135,618
1,534,311
Wgtd. Avg.
Exercise
Price
$2.92
$4.23
$7.01
$7.71
$5.31
The Company computes the fair value of its service based restricted stock using the closing price of the Company’s stock
at the date of grant, and compensation expense is recognized assuming a 5% estimated forfeiture rate. Restricted stock granted to
employees prior to 2011 generally vests over a five-year period with one-fourth vesting on each of the first, second, third and fifth
anniversaries of the date of the grant. No portion of the restricted stock vests on the fourth anniversary of the date of the grant.
Restricted stock granted to directors generally vests evenly over a three year period. Beginning January 1, 2011, restricted stock
granted to employees generally vests evenly over a three year period. Upon a change in control of the Company, all outstanding
shares of restricted stock will become immediately vested. Compensation expense related to restricted stock is recognized over
the vesting period using the accelerated expense attribution method.
The following table details restricted stock activity during 2012:
Outstanding at beginning of year
Granted
Expired/cancelled/forfeited
Lapse of restrictions
Outstanding at December 31, 2012
Number of
Shares
Wgtd. Avg.
Fair Value per
Share
1,988,602
659,915
(109,236)
(733,452)
1,805,829
$
$
6.69
5.24
6.64
6.40
6.28
The weighted average grant date fair value of restricted stock granted during the years ended December 31, 2012, 2011
and 2010 was $5.24, $7.54 and $5.44, respectively, per share. The total fair value of restricted stock that vested during the years
ended December 31, 2012, 2011 and 2010 was $4.7 million, $5.6 million and $2.6 million, respectively. At December 31, 2012,
the weighted average remaining life of restricted stock outstanding was two years and the intrinsic value of restricted stock
outstanding, using the closing stock price on December 31, 2012, was $8.9 million.
F-13
Restricted Stock Units
The Company granted restricted stock units ("RSUs") to employees during 2012. The RSUs vest in one-third increments
on each of the first, second and third anniversaries of the date of grant. Cash payment will be made to employees on each vesting
date based upon the Company's closing stock price on that date. Upon change in control of the Company, all of the RSUs will
become immediately vested. Compensation expense is recognized on a straight line basis over the vesting period assuming a 5%
estimated forfeiture rate. The Company computes the fair value of the RSUs using the closing price of the Company's stock for
purposes of determining the amount of the liability at the end of each period. As of December 31, 2012, the Company had 1.1
million RSUs outstanding with an aggregate fair value of $5.2 million. There were no cash payments made to settle RSUs during
2012 and no RSUs were vested as of December 31, 2012.
Note 6—Asset Retirement Obligation
The Company accounts for asset retirement obligations in accordance with ASC Topic 410-20, which requires recording
the fair value of an asset retirement obligation associated with tangible long-lived assets in the period incurred. Asset retirement
obligations associated with long-lived assets included within the scope of ASC Topic 410-20 are those for which there is a legal
obligation to settle under existing or enacted law, statute, written or oral contract or by legal construction under the doctrine of
promissory estoppel. The Company has legal obligations to plug, abandon and dismantle existing wells and facilities that it has
acquired and constructed.
The following table describes all changes to the Company’s asset retirement obligation liability (in thousands):
Asset retirement obligation, beginning of period
Liabilities incurred
Liabilities settled
Accretion expense
Revisions in estimated cash flows
Asset retirement obligation, end of period
Less: current portion of asset retirement obligation
Long-term asset retirement obligation
Year Ended December 31,
2012
30,427
892
(2,627)
2,078
(3,510)
27,260
(2,351)
24,909
$
$
2011
24,592
220
(905)
2,049
4,471
30,427
(3,110)
27,317
$
$
Liabilities settled during 2012 included two offshore fields and one onshore field that were decommissioned. Additionally,
the liabilities for three onshore fields were settled due to the sale of the fields. Revisions during 2012 primarily represent revised
timing of plugging and abandonment operations. Revisions during 2011 primarily represent increased cost estimates to
decommission the Company’s offshore fields including platforms, pipelines and the related wells.
Note 7—Derivative Instruments
The Company seeks to reduce its exposure to commodity price volatility by hedging a portion of its production through
commodity derivative instruments. When the conditions for hedge accounting are met, the Company may designate its commodity
derivatives as cash flow hedges.
Oil and gas sales include additions (reductions) related to the settlement of gas hedges of $6,846,000, $2,609,000 and
$17,538,000, Ngl hedges of $722,000, zero and zero, and oil hedges of $1,529,000, ($192,000) and zero, for the years ended
December 31, 2012, 2011 and 2010, respectively.
As of December 31, 2012, the Company had entered into the following gas hedge contracts:
Production Period
Natural Gas:
2013
2013
Instrument
Type
Daily Volumes
Weighted
Average Price
3-way collar
Swap
10,000 Mmbtu
5,000 Mmbtu
$2.00-$3.00-$4.09
$4.00
At December 31, 2012, the Company had recognized a net asset of approximately $0.6 million related to the estimated
fair value of these derivative instruments. Based on estimated future commodity prices as of December 31, 2012, the Company
would realize a $0.4 million gain, net of taxes, during the next 12 months. These gains are expected to be reclassified to oil and
gas sales based on the schedule of gas volumes stipulated in the derivative contracts.
F-14
During January and February 2013, we entered into the following additional hedge contracts accounted for as cash flow
hedges:
Production Period
Crude Oil:
February - December 2013
Natural Gas:
February - December 2013
March - December 2013
April - December 2013
January - December 2014
Instrument
Type
Daily Volumes
Weighted
Average Price
Swap
Swap
Swap
Swap
Swap
250 Bbls
$104.75
10,000 Mmbtu
5,000 Mmbtu
5,000 Mmbtu
10,000 Mmbtu
$3.71
$3.50
$3.74
$4.08
Derivatives designated as hedging instruments:
The following tables reflect the fair value of the Company’s effective cash flow hedges in the consolidated financial
statements (in thousands):
Effect of Cash Flow Hedges on the Consolidated Balance Sheet at December 31, 2012 and December 31, 2011:
Period
December 31, 2012
December 31, 2011
Commodity Derivatives
Balance Sheet
Location
Fair Value
Derivative asset
Derivative asset
$
$
830
6,418
Effect of Cash Flow Hedges on the Consolidated Statement of Operations for the years ended December 31, 2012, 2011 and 2010:
Instrument
Commodity Derivatives at December 31, 2012
Commodity Derivatives at December 31, 2011
Commodity Derivatives at December 31, 2010
Derivatives not designated as hedging instruments:
Amount of Gain (Loss)
Recognized in Other
Comprehensive Income
(3,510)
$
5,120
$
(2,857)
$
Location of
Gain Reclassified
into Income
Oil and gas sales
Oil and gas sales
Oil and gas sales
$
$
$
Amount of Gain
Reclassified into
Income
9,097
2,417
17,538
The Company’s three-way collar contract for 2013 gas production has not been designated as an effective cash flow
hedge and therefore both realized and unrealized (mark-to-market) gains or losses on this derivative are recorded as derivative
expense (income) on the statement of operations. The following tables reflect the fair value of this contract in the consolidated
financial statements (in thousands):
Effect of Non-designated Derivative Instrument on the Consolidated Balance Sheet at December 31, 2012 and December 31,
2011:
Period
December 31, 2012
December 31, 2011
Commodity Derivatives
Balance Sheet Location
Fair Value
Derivative liability
$
$
(233)
—
F-15
Effect of Non-designated Derivative Instrument on the Consolidated Statement of Operations for the twelve months ended
December 31, 2012, 2011 and 2010:
Instrument
Commodity Derivatives at December 31, 2012
Commodity Derivatives at December 31, 2011
Commodity Derivatives at December 31, 2010
Note 8 - Fair Value Measurements
Amount of Unrealized Loss
Recognized in Derivative
Expense
$
$
$
(233)
—
—
ASC Topic 820 defines fair value 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 and establishes 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.
The Company's commodity derivatives are required to be measured at fair value on a recurring basis. The fair value of
these derivatives is derived using an independent third-party’s valuation model that utilizes market-corroborated inputs that are
observable over the term of the derivative contract. 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. As a result,
the Company designates its commodity derivatives as Level 2 in the fair value hierarchy.
The following table summarizes the Company’s assets (liabilities) that are subject to fair value measurement on a recurring
basis as of December 31, 2012 and December 31, 2011 (in thousands):
Instrument
Commodity Derivatives:
At December 31, 2012
At December 31, 2011
Fair Value Measurements Using
Quoted Prices
in Active
Markets (Level 1)
Significant Other
Observable
Inputs (Level 2)
Significant
Unobservable
Inputs (Level 3)
$
$
— $
— $
597
6,418
$
$
—
—
The fair value of the Company's cash and cash equivalents and variable-rate bank debt approximated book value at
December 31, 2012 and 2011. As of December 31, 2012 and 2011, the fair value of the Company's $150 million 10% Senior
Notes due 2017 (the “Notes”) was approximately $155.3 million and $151.5 million, respectively. The fair value of the Notes
was determined based upon a market quote provided by an independent broker, which represents a Level 2 input.
Note 9—Long-Term Debt
On August 19, 2010, PetroQuest issued $150 million in principal amount of the Notes in a public offering. The Notes
are guaranteed by certain of PetroQuest's subsidiaries. PetroQuest has no independent assets or operations and the subsidiaries
not providing guarantees are minor, as defined by the rules of the Securities and Exchange Commission ("SEC"). The Notes have
numerous covenants including restrictions on liens, incurrence of indebtedness, asset sales, dividend payments and other restricted
payments. Interest is payable semi-annually on March 1 and September 1. At December 31, 2012, $5.0 million had been accrued
in connection with the March 1, 2013 interest payment and the Company was in compliance with all of the covenants contained
in the Notes.
The Company and PetroQuest Energy, L.L.C. (the “Borrower”) have a Credit Agreement (as amended, the “Credit
Agreement”) with JPMorgan Chase Bank, N.A., Wells Fargo Bank, N.A., Capital One, N.A., IberiaBank and Whitney Bank. The
Credit Agreement provides the Company with a $300 million revolving credit facility that permits borrowings based on the
commitments of the lenders and the available borrowing base as determined in accordance with the Credit Agreement. The Credit
F-16
Agreement also allows the Company to use up to $25 million of the borrowing base for letters of credit. The credit facility matures
on October 3, 2016. As of December 31, 2012, the Company had $50.0 million of borrowings outstanding under (and no letters
of credit issued pursuant to) the Credit Agreement.
The borrowing base under the Credit Agreement is based upon the valuation of the reserves attributable to the Company’s
oil and gas properties as of January 1 and July 1 of each year. In connection with the most recent redetermination, the borrowing
base was increased from $125 million to $130 million (subject to the aggregate commitments of the lenders then in effect) effective
September 28, 2012. The aggregate commitments of the lenders is currently $100 million and can be increased to up to $300
million by either adding new lenders or increasing the commitments of existing lenders, subject to certain conditions. The next
borrowing base redetermination is scheduled to occur by March 31, 2013. The Company or the lenders may request two additional
borrowing base redeterminations each year. Each time the borrowing base is to be re-determined, the administrative agent under
the Credit Agreement will propose a new borrowing base as it deems appropriate in its sole discretion, which must be approved
by all lenders if the borrowing base is to be increased, or by lenders holding two-thirds of the amounts outstanding under the Credit
Agreement if the borrowing base remains the same or is reduced.
The Credit Agreement is secured by a first priority lien on substantially all of the assets of the Company and its subsidiaries,
including a lien on all equipment and at least 80% of the aggregate total value of the Company’s oil and gas properties. Outstanding
balances under the Credit Agreement bear interest at the alternate base rate (“ABR”) plus a margin (based on a sliding scale of
0.5% to 1.5% depending on total commitments) or the adjusted LIBO rate (“Eurodollar”) plus a margin (based on a sliding scale
of 1.5% to 2.5% depending on total commitments). The alternate base rate is equal to the highest of (i) the JPMorgan Chase prime
rate, (ii) the Federal Funds Effective Rate plus 0.5% or (iii) the adjusted LIBO rate plus 1%. For the purposes of the definition of
alternative base rate only, the adjusted LIBO rate is equal to the rate at which dollar deposits of $5,000,000 with a one month
maturity are offered by the principal London office of JPMorgan Chase Bank, N.A. in immediately available funds in the London
interbank market. For all other purposes, the adjusted LIBO rate is equal to the rate at which Eurodollar deposits in the London
interbank market for one, two, three or six months (as selected by the Company) are quoted, as adjusted for statutory reserve
requirements for Eurocurrency liabilities. Outstanding letters of credit are charged a participation fee at a per annum rate equal to
the margin applicable to Eurodollar loans, a fronting fee and customary administrative fees. In addition, the Company pays
commitment fees based on a sliding scale of 0.375% to 0.5% depending on total commitments.
The Company and its subsidiaries are subject to certain restrictive financial covenants under the Credit Agreement,
including a maximum ratio of total debt to EBITDAX, determined on a rolling four quarter basis, of 3.0 to 1.0, and a minimum
ratio of consolidated current assets to consolidated current liabilities of 1.0 to 1.0, all as defined in the Credit Agreement. The
Credit Agreement also includes customary restrictions with respect to debt, liens, dividends, distributions and redemptions,
investments, loans and advances, nature of business, international operations and foreign subsidiaries, leases, sale or discount of
receivables, mergers or consolidations, sales of properties, transactions with affiliates, negative pledge agreements, gas imbalances
and swap agreements. However, the Credit Agreement permits the Company to repurchase up to $10 million of the Company’s
common stock during the term of the Credit Agreement, as long as after giving effect to such repurchase the Borrower’s Liquidity
(as defined therein) is greater than 20% of the total commitments of the lenders at such time. As of December 31, 2012, the
Company was in compliance with all of the covenants contained in the Credit Agreement.
Note 10—Related Party Transactions
Three of the Company’s senior officers, Charles T. Goodson, Stephen H. Green, and Mark K. Stover, or their affiliates,
are working interest owners and overriding royalty interest owners and E. Wayne Nordberg and William W. Rucks, IV, two of the
Company’s directors, are working interest owners in certain properties operated by the Company or in which the Company also
holds a working interest. As working interest owners, they are required to pay their proportionate share of all costs and are entitled
to receive their proportionate share of revenues in the normal course of business. As overriding royalty interest owners, they are
entitled to receive their proportionate share of revenues in the normal course of business.
During 2012, in their capacities as working interest owners or overriding royalty interest owners, revenues, net of costs,
were disbursed to Messrs. Goodson, Green, Stover, Nordberg, or their affiliates, in the amounts of $104,000, $387,000, $112,000
and $100, respectively. During 2011, in their capacities as working interest owners or overriding royalty interest owners, revenues,
net of costs, were disbursed to Messrs. Goodson, Green, Stover, or their affiliates, in the amounts of $293,000, $546,000 and
$328,000, respectively, and with respect to Mr. Nordberg, costs billed exceeded revenues disbursed in the amount of $9. During
2010, in their capacities as working interest owners or overriding royalty interest owners, revenues, net of costs, were disbursed
to Messrs. Goodson, Green and Stover, or their affiliates, in the amounts of $103,000, $520,000 and $261,000, respectively, and
with respect to Mr. Nordberg, costs in the amount of $100 were billed with no revenue disbursed. No such disbursements were
made to Mr. Rucks during 2012, 2011 and 2010. With respect to Mr. Goodson, gross revenues attributable to interests, properties
or participation rights held by him prior to joining the Company as an officer and director on September 1, 1998 represent all of
the gross revenue received by him in 2012 and 2011.
F-17
In its capacity as operator, the Company incurs drilling and operating costs that are billed to its partners based on their
respective working interests. At December 31, 2012, the Company’s joint interest billing receivable included approximately $5,000
from the related parties discussed above or their affiliates, attributable to their share of costs. This represents less than 1% of the
Company’s total joint interest billing receivable at December 31, 2012.
Periodically, the Company charters private aircraft for business purposes. During 2012, 2011 and 2010, the Company
paid approximately $16,900, $128,200 and $169,400, respectively, to a third party operator in connection with the Company’s use
of flight hours owned by Charles T. Goodson through a fractional ownership arrangement with the third party operator. These
amounts represent the cost of the hours purchased by Mr. Goodson. The Company’s use of flight hours purchased by Mr. Goodson
was pre-approved by the Company’s Audit Committee and there is no agreement or obligation by or on behalf of the Company
to utilize this aircraft arrangement.
Note 11—Ceiling Test Write-downs
As a result of lower natural gas prices and their negative impact on certain of the Company’s longer-lived estimated
proved reserves and estimated future net cash flows, the Company recognized ceiling test write-downs of $137.1 million and
$18.9 million during 2012 and 2011, respectively. No such write-down occurred during 2010. At December 31, 2012, the prices
used in computing the estimated future net cash flows from the Company’s estimated proved reserves, including the effect of
hedges in place at that date, averaged $2.21 per Mcf of natural gas, $102.81 per barrel of oil and $6.07 per Mcfe of Ngl. The
Company’s cash flow hedges in place decreased the ceiling test write-down by approximately $2.2 million and $3.9 million during
2012 and 2011, respectively.
Note 12—Investment in Oil and Gas Properties
The following tables disclose certain financial data relative to the Company’s oil and gas producing activities, which are
located onshore and offshore in the continental United States:
Costs Incurred in Oil and Gas Property Acquisition, Exploration and Development Activities
(amounts in thousands)
Acquisition costs:
Proved
Unproved
Divestitures—unproved (1)
Exploration costs:
Proved
Unproved
Development costs
Capitalized general and administrative and interest costs
For the Year-Ended December 31,
2012
2011
2010
$
352
$
2,720
$
10,421
15,677
(8,889)
43,207
(14,461)
11,310
(36,139)
72,361
18,033
18,740
18,961
92,466
5,919
34,400
18,210
34,310
10,384
34,286
19,665
Total costs incurred
$ 135,235
$ 182,461
$
84,237
Accumulated depreciation, depletion and
amortization (DD&A)
Balance, beginning of year
Provision for DD&A
Ceiling test writedown
Sale of proved properties and other (2)
Balance, end of year
DD&A per Mcfe
For the Year-Ended December 31,
2012
2011
2010
(1,265,603) $
(59,496)
(137,100)
(10,045)
(1,472,244) $
(1,175,553) $
(57,143)
(18,907)
(14,000)
(1,265,603) $
(1,082,381)
(58,172)
—
(35,000)
(1,175,553)
1.75
$
1.89
$
1.88
$
$
$
F-18
(1) During 2012, the Company sold an additional portion of its Mississippian Lime acreage for $6.1 million. During 2011,
the Company sold a portion of its unproved Mississippian Lime acreage for $14.5 million. During 2010, the Company
recorded $36 million in consideration from the sale of a portion of its unevaluated acreage in the Woodford as part of its
Woodford joint development agreement.
(2) During 2012, the Company sold its non-operated Arkansas assets for a net cash purchase price of $9.2 million. During
2011, the Company received an additional $14 million payment associated with the achievement of certain production
metrics stipulated under the joint development agreement (See Note 3). During 2010, the Company recorded $35 million
in consideration from the sale of a portion of its evaluated properties in the Woodford as part of its Woodford joint
development agreement.
At December 31, 2012 and 2011, unevaluated oil and gas properties totaled $71.7 million and $70.4 million, respectively,
and were not subject to depletion. Unevaluated costs at December 31, 2012 included $12.7 million of costs related to 17 exploratory
wells in progress at year-end. These costs are expected to be transferred to evaluated oil and gas properties during 2013 upon the
completion of drilling. At December 31, 2011, unevaluated costs included $5.9 million related to 44 exploratory wells in progress.
All of these costs were transferred to evaluated oil and gas properties during 2012. The Company capitalized $7.0 million, $7.0
million and $7.8 million of interest during 2012, 2011 and 2010, respectively. Of the total unevaluated oil and gas property costs
of $71.7 million at December 31, 2012, $24.8 million, or 35%, was incurred in 2012, $26.5 million, or 37%, was incurred in 2011
and $20.4 million, or 28%, was incurred in prior years. The Company expects that the majority of the unevaluated costs at
December 31, 2012 will be evaluated within the next three years, including $28.3 million that the Company expects to be evaluated
during 2013.
Note 13—Income Taxes
The Company typically provides for income taxes at a statutory rate of 35% adjusted for permanent differences expected
to be realized, primarily statutory depletion, non-deductible stock compensation expenses and state income taxes. As a result of
the ceiling test write-downs recognized during 2008 and 2009, the Company incurred a cumulative three-year loss. Because of
the impact the cumulative loss had on the determination of the recoverability of deferred tax assets through future earnings, the
Company assessed the realizability of its deferred tax assets based on the future reversals of existing deferred tax liabilities.
Accordingly, the Company established a valuation allowance for a portion of the deferred tax asset. During 2011, the Company
reversed the remaining valuation allowance as future reversals of existing deferred tax liabilities were sufficient to realize the
entire deferred tax asset. However, as a result of the deferred tax benefit related to the ceiling test write-down in 2012, future
reversals of existing deferred tax liabilities are no longer sufficient to realize the entire deferred tax asset. Thus, the Company re-
established a valuation allowance for a portion of the deferred tax asset. The valuation allowance was $50.9 million as of
December 31, 2012.
An analysis of the Company’s deferred taxes follows (amounts in thousands):
December 31,
2012
2011
2010
Net operating loss carryforwards
$
16,641
$
2,409
$
Percentage depletion carryforward
Alternative minimum tax credits
Contributions carryforward and other
Temporary differences:
Oil and gas properties—full cost
Derivatives
Share-based compensation
Valuation allowance
Deferred tax liability
7,317
784
156
22,716
(222)
3,474
(50,866)
$
— $
6,103
784
130
(10,541)
(2,388)
2,952
—
(551) $
4,737
3,596
776
90
(10,141)
405
3,732
(3,195)
—
At December 31, 2012, the Company had approximately $56.4 million of operating loss carryforwards, of which $11.7
million relates to excess tax benefits with respect to share-based compensation that have not been recognized in the financial
statements. If not utilized, approximately $8.7 million of such carryforwards would expire in 2025 and the remainder would expire
by the year 2032. The Company has available for tax reporting purposes $20.9 million in statutory depletion deductions that may
be carried forward indefinitely.
F-19
Income tax expense (benefit) for each of the years ended December 31, 2012, 2011 and 2010 was different than the
amount computed using the Federal statutory rate (35%) for the following reasons (amounts in thousands):
For the Year Ended December 31,
2012
2011
2010
Amount computed using the statutory rate
$
(45,655) $
3,058
$
17,065
Increase (reduction) in taxes resulting from:
State & local taxes
Percentage depletion carryforward
Allowance for alternative minimum tax
Non-deductible stock option expense (1)
Share-based compensation (2)
Other
Change in valuation allowance
Income tax expense (benefit)
(2,870)
(1,309)
—
292
9
303
50,866
$
1,636
$
192
(2,507)
8
183
346
(300)
(2,790)
(1,810)
$
1,073
(252)
575
295
3,041
321
(20,488)
1,630
(1) Relates to compensation expense recognized on the vesting of Incentive Stock Options.
(2) Relates to the write-off of deferred tax assets associated with share based compensation that will not be recognized for tax
purposes.
Note 14—Commitments and Contingencies
The Company is a party to ongoing litigation in the normal course of business. While the outcome of lawsuits or other
proceedings against the Company cannot be predicted with certainty, management believes that the effect on its financial condition,
results of operations and cash flows, if any, will not be material. At December 31, 2010 the Company had accrued $2.25 million
in connection with estimated liabilities related to certain legal matters. All of these matters were settled during 2011, which resulted
in an additional charge of $1.4 million included in other expense for the year ended December 31, 2011.
In January 2010, the Company recorded a gain relative to a $9 million cash settlement received from a lawsuit that was
originally filed by the Company in 2008 relating to disputed interests in certain oil and gas assets purchased in 2007. The gain
was reduced by approximately $0.8 million of costs incurred by the Company directly related to the settlement. In addition to the
cash proceeds received, the Company was assigned additional working interests in certain producing properties. The Company
recorded an additional $4.2 million non-cash gain representing the estimated fair market value of those interests on the effective
date of the settlement, which represents a non-cash investing activity for purposes of the Statement of Cash Flows.
A portion of the production that the Company operates in Oklahoma is committed to a firm transportation agreement.
Under the terms of the agreement, the Company must deliver 7.6 Bcf of natural gas during the period January 1 through October 31,
2013.
Lease Commitments
The Company has operating leases for office space and equipment, which expire on various dates through 2017. Future
minimum lease commitments as of December 31, 2012 under these operating leases are as follows (in thousands):
2013
2014
2015
2016
2017
Thereafter
$
$
1,211
1,032
1,026
988
898
—
5,155
Total rent expense under operating leases was approximately $1.4 million, $1.3 million and $1.1 million in 2012, 2011
and 2010, respectively.
F-20
Note 15—Oil and Gas Reserve Information—Unaudited
The Company’s net proved oil and gas reserves at December 31, 2012 have been estimated by independent petroleum
engineers in accordance with guidelines established by the SEC using a historical 12-month average pricing assumption.
The estimates of proved oil and gas reserves constitute those quantities of oil, gas,and natural gas liquids, which, by
analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible—from a
given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government
regulations—prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is
reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. However, there are
numerous uncertainties inherent in estimating quantities of proved reserves and in providing the future rates of production and
timing of development expenditures. The following reserve data represents estimates only and should not be construed as being
exact. In addition, the present values should not be construed as the current market value of the Company’s oil and gas properties
or the cost that would be incurred to obtain equivalent reserves.
During 2012, the Company’s estimated proved reserves decreased by 14%. This decrease was primarily due to production,
the sale of the Company's non-operated Arkansas assets and the significant decrease in the historical 12-month average price per
Mcf of natural gas used to calculate estimated proved reserves which was $2.20 per Mcf at December 31, 2012 as compared to
$3.34 per Mcf at December 31, 2011. This decrease was partially offset by the success of our Oklahoma,Texas and Gulf Coast
drilling programs. In total, the Company added approximately 27 Bcfe of proved reserves in Oklahoma, 9 Bcfe from the La
Cantera discovery and 28 Bcfe in the Carthage Field from horizontal drilling in the Cotton Valley during 2012. Overall, the
Company had a 98% drilling success rate during 2012 on 107 gross wells drilled.
F-21
The following table sets forth an analysis of the Company’s estimated quantities of net proved and proved developed oil
(including condensate), gas and natural gas liquid reserves, all located onshore and offshore the continental United States:
Oil
in
MBbls
NGL
in
MMcfe
Natural Gas
in
MMcf
Total
Reserves
in MMcfe
Proved reserves as of December 31, 2009
1,931
10,508
Revisions of previous estimates
Extensions, discoveries and other additions
Purchase of producing properties
Sale of reserves in place
Production
Proved reserves as of December 31, 2010
Revisions of previous estimates
Extensions, discoveries and other additions
Purchase of producing properties
Production
Proved reserves as of December 31, 2011
Revisions of previous estimates
Extensions, discoveries and other additions
Sale of reserves in place
Production
Proved reserves as of December 31, 2012
Proved developed reserves
As of December 31, 2010
187
168
—
—
(663)
1,623
(294)
595
43
(572)
1,395
215
647
(81)
(521)
1,655
187
150
—
—
(2,472)
8,373
308
8,627
91
(2,288)
15,111
(958)
14,572
—
(3,365)
25,360
156,853
20,958
47,681
2,336
(28,761)
(24,501)
174,566
8,418
82,113
1,292
(24,463)
241,926
(52,076)
46,390
(15,806)
(27,466)
192,968
178,947
22,267
48,839
2,336
(28,761)
(30,951)
192,677
6,962
94,310
1,641
(30,183)
265,407
(51,744)
64,844
(16,292)
(33,957)
228,258
1,474
6,078
110,599
125,521
As of December 31, 2011
1,160
11,071
143,441
161,472
As of December 31, 2012
1,225
20,608
140,307
168,265
Proved undeveloped reserves
As of December 31, 2010
As of December 31, 2011
As of December 31, 2012
149
235
430
2,295
63,967
67,156
4,040
98,485
103,935
4,752
52,661
59,993
F-22
The following tables (amounts in thousands) present the standardized measure of future net cash flows related to proved
oil and gas reserves together with changes therein, as defined by ASC Topic 932. Future production and development costs are
based on current costs with no escalations. Estimated future cash flows have been discounted to their present values based on a
10% annual discount rate.
Standardized Measure
Future cash flows
Future production costs
Future development costs
Future income taxes
Future net cash flows
10% annual discount
December 31,
2012
2011
2010
$
$
748,914
(220,750)
(121,346)
(10,205)
396,613
$
1,080,392
(264,219)
(180,846)
(86,612)
548,715
(164,218)
(244,834)
810,131
(223,175)
(144,451)
(41,156)
401,349
(164,974)
Standardized measure of discounted future net cash flows $
232,395
$
303,881
$
236,375
Changes in Standardized Measure
Standardized measure at beginning of year
Year Ended December 31,
2012
2011
2010
$
303,881
$
236,375
$
174,288
Sales and transfers of oil and gas produced, net of production costs
Changes in price, net of future production costs
Extensions and discoveries, net of future production and development costs
Changes in estimated future development costs, net of development costs
incurred during this period
Revisions of quantity estimates
Accretion of discount
Net change in income taxes
Purchase of reserves in place
Sale of reserves in place
Changes in production rates (timing) and other
Net increase (decrease) in standardized measure
Standardized measure at end of year
$
(92,562)
(138,842)
104,066
(116,398)
(10,219)
178,901
(117,572)
93,702
42,028
69,499
(56,352)
34,137
30,617
—
(8,186)
(13,863)
(71,486)
232,395
$
915
11,236
25,565
(18,215)
4,805
—
(9,084)
67,506
303,881
$
5,803
46,373
17,700
(16,568)
1,478
(798)
(10,059)
62,087
236,375
The historical twelve-month average prices of oil, gas and natural gas liquids used in determining standardized measure
were:
Oil, $/Bbl
Ngls, $/Mcfe
Natural Gas, $/Mcf
2012
2011
2010
$102.81
$101.42
6.07
2.20
8.62
3.34
$79.72
7.00
3.56
F-23
Note 16 - Summarized Quarterly Financial Information - Unaudited
Summarized quarterly financial information is as follows (amounts in thousands except per share data):
2012:
Revenues
Loss from operations (1)
Loss available to common stockholders (1)
Earnings per share:
Basic
Diluted
2011:
Revenues
Income (loss) from operations (2)
Net income (loss) available to common stockholders (2)
Earnings per share:
Basic
Diluted
$
$
$
$
$
$
Quarter Ended
March 31
June 30
September 30 December 31
36,041 $
(18,314)
(18,608)
33,413 $
(52,183)
(54,520)
33,951 $
(35,919)
(38,639)
38,186
(24,027)
(25,451)
(0.30) $
(0.30) $
(0.87) $
(0.87) $
(0.62) $
(0.62) $
(0.41)
(0.41)
41,603 $
3,178
1,897
41,975 $
(2,088)
(3,045)
4,749
3,727
39,029 $
38,093
0.03 $
0.03 $
(0.05) $
(0.05) $
0.06 $
0.06 $
2,899
2,830
0.04
0.04
(1) Loss from operations and net loss available to common stockholders reported during the three months ended March 31,
June 30, September 30 and December 31, 2012 included ceiling test write-downs of $20.1 million, $53.5 million, $35.4 million
and $28.1 million, respectively.
(2) Income (loss) from operations and net income (loss) available to common stockholders reported during the three months ended
March 31 and June 30, 2011 included ceiling test write-downs of $5.9 million and $13.0 million, respectively.
F-24
[THIS PAGE INTENTIONALLY LEFT BLANK]
Corporate Information
Board of Directors
Charles T. Goodson
Chairman of the Board,
Chief Executive Officer, and President
W.J. Gordon III *#^
Vice President of Strategic Planning,
Franciscan Missionaries of Our Lady Health System
Corporate Address
PetroQuest Energy, Inc.
400 East Kaliste Saloom Road, Suite 6000
Lafayette, Louisiana 70508
Telephone: (337) 232-7028
Fax: (337) 232-0044
Web: www.petroquest.com
Michael L. Finch *#^
Private Investments
Charles F. Mitchell II, M.D. *#^
Physician, Private Investments
E. Wayne Nordberg *#^
Hollow Brook Associates, LLC
William W. Rucks, IV *#^
Private Investments
* Member of the Compensation Committee
# Member of the Audit Committee
^ Member of the Nominating and
Corporate Governance Committee
Senior Management
Charles T. Goodson
Chairman of the Board,
Chief Executive Officer, and President
W. Todd Zehnder
Chief Operating Officer
Daniel G. Fournerat
Executive Vice President, General Counsel,
Chief Administrative Officer, and Secretary
J. Bond Clement
Executive Vice President,
Chief Financial Officer, and Treasurer
Art M. Mixon
Executive Vice President,
Operations and Production
Tracy Price
Executive Vice President,
Business Development & Land
Stephen H. Green
Senior Vice President,
Exploration
Mark K. Castell
Vice President - Oklahoma Assets
Edgar A. Anderson
Vice President - ArkLaTex
Exploration Offices
450 Gears Road, Suite 330
Houston, Texas 77067
Telephone: (713) 784-8300
Fax: (713) 784-8327
1717 S. Boulder, Suite 201
Tulsa, Oklahoma 74119
Telephone: (918) 582-2770
Fax: (918) 582-2778
Transfer Agent and Registrar
American Stock Transfer & Trust Company
59 Maiden Lane
New York, New York 10038
Telephone: (718) 921-8145
Independent Auditors
Ernst & Young LLP
New Orleans, Louisiana 70170
Legal Counsel
Porter & Hedges, LLP
Houston, Texas 77002
Onebane Law Firm
Lafayette, Louisiana 70502
Annual Meeting
The Company’s Annual Meeting of Stockholders
will be held at 9:00 A.M. CDT on May 21, 2013, at
the City Club at River Ranch at 221 Elysian Fields Dr.,
Lafayette, LA, 70508.
Form 10-K
Copies of the Company’s Annual Report on
Form 10-K may be obtained, without charge,
by writing to our Corporate Secretary at our
Corporate Address or on the Company’s website
at www.petroquest.com.
Common Stock Listing
Listed on NYSE as PQ
Table of Contents
Corporate Profile ....................................Inside Front Cover
Financial & Operational Highlights ......2
Letter to Stockholders ............................3
Areas of Operation ................................4
2012 Form 10-K .......................................After Page 8
Corporate Information ..........................Inside Back Cover
Corporate Profile
PetroQuest Energy, Inc. is an independent
energy company engaged in the exploration,
development, acquisition and production of oil
and natural gas reserves in Texas, the Arkoma
Basin, South Louisiana and the shallow waters of
the Gulf of Mexico.
Cover Photos - La Cantera production facilities and Broussard Estates #2 well at the La Cantera Field, Vermilion Parish, LA
2012 AnnuAl RepoRt
PeoPle.
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Perfo r m
400 East Kaliste Saloom Road, Suite 6000
Lafayette, Louisiana 70508
Telephone: (337) 232-7028
Fax: (337) 232-0044
PETROQUEST.COM