10-Q 1 qre-20120630x10q.htm 10-Q 5a3dc02ceba4427

 


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

 

 

 

 

 

þ

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

     For the quarterly period ended June 30, 2012

or

 

 

 

 

 

 

o

 

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: 001-35010

QR ENERGY, LP

(Exact name of registrant as specified in its charter)

 

 

 

 

 

 

 

 

 

Delaware

 

90-0613069

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

1401 McKinney Street, Suite 2400, Houston, Texas

 

77010

(Address of principal executive offices)

 

(Zip Code)

(Registrant’s telephone number, including area code): (713) 452-2200

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.   þ Yes o 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).   þ Yes o No

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Large accelerated filer

o

Accelerated filer

þ

Non-accelerated filer

o

Smaller reporting company

o

(Do not check if a smaller reporting company)

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

 

As of August 9, 2012, there were 16,666,667 Class C Preferred Units,  37,422,351 Common Units, 7,145,866 Subordinated Units and 41,747 General Partner Units outstanding.

 

 

 


 

TABLE OF CONTENTS

 

 

 

PART I - FINANCIAL INFORMATION

 

 

 

Item 1.

Financial Statements

4

 

Consolidated Balance Sheets as of June 30, 2012 (Unaudited) and December 31, 2011

4

 

Unaudited Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2012 and 2011

5

 

Unaudited Consolidated Statement of Changes in Partners' Capital for the Six Months Ended June 30, 2012

6

 

Unaudited Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011

7

 

Unaudited Notes to the Consolidated Financial Statements

8

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

24 

Item 3.

Quantitative and Qualitative Disclosure About Market Risk

36 

Item 4.

Controls and Procedures

36

 

 

 

PART II - OTHER INFORMATION

 

 

 

Item 1.

Legal Proceedings

37

Item 1A.

Risk Factors

37

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

37

Item 3.

Defaults Upon Senior Securities

37

Item 4.

Mine Safety Disclosure

38

Item 5.

Other Information

38

Item 6.

Exhibits

38

 

 

 

Signatures 

40 

 

 

 

 

1

 


 

CAUTIONARY STATEMENT ABOUT FORWARD–LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q contains forward-looking statements that are subject to a number of risks and uncertainties, many of which are beyond our control, which may include statements about our:

 

·

business strategies;

 

·

ability to replace the reserves we produce through drilling and property acquisitions;

 

·

drilling locations;

 

·

oil and natural gas reserves;

 

·

technology;

 

·

realized oil, natural gas and natural gas liquids (NGLs) prices;

 

·

production volumes;

 

·

lease operating expenses;

 

·

general and administrative expenses;

 

·

future operating results; and

 

·

plans, objectives, expectations and intentions.

 

All statements, other than statements of historical fact, concerning, among other things, planned capital expenditures, potential increases in oil and natural gas production, the number of anticipated wells to be drilled in the future, future cash flows and borrowings, pursuit of potential acquisition opportunities, our financial position, business strategy and other plans and objectives for future operations, are forward-looking statements. These forward-looking statements are identified by their use of terms and phrases such as “may,” “expect,” “estimate,” “project,” “plan,” “believe,” “intend,” “achievable,” “anticipate,” “will,” “continue,” “potential,” “should,” “could” and similar terms and phrases. Although we believe that the expectations reflected in these forward-looking statements are reasonable, they do involve certain assumptions, risks and uncertainties some of which are beyond our control. Actual results could differ materially from those anticipated in these forward-looking statements. One should consider carefully the statements under “Risk Factors” in this report and in our Annual Report on Form 10-K for the year ended December 31, 2011 or our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 and the other disclosures contained herein and therein, which describe known material factors that could cause our actual results to differ from those anticipated in the forward-looking statements, including, but not limited to, the following factors:

 

·

our ability to generate sufficient cash to pay the minimum quarterly distribution on our common units;

 

·

our substantial future capital requirements, which may be subject to limited availability of financing;

 

·

uncertainty inherent in estimating our reserves;

 

·

our need to make accretive acquisitions or substantial capital expenditures to maintain our declining asset base;

 

·

cash flows and liquidity;

 

·

potential shortages of drilling and production equipment;

 

·

potential difficulties in the marketing of, and volatility in the prices for, oil, natural gas and NGLs;

 

·

uncertainties surrounding the success of our secondary and tertiary recovery efforts;

 

2

 


 

·

competition in the oil and natural gas industry;

 

·

general economic conditions, globally and in the jurisdictions in which we operate;

 

·

legislation and governmental regulations, including climate change legislation and federal or state regulation of hydraulic fracturing;

 

·

the risk that our hedging strategy may be ineffective or may reduce our income;

 

·

the material weakness in our internal control over financial reporting;

 

·

actions of third party co-owners of interest in properties in which we also own an interest; and

 

·

risks related to potential acquisitions, including our ability to make acquisitions on favorable terms or to integrate acquired properties.

 

      The forward-looking statements contained in this report are largely based on our expectations, which reflect estimates and assumptions made by our management. These estimates and assumptions reflect our best judgment based on currently known market conditions and other factors. Although we believe such estimates and assumptions to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond our control. In addition, management’s assumptions about future events may prove to be inaccurate. All readers are cautioned that the forward-looking statements contained in this report are not guarantees of future performance, and we cannot assure any reader that such statements will be realized or that the forward-looking events and circumstances will occur. All forward-looking statements speak only as of the date of this report. We do not intend to update or revise any forward-looking statements as a result of new information, future events or otherwise. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf.

3

 


 

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

QR ENERGY, LP

CONSOLIDATED BALANCE SHEETS

(In thousands, except unit amounts)

 

 

 

 

 

 

June 30,

 

December 31,

 

 

2012

 

2011

 

 

 

(Unaudited)

 

 

 

ASSETS

Current assets:

 

 

 

 

 

 

Cash

 

$

22,529 

 

$

17,433 

Accounts receivable

 

 

36,955 

 

 

32,263 

Due from affiliates

 

 

332 

 

 

3,734 

Derivative instruments

 

 

61,281 

 

 

32,683 

Prepaid and other current assets

 

 

904 

 

 

249 

Total current assets

 

 

122,001 

 

 

86,362 

Noncurrent assets:

 

 

 

 

 

 

Oil and gas properties, using the full cost method of accounting

 

 

 

 

 

 

Evaluated

 

 

1,259,868 

 

 

975,182 

Unevaluated

 

 

9,000 

 

 

 -

Gross oil and natural gas properties

 

 

1,268,868 

 

 

975,182 

Gas processing equipment

 

 

2,552 

 

 

865 

Less accumulated depreciation, depletion, and amortization

 

 

(120,614)

 

 

(80,484)

Total property and equipment, net

 

 

1,150,806 

 

 

895,563 

Derivative instruments

 

 

115,797 

 

 

70,570 

Deferred taxes

 

 

 -

 

 

270 

Other assets

 

 

7,265 

 

 

4,279 

Total noncurrent assets

 

 

1,273,868 

 

 

970,682 

Total assets

 

$

1,395,869 

 

$

1,057,044 

 

 

 

 

 

 

 

LIABILITIES AND PARTNERS' CAPITAL

Current liabilities:

 

 

 

 

 

 

Current portion of asset retirement obligations

 

$

808 

 

$

348 

Derivative instruments

 

 

9,473 

 

 

9,569 

Accrued and other liabilities

 

 

58,162 

 

 

50,027 

Total current liabilities

 

 

68,443 

 

 

59,944 

Noncurrent liabilities:

 

 

 

 

 

 

Long-term debt

 

 

596,500 

 

 

500,000 

Derivative instruments

 

 

20,391 

 

 

16,906 

Asset retirement obligations

 

 

71,652 

 

 

65,353 

Other liabilities

 

 

6,724 

 

 

 -

Deferred taxes

 

 

320 

 

 

 -

Total noncurrent liabilities

 

 

695,587 

 

 

582,259 

Commitments and contingencies (see Note 11)

 

 

 

 

 

 

Partners' capital:

 

 

 

 

 

 

Class C convertible preferred unitholders (16,666,667 issued and outstanding

 

 

 

 

 

 

as of June 30, 2012 and December 31, 2011)

 

 

365,527 

 

 

358,138 

General partner (41,747 and 35,729 units issued and outstanding

 

 

 

 

 

 

as of June 30, 2012 and December 31, 2011)

 

 

672 

 

 

546 

Public common unitholders (37,422,351 and 17,292,279 units issued

 

 

 

 

 

 

and outstanding as of June 30, 2012 and December 31, 2011)

 

 

322,932 

 

 

241,306 

Affiliated common unitholders (0 and 11,297,737 units issued

 

 

 

 

 

 

and outstanding as of June 30, 2012 and December 31, 2011)

 

 

 -

 

 

(113,414)

Subordinated unitholders (7,145,866 units issued and outstanding

 

 

 

 

 

 

as of June 30, 2012 and December 31, 2011)

 

 

(57,292)

 

 

(71,735)

Total partners' capital

 

 

631,839 

 

 

414,841 

Total liabilities and partners' capital

 

$

1,395,869 

 

$

1,057,044 

 

 

 

 

 

 

 

See accompanying notes to the consolidated financial statements

 

 

 

 

 

4

 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

QR ENERGY, LP

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In thousands, except per unit amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

June 30, 2012

 

 

June 30, 2011

 

 

June 30, 2012

 

 

June 30, 2011

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Oil and natural gas sales

 

$

61,834 

 

$

67,327 

 

$

127,163 

 

$

129,680 

Processing and other

 

 

375 

 

 

553 

 

 

833 

 

 

1,031 

Total revenues

 

 

62,209 

 

 

67,880 

 

 

127,996 

 

 

130,711 

Operating Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

Production expenses

 

 

25,747 

 

 

21,238 

 

 

48,767 

 

 

41,036 

Depreciation, depletion and amortization

 

 

20,540 

 

 

19,421 

 

 

40,130 

 

 

38,330 

Accretion of asset retirement obligations

 

 

887 

 

 

666 

 

 

1,730 

 

 

1,314 

General and administrative

 

 

8,771 

 

 

7,690 

 

 

17,113 

 

 

14,239 

Acquisition and transaction costs

 

 

920 

 

 

 -

 

 

1,008 

 

 

 -

Total operating expenses

 

 

56,865 

 

 

49,015 

 

 

108,748 

 

 

94,919 

Operating income

 

 

5,344 

 

 

18,865 

 

 

19,248 

 

 

35,792 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

Realized gains (losses) on commodity derivative contracts

 

 

14,222 

 

 

(42,161)

 

 

22,293 

 

 

(40,852)

Unrealized gains on commodity derivative contracts

 

 

89,682 

 

 

68,460 

 

 

67,913 

 

 

6,855 

Interest expense, net

 

 

(9,393)

 

 

(15,820)

 

 

(16,865)

 

 

(19,211)

Total other income (expense), net

 

 

94,511 

 

 

10,479 

 

 

73,341 

 

 

(53,208)

Income (loss) before income taxes

 

 

99,855 

 

 

29,344 

 

 

92,589 

 

 

(17,416)

Income tax expense, net

 

 

(730)

 

 

(356)

 

 

(699)

 

 

(145)

Net income (loss)

 

$

99,125 

 

$

28,988 

 

$

91,890 

 

$

(17,561)

Net income (loss) per limited partner unit:

 

 

 

 

 

 

 

 

 

 

 

 

Common unitholders' (basic)

 

$

2.15 

 

$

0.44 

 

$

1.92 

 

$

(0.38)

Common unitholders' (diluted)

 

 

1.67 

 

 

0.44 

 

 

1.60 

 

 

(0.38)

Subordinated unitholders' (basic)

 

 

2.12 

 

 

0.44 

 

 

1.76 

 

 

(0.38)

Subordinated unitholders' (diluted)

 

 

1.65 

 

 

0.44 

 

 

1.50 

 

 

(0.38)

Weighted average number of limited partner units outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

Common units (basic)

 

 

36,114 

 

 

28,723 

 

 

32,486 

 

 

28,518 

Common units (diluted)

 

 

52,780 

 

 

28,723 

 

 

49,153 

 

 

28,518 

Subordinated units (basic and diluted)

 

 

7,146 

 

 

7,146 

 

 

7,146 

 

 

7,146 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to the consolidated financial statements

 

 

 

5

 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

QR ENERGY, LP

CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS' CAPITAL (UNAUDITED)

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Class C

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Convertible

 

 

 

 

 

Limited Partners

 

 

Total

 

 

 

Preferred

 

 

General

 

 

Public

 

 

Affiliated

 

 

Partners'

 

 

 

Unitholders

 

 

Partner

 

 

Common

 

 

Common

 

 

Subordinated

 

 

Capital

Balances - December 31, 2011

 

$

358,138 

 

$

546 

 

$

241,306 

 

$

(113,414)

 

$

(71,735)

 

$

414,841 

Contributions from the Predecessor

 

 

 -

 

 

 -

 

 

 -

 

 

4,985 

 

 

9,978 

 

 

14,963 

Proceeds from unit offering

 

 

 -

 

 

115 

 

 

162,080 

 

 

 -

 

 

 -

 

 

162,195 

Recognition of unit-based awards

 

 

 -

 

 

 -

 

 

768 

 

 

 -

 

 

 -

 

 

768 

Reduction in units to cover individuals' tax withholding

 

 

 -

 

 

 -

 

 

(21)

 

 

 -

 

 

 -

 

 

(21)

Distributions to unitholders

 

 

(7,000)

 

 

(40)

 

 

(36,496)

 

 

 -

 

 

(6,878)

 

 

(50,414)

Amortization of discount on increasing rate distributions

 

 

7,389 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

7,389 

Noncash distribution to preferred unitholders

 

 

(7,389)

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

(7,389)

Affiliated unit sale to public

 

 

 -

 

 

 -

 

 

(113,325)

 

 

113,325 

 

 

 -

 

 

 -

Management incentive fee earned

 

 

 -

 

 

(2,383)

 

 

 -

 

 

 -

 

 

 -

 

 

(2,383)

Net income

 

 

14,389 

 

 

2,434 

 

 

68,620 

 

 

(4,896)

 

 

11,343 

 

 

91,890 

Balances - June 30, 2012

 

$

365,527 

 

$

672 

 

$

322,932 

 

$

 -

 

$

(57,292)

 

$

631,839 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to consolidated financial statements

 

 

6

 


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

QR ENERGY, LP

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

June 30, 2012

 

 

June 30, 2011

Cash flows from operating activities:

 

 

 

 

 

 

Net income (loss)

 

$

91,890 

 

$

(17,561)

Adjustments to reconcile net income (loss) to net cash provided by

 

 

 

 

 

 

operating activities:

 

 

 

 

 

 

Depreciation, depletion and amortization

 

 

40,130 

 

 

38,330 

Accretion of asset retirement obligations

 

 

1,730 

 

 

1,314 

Recognition of unit-based awards

 

 

768 

 

 

624 

General and administrative expense contributed by affiliates

 

 

14,963 

 

 

13,916 

Unrealized (gains) losses on derivative contracts

 

 

(65,624)

 

 

3,192 

Deferred income tax benefit

 

 

590 

 

 

86 

Other items

 

 

1,461 

 

 

1,081 

Changes in operating assets and liabilities:

 

 

 

 

 

 

Accounts receivable and other assets

 

 

(3,566)

 

 

(23,269)

Accounts payable and other liabilities

 

 

2,713 

 

 

2,583 

Net cash provided by operating activities

 

 

85,055 

 

 

20,296 

Cash flows from investing activities:

 

 

 

 

 

 

Additions to oil and gas properties

 

 

(63,087)

 

 

(29,898)

Proceeds from the sale of oil and gas properties

 

 

240 

 

 

1,327 

Acquisitions

 

 

(225,118)

 

 

 -

Net cash used in investing activities

 

 

(287,965)

 

 

(28,571)

Cash flows from financing activities:

 

 

 

 

 

 

Proceeds from unit offering, net of offering costs

 

 

162,195 

 

 

41,963 

Distributions to the Fund

 

 

 -

 

 

(42,000)

Contributions from the General Partner

 

 

 -

 

 

715 

Management incentive fee to the General Partner

 

 

(1,730)

 

 

 -

Distributions to unitholders

 

 

(45,351)

 

 

(16,416)

Contributions from the Predecessor

 

 

 -

 

 

(18,816)

  Proceeds from bank borrowings

 

 

96,500 

 

 

41,000 

  Deferred financing costs

 

 

(3,608)

 

 

(214)

Net cash provided by financing activities

 

 

208,006 

 

 

6,232 

Increase (decrease) in cash

 

 

5,096 

 

 

(2,043)

Cash at beginning of period

 

 

17,433 

 

 

2,195 

Cash at end of period

 

$

22,529 

 

$

152 

 

 

 

 

 

 

 

See accompanying notes to the consolidated financial statements

 

 

 

7

 


 

QR Energy, LP

Notes to Consolidated Financial Statements (Unaudited)

 

Except as noted within the context of each footnote disclosure, the dollar amounts presented in the tabular data within these footnote disclosures are stated in thousands of dollars.

 

NOTE 1 – ORGANIZATION AND OPERATIONS

QR Energy, LP (“we,” “us,” “our,” or the “Partnership”) is a Delaware limited partnership formed on September 20, 2010, to receive certain assets of the affiliated entity, QA Holdings, LP (the “Predecessor”) and own other assets. Certain of the Predecessor’s subsidiaries (collectively known as the “Fund”) include Quantum Resources A1, LP, Quantum Resources B, LP, Quantum Resources C, LP, QAB Carried WI, LP, QAC Carried WI, LP and Black Diamond Resources, LLC. Quantum Resources Management, LLC (“QRM”) provides management and operational services for us and the Fund. Our general partner is QRE GP, LLC (or “QRE GP”). We conduct our operations through our wholly owned subsidiary QRE Operating, LLC (“OLLC”). Our wholly owned subsidiary, QRE Finance Corporation (“QRE FC”), has no material assets and was formed for the sole purpose of being a co-issuer of our debt securities.

We completed our initial public offering of 15,000,000 common units representing limited partner interests in the Partnership on December 22, 2010 (the “Closing Date”). On the Closing Date, a Contribution, Conveyance and Assumption Agreement (the “Contribution Agreement”) was executed by and among the Fund, the Partnership and QRE GP with net assets contributed by the Fund. In exchange for the net assets, the Fund received 11,297,737 common and 7,145,866 subordinated limited partner units. QRE GP made a capital contribution to the Partnership in exchange for 35,729 general partner units.  The underwriters exercised their over-allotment option in full for 2,250,000 common units issued by the Partnership. Net proceeds from the sale of these common units, after deducting offering costs, were approximately $42 million.

On October 3, 2011, the Fund contributed certain oil and gas properties (the “Transferred Properties”) pursuant to a purchase and sale agreement by and among the Fund, the Partnership and OLLC in exchange for 16,666,667 Class C Convertible Preferred Units (“Preferred Units”) and the assumption of $227 million in debt (the “Transaction”).  The fair value of the Preferred Units on October 1, 2011 was $21.27 per unit or $354.5 million with net assets of $252.0 million contributed to the Partnership by the Fund. The Transaction was accounted for as a transaction between entities under common control whereby the Transferred Properties were recorded at historical book value. As such, the value of the Preferred Units in excess of the net assets contributed by the Fund was deemed a $102.5 million distribution from the Partnership and allocated pro rata to the general partner and existing limited partners.  

On April 17, 2012, we issued 6,202,263 common units representing limited partnership interests in us, and the Fund sold 11,297,737 of its common units it held in us (the “Equity Offering”), to the public pursuant to a registration statement filed with the Securities and Exchange Commission (the “SEC”).  In conjunction with the Equity Offering, the Partnership granted the underwriters an over-allotment option for 30 days to purchase up to an additional 2,625,000 common units from the Partnership, which they exercised in full. The common units, including the units issued pursuant to the underwriters’ full exercise of their option, were issued by us or sold by the Fund at $19.18 per unit. Refer to Note 10 – Partners’ Capital for further details. Proceeds from the Equity Offering, net of transaction costs of $0.5 million and underwriter’s discount of $6.8 million, were approximately $162 million.

On April 20, 2012, we closed the acquisition of primarily oil properties from Prize Petroleum, LLC and Prize Petroleum Pipeline, LLC (“Prize”) for approximately $225 million in cash (the “Prize Acquisition”), with an effective date of January 1, 2012.  Refer to Note 3 – Acquisitions for further details.

On June 1, 2012, we filed a registration statement on Form S-3 with the SEC to register, among other securities, our debt securities, which may be co-issued by QRE FC. The registration statement also registered guarantees of debt securities by OLLC. Refer to Note 16 – Subsidiary Guarantors for details.

On July 30, 2012, we and our wholly-owned subsidiary QRE FC, issued $300 million of 9.25% Senior Notes (the “Senior Notes”) due 2020.  Refer to Note 9 – Long-Term Debt for further details.

 

8

 


 

      At June 30, 2012, our ownership structure comprised a 0.1% general partner interest held by QRE GP, a 38.8% limited partner interest held by the Fund, represented by all of our preferred and subordinated units, and a 61.1% limited partner interest held by the public unitholders.

 

NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States (“U.S. GAAP”) for complete annual financial statements. During interim periods, the Partnership follows the accounting policies disclosed in its Annual Report on Form 10-K for the year ended December 31, 2011 (“2011 Annual Report”), filed with the SEC. The unaudited consolidated financial statements for the three and the six months ended June 30, 2012 and 2011 include all adjustments we believe are necessary for a fair statement of the results for the interim periods. Prior period amounts have been revised to conform to current period presentation. Operating results for the three and six month period ended June 30, 2012 are not necessarily indicative of the results that may be expected for the full year ended December 31, 2012. These unaudited consolidated financial statements and other information included in this Quarterly Report should be read in conjunction with our consolidated financial statements and notes thereto included in our 2011 Annual Report.

The Partnership’s historical financial statements previously filed with the SEC have been revised in this quarterly report on Form 10-Q to include the results attributable to the Transferred Properties as if the Partnership owned such assets for all periods presented by the Partnership including the period from January 1, 2011 to June 30, 2011 as the Transaction was between entities under common control. The consolidated financial statements for periods prior to the Partnership’s acquisition of the Transferred Properties have been prepared from the Predecessor’s historical cost-basis accounts and may not necessarily be indicative of the actual results of operations that would have occurred if the Partnership had owned the assets during the periods reported. See our accounting policy for transactions between entities under common control set forth in Note 2 of the Notes to Consolidated Financial Statements in our 2011 Annual Report.

Accounting Policy Updates/Revisions

The accounting policies followed by the Partnership are set forth in Note 2 – Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements in our 2011 Annual Report. There have been no significant changes to these policies during the three months ended June 30, 2012 with the exception to the updates below.

Unevaluated Properties

In conjunction with the Prize Acquisition, we acquired unevaluated properties which are not being depleted pending determination of the existence of proved reserves.  Unevaluated properties are assessed periodically to ascertain whether there is a probability of obtaining proved reserves in the future.  When it is determined that these properties have been promoted to a proved reserve category or there is no longer any probability of obtaining proved reserves from the properties, the costs associated with these properties are transferred into the amortization base to be included in the depletion calculation. Unevaluated properties whose costs are individually significant are assessed individually by considering the primary lease terms of the properties, the holding period of the properties, and geographic and geological data obtained relating to the properties.  Where it is not practical to assess properties individually as their costs are not individually significant, such properties are grouped for purposes of the periodic assessment.

Business Combinations 

We account for all business combinations using the purchase method, in accordance with U.S. GAAP. Under the purchase method of accounting, a business combination is accounted for at the purchase price based upon the fair value of the consideration given, whether in the form of cash, assets, equity or the assumption of liabilities. The assets and liabilities acquired are measured at their fair values. The difference between the fair value of assets

9

 


 

acquired and liabilities assumed over the cost of the entity, if any, is recorded as either goodwill or a bargain purchase gain. The Partnership has not recognized any goodwill from business combinations.

Recent Accounting Pronouncements

In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (ASU 2011-04). The amendments in ASU 2011-04 are the result of the FASB's and the International Accounting Standards Board's (“IASB”) work to develop common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and the International Financial Reporting Standards (“IFRS”). ASU 2011-04 explains how to measure fair value and changes the wording used to describe many of the fair value requirements in GAAP, but does not require additional fair value measurements. This guidance becomes effective for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. This amendment was adopted by us on January 1, 2012 and did not have a material impact on our financial position, results of operations or cash flows.

 

In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities (ASU 2011-11).  The objective of this update is to provide enhanced disclosures that will enable the users of its financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position.  The amendment will require entities to disclose both gross information and net information about instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement.  This scope would include financial and derivative instruments that either offset in accordance with U.S. GAAP or are subject to an enforceable master netting arrangement or similar agreement, irrespective of whether they are offset in accordance with U.S. GAAP.  This amendment becomes effective for annual reporting periods beginning on or after January 1, 2013, and the interim periods within those annual periods.  We are evaluating the potential impacts this ASU will have on our disclosures.

 

NOTE 3 – ACQUISITIONS

 

Prize Properties

 

On April 20, 2012 we closed the Prize Acquisition. We acquired predominantly low decline, long life oil properties, almost all of which are located in the Ark-La-Tex area, for $225 million in cash after customary purchase price adjustments. The acquired properties had estimated proved reserves as of December 31, 2011 utilizing SEC prices of 13.3 MMBoe. The acquisition had an effective date of January 1, 2012.

The Prize Acquisition qualified as a business combination and was accounted for under the acquisition method of accounting.  Effective April 20, 2012 the results of operations of the acquired Prize assets are included in our unaudited statement of operations for the three and six months ended June 30, 2012. Accordingly, we recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values. The fair value measurements of the oil and gas properties and asset retirement obligations were measured using valuation techniques and inputs that convert future cash flows to a single discounted amount.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed as of the acquisition closing date (in thousands):

 

 

 

 

 

 

 

 

Oil and gas properties

 

 

 

Evaluated

 

$

223,740 

Unevaluated

 

 

9,000 

Asset retirement obligation

 

 

(4,738)

Environmental liability

 

 

(1,891)

Other current liabilities

 

 

(993)

Net assets acquired

 

$

225,118 

 

 

 

 

 

The above estimated fair values of assets acquired and liabilities assumed are provisional and are based on the information that was available as of the acquisition date to estimate the fair value of assets acquired and liabilities assumed. We believe that the information provides a reasonable basis for estimating the fair values of assets acquired and liabilities assumed. We expect to finalize the valuation and complete the purchase price allocation as soon as practicable but no later than one year from the acquisition date.

10

 


 

 

Costs associated with the acquisition of Prize totaled $0.6 million of which are recorded in the acquisition and transaction costs caption of the consolidated statement of operations for the three and six months ended June 30, 2012. In conjunction with the Prize Acquisition, we assumed an estimated environmental liability of $1.9 million. Refer to Note 11 – Commitments And Contingencies for further details.

 

Since the closing date, revenues of $6.5 million and operating expenses of $2.7 million related to the operation of the Prize properties are included in the three and six months ended consolidated results of operations. The following unaudited consolidated income statement information provides unaudited pro forma consolidated income statement information for the three and six months ended June 30, 2012 and unaudited pro forma consolidated income statement information for the three and six months ended June 30, 2011, which assumes the acquisition of Prize had occurred on January 1, 2011. The unaudited pro forma results reflect certain adjustments related to the acquisition, such as increased depreciation and amortization expense on the assets acquired from Prize resulting from the fair value of assets acquired. The unaudited pro forma financial results may not be indicative of the results that would have occurred had the acquisition been completed at the beginning the periods presented, nor are they indicative of future results of operations.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

(Unaudited)

 

 

(Unaudited)

 

 

 

June 30, 2012

 

 

June 30, 2011

 

 

June 30, 2012

 

 

June 30, 2011

 

 

 

Pro Forma

 

 

Pro Forma

 

 

Pro Forma

 

 

Pro Forma

Total Revenue

 

$

64,258 

 

$

77,285 

 

$

140,112 

 

$

148,758 

Operating Income

 

$

6,220 

 

$

23,586 

 

$

24,749 

 

$

44,057 

Net income (loss)

 

$

99,929 

 

$

33,380 

 

$

96,990 

 

$

(9,954)

Net income (loss) per unit:

 

 

 

 

 

 

 

 

 

 

 

 

Common unitholders' (basic)

 

$

2.16 

 

 

0.45 

 

 

2.05 

 

 

(0.13)

Common unitholders' (diluted)

 

$

1.68 

 

 

0.45 

 

 

1.69 

 

 

(0.13)

Subordinated units (basic)

 

$

2.14 

 

 

0.45 

 

 

1.88 

 

 

(0.13)

Subordinated units (diluted)

 

$

1.67 

 

 

0.45 

 

 

1.62 

 

 

(0.13)

 

 

 

 

 

 

 

NOTE 4 – FAIR VALUE MEASURMENTS

 

Our financial instruments, including cash, accounts receivable and accounts payable, are carried at cost, which approximates fair value due to the short-term maturity of these instruments. Our financial and non-financial assets and liabilities that are being measured on a recurring basis are measured and reported at fair value.

 

Fair value is defined 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 (exit price). U.S. GAAP establishes a three-tier fair value hierarchy, which prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of fair value hierarchy are as follows:

 

Level 1 – Defined as inputs such as unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 – Defined as inputs other than quoted prices in active markets that are either directly or indirectly observable for the asset or liability.

Level 3 – Defined as unobservable inputs for use when little or no market data exists, therefore requires an entity to develop its own assumptions for the asset or liability.

 

Commodity Derivative Instruments — The fair value of the commodity derivative instruments is estimated using a combined income and market valuation methodology based upon observable forward commodity price and volatility curves. The curves are obtained from independent pricing services. We validate the data provided by independent pricing services by comparing such pricing against other third party pricing data.

 

Interest Rate Derivative Instruments — The fair value of the interest rate derivative instruments is estimated using a combined income and market valuation methodology based upon observable forward interest rates and volatility curves. The curves are obtained from independent pricing services. We validate the data provided by independent pricing services by comparing such pricing against other third party pricing data.

11

 


 

 

Long-Term Debt — The fair value of our long term debt depends primarily on the current active market LIBOR. The carrying value of our long term debt as of June 30, 2012 approximates fair value based on the current LIBOR and is classified as a Level 2 input in the fair value hierarchy.

 

Derivative Premiums – The fair value of the deferred premiums on our commodity derivatives is based on the current active market LIBOR.  The carrying value of the premiums as of June 30, 2012 approximates fair value based on the current LIBOR and is classified as a Level 2 input in the fair value hierarchy.  Refer to Note 5 – Derivative Activities for further information on the derivative premiums.

 

We utilize the most observable inputs available for the valuation technique utilized. The financial assets and liabilities are classified in their entirety based on the lowest level of input that is of significance to the fair value measurement. The following table sets forth, by level within the hierarchy, the fair value of our financial assets and liabilities that were accounted for at fair value on a recurring basis as of June 30, 2012 and December 31, 2011.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2012

 

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

Assets from commodity derivative instruments

 

$

177,078 

 

$

 -

 

$

177,078 

 

$

 -

 

 

$

177,078 

 

$

 -

 

$

177,078 

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities from commodity derivative instruments

 

$

3,622 

 

$

 -

 

$

3,622 

 

$

 -

Liabilities from interest rate derivative instruments

 

 

26,242 

 

 

 -

 

 

26,242 

 

 

 -

 

 

$

29,864 

 

$

 -

 

$

29,864 

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2011

 

 

Total

 

 

Level 1

 

 

Level 2

 

 

Level 3

Assets from commodity derivative instruments

 

$

103,233 

 

$

 -

 

$

103,233 

 

$

 -

Assets from interest rate derivative instruments

 

 

20 

 

 

 -

 

 

20 

 

 

 -

 

 

$

103,253 

 

$

 -

 

$

103,253 

 

$

 -

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities from commodity derivative instruments

 

$

2,502 

 

$

 -

 

$

2,502 

 

$

 -

Liabilities from interest rate derivative instruments

 

 

23,973 

 

 

 -

 

 

23,973 

 

 

 -

 

 

$

26,475 

 

$

 -

 

$

26,475 

 

$

 -

 

There have been no transfers between levels within the fair value measurement hierarchy during the six months ended June 30, 2012.

 

NOTE 5 – DERIVATIVE ACTIVITIES

 

We have elected not to designate any of our derivatives as hedging instruments. As a result, these derivative instruments are marked to market at the end of each reporting period, and changes in the fair value of the derivatives are recorded as gains or losses in the consolidated statements of operations.

 

Although we have the ability to elect to enter into netting agreements under our derivative instruments with certain of our counterparties, we have presented all asset and liability positions without netting. It is our policy to enter into derivative contracts, including interest rate swaps, only with counterparties that are creditworthy financial institutions deemed by management as competent and competitive market makers.  We do not post collateral under any of these contracts as they are secured under our credit facility.

 

Commodity Derivatives

 

Our business activities expose us to risks associated with changes in the market price of oil, natural gas and natural gas liquids. As such, future earnings are subject to fluctuations due to changes in the market price of oil and natural gas. We use derivatives to reduce our exposure to changes in the prices of oil and natural gas. Our policies do not permit the use of derivatives for speculative purposes.

 

During the six months ended June 30, 2012, we entered into new oil swap contracts with settlement dates ranging from 2012 through 2017, natural gas put contracts, with deferred premiums, and swap contracts with settlement dates ranging from 2015 through 2017.  All of the new contracts were entered into with the same counterparties as our existing contracts.

12

 


 

 

The deferred premiums associated with certain of our oil and natural gas derivative instruments are  $4.8 million and are classified as other non-current liabilities on the consolidated balance sheet at June 30, 2012.  There were no deferred derivative contract premiums at December 31, 2011. These deferred premiums will be paid to the counterparty with each monthly settlement (January 2015 – December 2017)  and recognized as an adjustment of realized gain (loss) on derivative instruments. 

 

We hold commodity derivative contracts to manage our exposure to changes in the price of oil and natural gas related to our oil and natural gas production.  As of June 30, 2012, the notional volumes of our commodity derivative contracts were:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity

 

 

Index

 

 

Jul 1 - Dec 31, 2012

 

 

2013

 

 

2014

 

 

2015

 

 

2016

 

 

2017

Oil positions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Swaps

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedged Volume (Bbls/d)

 

 

WTI

 

 

5,872 

 

 

6,543 

 

 

5,661 

 

 

4,540 

 

 

2,480 

 

 

3,730 

Average price ($/Bbls)

 

 

 

 

$

100.34 

 

$

99.75 

 

$

97.91 

 

$

96.87 

 

$

92.07 

 

$

87.57 

Collars

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedged Volume (Bbls/d)

 

 

WTI

 

 

 

 

 

 

 

 

425 

 

 

1,025 

 

 

1,500 

 

 

 

Average floor price ($/Bbls)

 

 

 

 

 

 

 

 

 

 

$

90.00 

 

$

90.00 

 

$

80.00 

 

 

 

Average ceiling price ($/Bbls)

 

 

 

 

 

 

 

 

 

 

$

106.50 

 

$

110.00 

 

$

102.00 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Natural gas positions:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Swaps

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedged Volume (MMBtu/d)

 

 

Henry Hub

 

 

30,267 

 

 

29,674 

 

 

25,907 

 

 

6,520 

 

 

11,350 

 

 

10,445 

Average price ($/MMBtu)

 

 

 

 

$

5.83 

 

$

6.07 

 

$

6.23 

 

$

5.43 

 

$

4.27 

 

 

4.47 

Basis Swaps

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedged Volume (MMBtu/d)

 

 

Henry Hub

 

 

20,709 

 

 

18,466 

 

 

17,066 

 

 

14,400 

 

 

 

 

 

 

Average price ($/MMBtu)

 

 

 

 

$

(0.15)

 

$

(0.17)

 

$

(0.19)

 

$

(0.19)

 

 

 

 

 

 

Collars

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedged Volume (MMBtu/d)

 

 

Henry Hub

 

 

2,609 

 

 

2,466 

 

 

4,966 

 

 

18,000 

 

 

 

 

 

 

Average floor price ($/MMBtu)

 

 

 

 

$

6.50 

 

$

6.50 

 

$

5.74 

 

$

5.00 

 

 

 

 

 

 

Average ceiling price ($/MMBtu)

 

 

 

 

$

8.60 

 

$

8.65 

 

$

7.51 

 

$

7.48 

 

 

 

 

 

 

Puts

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Hedged Volume (MMBtu/d)

 

 

Henry Hub

 

 

 

 

 

 

 

 

 

 

 

420 

 

 

11,350 

 

 

10,445 

Average price ($/MMBtu)

 

 

 

 

 

 

 

 

 

 

 

 

 

$

4.00 

 

$

4.00 

 

$

4.00 

 

Interest Rate Derivatives

 

In an effort to mitigate exposure to changes in market interest rates, we have entered into interest rate swaps that effectively fix the LIBOR component on our outstanding variable rate debt.  The changes in the fair value of these instruments are recorded in current earnings.

 

The fair value of our derivatives was as follows as of the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2012

 

 

December 31, 2011

 

 

 

Asset

 

 

Liability

 

 

Asset

 

 

Liability

 

 

 

Derivatives

 

 

Derivatives

 

 

Derivatives

 

 

Derivatives

Commodity contracts

 

$

177,078 

 

$

3,622 

 

$

103,233 

 

$

2,502 

Interest rate contracts

 

 

 -

 

 

26,242 

 

 

20 

 

 

23,973 

 

 

$

177,078 

 

$

29,864 

 

$

103,253 

 

$

26,475 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commodity

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

$

61,281 

 

$

630 

 

$

32,683 

 

$

1,284 

Noncurrent

 

 

115,797 

 

 

2,992 

 

 

70,550 

 

 

1,218 

 

 

$

177,078 

 

$

3,622 

 

$

103,233 

 

$

2,502 

Interest

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

$

 -

 

$

8,843 

 

$

 -

 

$

8,285 

Noncurrent

 

 

 -

 

 

17,399 

 

 

20 

 

 

15,688 

 

 

$

 -

 

$

26,242 

 

$

20 

 

$

23,973 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Derivatives

 

 

 

 

 

 

 

 

 

 

 

 

Current

 

$

61,281 

 

$

9,473 

 

$

32,683 

 

$

9,569 

Noncurrent

 

 

115,797 

 

 

20,391 

 

 

70,570 

 

 

16,906 

 

 

$

177,078 

 

$

29,864 

 

$

103,253 

 

$

26,475 

13

 


 

 

 

The following table presents the impact of derivatives and their location within our unaudited consolidated statements of operations for the three and six months ended June 30, 2012 and June 30, 2011:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

June 30, 2012

 

 

June 30, 2011

 

 

June 30, 2012

 

 

June 30, 2011

Realized gains (losses):

 

 

 

 

 

 

 

 

 

 

 

 

Commodity contracts (1)

 

$

14,222 

 

$

(42,161)

 

$

22,293 

 

$

(40,852)

Interest rate swaps (2)

 

 

(2,326)

 

 

(948)

 

 

(4,629)

 

 

(1,262)

Total

 

$

11,896 

 

$

(43,109)

 

$

17,664 

 

$

(42,114)

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains (losses):

 

 

 

 

 

 

 

 

 

 

 

 

Commodity contracts (1)

 

$

89,682 

 

$

68,460 

 

$

67,913 

 

$

6,855 

Interest rate swaps (2)

 

 

(2,703)

 

 

(10,905)

 

 

(2,289)

 

 

(10,047)

Total

 

$

86,979 

 

$

57,555 

 

$

65,624 

 

$

(3,192)

 

 

 

 

 

 

 

 

 

 

 

 

 

Total gains (losses):

 

 

 

 

 

 

 

 

 

 

 

 

Commodity contracts (1)

 

$

103,904 

 

$

26,299 

 

$

90,206 

 

$

(33,997)

Interest rate swaps (2)

 

 

(5,029)

 

 

(11,853)

 

 

(6,918)

 

 

(11,309)

Total

 

$

98,875 

 

$

14,446 

 

$

83,288 

 

$

(45,306)

 

(1) Gain (loss) on commodity derivative contracts is located in other income (expense) in the consolidated statement of operations.

(2) Gain (loss) on interest rate derivatives contracts is recorded as part of interest expense and is located in other income (expense) in the consolidated statement of operations.

 

 

NOTE 6 – INCOME TAXES

 

We do not pay federal income taxes as its profits or losses are reported to the taxing authorities by the individual partners.

 

We pay Texas Margin Tax. We recorded a deferred tax asset of $0.3 million and $0.3 million related to its operations located in Texas as of June 30, 2012 and December 31, 2011 and a deferred tax liability of $0.6 million and less than $0.1 million as of June 30, 2012 and December 31, 2011. The deferred tax asset and deferred tax liability are presented net as a deferred tax liability of $0.3 million on the consolidated balance sheet as of June 30, 2012 and deferred tax asset of $0.3 million on the consolidated balance sheet as of December 31, 2011. Our provision for income taxes was a net expense of $0.7 million and $0.7 million for the three and six months ended June 30, 2012 and a net expense of $0.4 million and $0.1 million for the three and six months ended June 30, 2011.

 

NOTE 7 – ASSET RETIREMENT OBLIGATIONS

 

We record the asset retirement obligation (“ARO”) liability on our unaudited consolidated balance sheet and capitalize the cost in the “Oil and gas properties, using the full cost method of accounting” balance sheet caption during the period in which the obligation is incurred. We record the accretion of our ARO liabilities in “Accretion of asset retirement obligations” expense in our unaudited consolidated statements of operations. Payments to settle asset retirement obligations occur over the lives of the oil and gas properties. Revisions during the reporting period were due to changes in cost estimates for wells currently being retired.

 

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Changes in our asset retirement obligations for the six months ended June 30, 2012 are presented in the following table:

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended

 

 

 

June 30, 2012

Beginning of period

 

$

65,701 

Assumed in acquisition

 

 

4,738 

Divested

 

 

(23)

Revisions to previous estimates

 

 

1,223 

Liabilities incurred

 

 

 -

Liabilities settled

 

 

(909)

Accretion expense

 

 

1,730 

End of period

 

$

72,460 

Less: Current portion of asset retirement obligations

 

 

(808)

Asset retirement obligations - non-current

 

$

71,652 

 

 

 

 

 

 

NOTE 8 – ACCRUED AND OTHER LIABILITIES

 

As of June 30, 2012 and December 31, 2011, we had the following accrued and other liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2012

 

 

December 31, 2011

Distributions payable

 

$

25,587 

 

$

20,545 

Accrued capital spending

 

 

8,177 

 

 

9,591 

Production expense accrual

 

 

16,885 

 

 

12,872 

Other

 

 

7,513 

 

 

7,019 

 

 

$

58,162 

 

$

50,027 

 

 

 

NOTE 9 – LONG-TERM DEBT

 

Revolving Credit Facility

 

On December 22, 2010, the Partnership entered into a Credit Agreement along with QRE GP, OLLC as Borrower, and a syndicate of banks (the “Credit Agreement”).

We entered into a Second Amendment to the Credit Agreement on March 16, 2012 to provide for additional derivative contracts to cover production to proved reserves to be acquired, as discussed below.

In April 2012, we entered into the Third Amendment to the Credit Agreement whereby increasing our credit facility from $750 million to $1.5 billion, increasing our borrowing base from $630 million to $730 million, and the maturity date was extended from December 22, 2015 to April 20, 2017. The Third Amendment became effective upon the closing of the Prize Acquisition.

 

As of June 30, 2012, we had $596.5 million of borrowings outstanding and $0.5 million of letters of credit outstanding resulting in $133.0 million of borrowing availability. As of December 31, 2011, we had $500.0 million of borrowings and $0.4 million letters of credit outstanding resulting in $129.6 million of borrowing availability. Under the Credit Agreement we are required to reduce our borrowing base by an amount equal to 0.25 multiplied by the stated principal amount of any issuances of senior notes. As a result of the issuance of the Senior Notes on July 30, 2012, our borrowing base was reduced by $75 million to $655 million from $730 million. On July 30, 2012, we made a payment on our outstanding borrowings under our revolving credit facility of $291.5 million using the cash proceeds from the Senior Notes issuance and cash on hand. In addition, on August 3, 2012, we borrowed an additional $20.0 million from our revolving credit facility. As of August 9, 2012 we had $325.0 million of borrowings outstanding under our revolving credit facility and $329.5 million of borrowing availability.

 

As of June 30, 2012, the Credit Agreement provides for a five-year, $1.5 billion revolving credit facility maturing on April 20, 2017, with a borrowing base of approximately $730 million as of June 30, 2012. The

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borrowing base is subject to redetermination on a semi-annual basis as of May 1 and November 1 of each year and is subject to a number of factors including quantities of proved oil and natural gas reserves, the banks’ price assumptions, and other various factors unique to each member bank. Borrowings under the Credit Agreement are collateralized by liens on at least 80% of our oil and natural gas properties and all of our equity interests in OLLC and any future guarantor subsidiaries. Borrowings bear interest at our option of either (i) the greater of the prime rate of Wells Fargo Bank, National Association, the federal funds effective rate plus 0.50%, or the one-month adjusted LIBOR plus 1.0%, all of which would be subject to a margin that varies from 0.50% to 1.50% per annum according to the borrowing base usage (which is the ratio of outstanding borrowings and letters of credit to the borrowing base then in effect), or (ii) the applicable LIBOR plus a margin that varies from 1.50% to 2.50% per annum according to the borrowing base usage. The unused portion of the borrowing base is subject to a commitment fee that varies from 0.375% to 0.50% per annum.

The Credit Agreement requires us to maintain a ratio of total debt to EBITDAX (as such term is defined in the Credit Agreement) of not more than 4.0 to 1.0 and a current ratio (as such term is defined in the Credit Agreement) of not less than 1.0 to 1.0. Additionally, the Credit Agreement contains various covenants and restrictive provisions which limit our ability to incur additional debt, guarantees or liens; consolidate, merge or transfer all or substantially all of our assets; make certain investments, acquisitions or other restricted payments; modify certain material agreements; engage in certain types of transactions with affiliates; dispose of assets; prepay certain indebtedness; and also requires us to provide audited financial statements within 90 days of year end and quarterly unaudited financial statements within 45 days of quarter end. The Credit Agreement also prohibits us from entering into commodity derivative contracts covering, in any given year, in excess of the greater of (i) 90% of our forecasted production attributable to proved developed producing reserves and reserves to be acquired and (ii) 85% of our forecasted production for the next two years from total proved reserves and total proved reserves to be acquired and 75% of our forecasted production from total proved reserves and total proved reserves to be acquired thereafter, in each case, based upon production estimates in the most recent reserve report. If we fail to perform our obligations under these and other covenants, the revolving credit commitments may be terminated and any outstanding indebtedness under the Credit Agreement, together with accrued interest, could be declared immediately due and payable. As of June 30, 2012, we were in compliance with all of the Credit Agreement covenants.

 

Bridge Loan Commitment

 

In conjunction with the Prize Acquisition, we entered into a secured commitment (the “Bridge Loan Commitment”) to provide an additional $200 million of bank loans to fund the acquisition as needed. We did not utilize any borrowings under the commitment and as of May 10, 2012 the Bridge Loan Commitment was terminated by us. We incurred $1.6 million of commitment fees related to the Bridge Loan Commitment which is recorded in interest expense for the six months ended June 30, 2012.

 

9.25% Senior Notes

 

On July 30, 2012, we and our wholly-owned subsidiary QRE FC, issued $300 million of 9.25% Senior Notes, due 2020. The Senior Notes were issued at 98.62% of par. We received approximately $291.2 million of cash proceeds, net of the underwriting discount, with total net proceeds of $290.7 million, after $0.5 million of estimated offering costs. We will have the option to redeem the notes, in whole or in part, at any time on or after August 1, 2016, at the specified redemption prices together with any accrued and unpaid interest to the date of redemption, except as otherwise described below.  Prior to August 1, 2016, we may redeem all or any part of the notes at the “make-whole” redemption price. In addition, prior to August 1, 2015, we may at our option, redeem up to 35% of the aggregate principal amount of the notes at the redemption price with the net proceeds of a public or private equity offering. We used the cash proceeds from the Senior Note issuance to reduce indebtedness outstanding under our revolving credit facility. Our and QRE FC’s obligations under the Senior Notes are guaranteed by OLLC. In the future, the guarantees may be released or terminated under the following circumstances: (i) in connection with any sale or other disposition of all or substantially all of the properties of the guarantor; (ii) in connection with any sale or other disposition of sufficient capital stock of the guarantor so that it no longer qualifies as our Restricted Subsidiary (as defined in the indenture); (iii) if designated to be an unrestricted subsidiary; (iv) upon legal defeasance, covenant defeasance or satisfaction and discharge of the indenture; (v) upon the liquidation of the guarantor provided no default or event of default has occurred or is occurring; (vi) at such time the guarantor does not have outstanding guarantees of our, or any other guarantor’s, other, debt; or (vii) upon merging into, or transferring all of its properties to us or another guarantor and ceasing to exist. Refer to Note 16 – Subsidiary Guarantors for further details of our guarantors.

 

The indenture governing the Senior Notes (the “Indenture”) restricts our ability and the ability of certain of our subsidiaries to: (i) incur additional debt or enter into sale and leaseback transactions; (ii) pay distributions on, or

16

 


 

repurchase, equity interests; (iii) make certain investments; (iv) incur liens; (v) enter into transactions with affiliates; (vi) merge or consolidate with another company; and (vii) transfer and sell assets. These covenants are subject to a number of important exceptions and qualifications. If at any time when the Senior Notes are rated investment grade by each of Moody’s Investors Service, Inc. and Standard & Poor’s Ratings Services and no Default (as defined in the Indenture) has occurred and is continuing, many of such covenants will terminate and the Partnership and its subsidiaries will cease to be subject to such covenants.  The Indenture also includes customary events of default.

 

Registration Rights Agreement

 

In connection with the Senior Notes issuance we entered into a registration rights agreement with the holders of the Senior Notes that obligates us and QRE FC, as co-issuers, and OLLC, as guarantor, to complete an exchange offer of the Senior Notes for notes that are registered with the SEC within 365 days after the issuance of the Senior Notes, or we will incur additional interest on the Senior Notes. The terms of any new notes issued in connection with an exchange offer will be identical to the terms of the Senior Notes, except that the new notes will be registered under the Securities Act and will not contain restrictions on transfer, registration rights or provisions for additional interest.

 

NOTE 10 — PARTNERS’ CAPITAL

 

Units Outstanding

 

The table below details the units outstanding as of June 30, 2012 and December 31, 2011, and the changes in outstanding units for the six months ended June 30, 2012.  As of June 30, 2012, the Fund owns all preferred units and all subordinated units.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred Units

 

 

General Partner

 

 

Public Common

 

 

Affiliated Common

 

 

Subordinated

Balance - December 31, 2011

 

 

16,666,667 

 

 

35,729 

 

 

17,292,279 

 

 

11,297,737 

 

 

7,145,866 

Vested units awarded under our Long Term Incentive

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Performance Plan

 

 

 -

 

 

 -

 

 

5,990 

 

 

 -

 

 

 -

Reduction in units to cover individuals' tax withholdings

 

 

 -

 

 

 -

 

 

(918)

 

 

 -

 

 

 -

Issuance of units to General Partner

 

 

 -

 

 

6,018 

 

 

 -

 

 

 -

 

 

 -

Affiliated unit sale to the public

 

 

 -

 

 

 -

 

 

11,297,737 

 

 

(11,297,737)

 

 

 -

Unit offering

 

 

 -

 

 

 -

 

 

8,827,263 

 

 

 -

 

 

 -

Balance - June 30, 2012

 

 

16,666,667 

 

 

41,747 

 

 

37,422,351 

 

 

 -

 

 

7,145,866 

 

On April 17, 2012, we issued 6,202,263 common units representing limited partnership interests in us, and the Fund sold 11,297,737 of its common units it held in us to the public pursuant to a registration statement filed with the SEC.  In conjunction with the Equity Offering, the Partnership granted the underwriters an over-allotment option for 30 days to purchase up to an additional 2,625,000 common units from the Partnership, which they exercised in full. The common units, including the units issued pursuant to the underwriters’ full exercise of their option, were issued by us or sold by the Fund at $19.18 per unit. Proceeds from the Equity Offering, net of transaction costs of $0.5 million and underwriter’s discount of $6.8 million, were approximately $162 million.

 

On April 25, 2012, QRE GP purchased 6,018 general partner units in order to maintain their 0.1% ownership percentage in us. The units were purchased at a price of $19.18 per unit.

 

On June 1, 2012, we filed a registration statement on Form S-3 with the SEC to register, among other securities, our debt securities, which may be co-issued by QRE FC. The registration statement also registered guarantees of debt securities by OLLC. Refer to Note 16 – Subsidiary Guarantors for details

 

Allocations of Net Income (Loss)

 

Net income (loss) is allocated to the preferred unitholders to the extent distributions are made or accrued to them during the period with the remaining income being allocated between QRE GP and the common and subordinated unitholders in proportion to their pro rata ownership during the period.

 

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Cash Distributions

 

We intend to continue to make regular cash distributions to unitholders on a quarterly basis, although there is no assurance as to the future cash distributions since they are dependent upon future earnings, cash flows, capital requirements, financial condition and other factors. Our credit facility prohibits us from making cash distributions if any potential default or event of default, as defined in our credit facility, occurs or would result from the cash distribution.

 

Our partnership agreement, as amended, requires us to distribute all of our available cash on a quarterly basis. Our available cash is our cash on hand at the end of a quarter after the payment of our expenses and the establishment of reserves for future capital expenditures and operational needs, including cash from working capital borrowings. We intend to fund a portion of our capital expenditures with additional borrowings or issuances of additional units. We may also borrow to make distributions to unitholders, for example, in circumstances where we believe that the distribution level is sustainable over the long term, but short term factors have caused available cash from operations to be insufficient to pay the distribution at the current level. Our cash distribution policy reflects a basic judgment that our unitholders will be better served by us distributing our available cash, after expenses and reserves, rather than retaining it.

 

As of June 30, 2012, QRE GP owns a 0.1% general partner interest in us, represented by 41,747 general partner units. QRE GP has the right, but not the obligation, to contribute a proportionate amount of capital to us to maintain its current general partner interest. QRE GP’s 0.1% interest in these distributions will be reduced if we issue additional units in the future and QRE GP does not contribute a proportionate share of capital to us to maintain its 0.1% general partnership interest.

 

Our partnership agreement, as amended, requires that within 45 days after the end of each quarter, we distribute all of our available cash to preferred unitholders, in arrears, and common unitholders of record on the applicable record date, as determined by QRE GP.

 

 

Distribution activities are as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Limited Partners

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Affiliated

 

 

 

 

 

 

Payment Date

 

 

For the period ended

 

 

Distributions to Preferred Unitholders

 

 

Distributions per Preferred Unit(1)

 

 

General Partner

 

 

Public Common

 

 

Common

 

 

Subordinated

 

 

Total Distributions to Other Unitholders 

 

 

Distributions per other units

(In thousands, except per unit amounts)

February 10, 2012

 

 

December 31, 2011

 

 

3,424 

 

$

0.2054 

 

 

16 

 

 

8,344 

 

 

5,368 

 

 

3,393 

 

 

17,121 

 

 

0.4750 

May 11, 2012

 

 

March 31, 2012

 

 

3,500 

 

$

0.21 

 

 

20 

 

 

17,892 

 

 

 -

 

 

3,394 

 

 

21,306 

 

 

0.4750 

August 10, 2012

 

 

June 30, 2012

 

 

3,500 

 

$

0.21 

 

 

20 

 

 

18,604 

 

 

 -

 

 

3,484 

 

 

22,108 

 

 

0.4875 

 

(1)

Preferred units paid in February 2012 were prorated a quarterly distribution for the portion of the fourth quarter beginning on October 3, 2011 through December 31, 2011 in accordance with the Partnership Agreement.

 

On March 29, 2012, the board of directors of QRE GP declared a $0.4875 per unit cash distribution for the second quarter 2012 which is payable on August 10, 2012 to unitholders of record at the close of business on July 30, 2012.  The aggregate amount of the second quarter common and preferred unit holder distribution accrued, as of June 30, 2012, was $25.6 million.

 

 

NOTE 11  COMMITMENTS AND CONTINGENCIES

 

Services Agreement

 

            We have entered into a services agreement (the “Services Agreement”) with QRM as described in Note 14 – Related Party Transactions, under which QRM will be entitled to a quarterly administrative services fee equal to 3.5% of the Adjusted EBITDA generated by us during the preceding quarter, calculated prior to the payment of the fee.  The Partnership had no other commitments as of June 30, 2012.

 

Legal Proceedings

In the ordinary course of business, we are involved in various legal proceedings. To the extent we are able to

18

 


 

assess the likelihood of a negative outcome for these proceedings, our assessments of such likelihood range from remote to probable. If we determine that a negative outcome is probable and the amount of loss is reasonably estimable, we accrue the estimated amount.  We currently have no legal proceedings with a probable adverse outcome. Therefore, we do not believe that the outcome of these legal proceedings, individually or in the aggregate, will have a materially adverse effect on our financial condition, results of operations or cash flows. 

 

 

 

Environmental Contingencies

 

As of June 30, 2012, we have approximately $1.9 million in environmental liabilities related to the Prize Acquisition. This is management’s best estimate of the costs for remediation and restoration with respect to these environmental matters, although the ultimate cost could increase materially. The environmental liability is recorded in the other liabilities caption on the consolidated balance sheet. Inherent uncertainties exist in these estimates primarily due to unknown conditions, changing governmental regulation and legal standards regarding liability, and emerging remediation technologies for handling site remediation and restoration.

 

NOTE 12 – NET INCOME/LOSS PER LIMITED PARTNER UNIT

 

The following sets forth the calculation of net loss per limited partner unit for the three and six months ended June 30, 2012 and June 30, 2011:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

June 30, 2012

 

 

June 30, 2011

 

 

June 30, 2012

 

 

June 30, 2011

Net income (loss)

 

$

99,125 

 

$

28,988