---

 

 

Explanatory Note

 

We are filing this amendment (the “Amendment”) to our Annual Report on Form 10-K for the year ended December 31, 2013 (our “Annual Report”) to correct a typographical correction to the date of the Report of Independent Registered Public Accounting Firm provided by Ernst & Young LLP.  Our consolidated financial position and consolidated results of operations for the periods presented have not been restated from the consolidated financial position and consolidated results of operations originally reported.

 

We are only filing the items of our Annual Report that have been revised to reflect the typographical change and all other information in our Annual Report remains unchanged.  Accordingly, this Amendment should be read in conjunction with our Annual Report.

 

Pursuant to the Rules of the SEC, currently dated certifications from our Chief Executive Officer and Chief Financial Officer as required by Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 are filed or furnished herewith, as applicable.

 

 

---

 

 

Item 8.  Financial Statements and Supplementary Data

 

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholders of

Endeavour International Corporation

 

We have audited the accompanying consolidated balance sheets of Endeavour International Corporation and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of operations, stockholders' equity and cash flows for the years then ended. 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 Endeavour International Corporation and subsidiaries at December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Endeavour International Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) and our report dated March 17, 2014 expressed an unqualified opinion thereon.

 

 

/s/  Ernst & Young LLP

 

Houston, Texas

March 17, 2014

---

 

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders

Endeavour International Corporation:

We have audited the accompanying consolidated statements of income, stockholders’ equity, and cash flows of Endeavour International Corporation and subsidiaries (the Company) for the year ended December 31, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements 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 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 audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and the cash flows of Endeavour International Corporation and subsidiaries for the year ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.

(signed) KPMG LLP

Houston, Texas
March 7, 2012, except for Note 25, as to which date is March 18, 2013

 

 

 

 

 

---

 

 

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

 

 

 

---

 

 

 

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

 

 

---

 

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

 

---

 

 

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

 

---

 

 

 

 

 

 

 

See accompanying notes to consolidated financial statements.

 

 

 

---

 

Note 1 – General

 

Description of Business

 

Endeavour International Corporation is an independent oil and gas company engaged in the exploration, development, production and acquisition of energy reserves in the U.S. and U.K.  Endeavour was incorporated under the laws of the state of Nevada on January 13, 2000.  As used in these Notes to Consolidated Financial Statements, the terms “Endeavour,”  “Company,” “we,” “us,” “our” and similar terms refer to Endeavour International Corporation and, unless the context indicates otherwise, its consolidated subsidiaries.

 

2014 Liquidity and Capital Resources

 

As of December 31, 2013, we had $882.6 million in outstanding indebtedness.  Being highly leveraged, servicing our debt and other long-term obligations will continue to require a significant portion of our cash flow from operations and available cash on hand.  The combination of these debt servicing requirements, capital expenditures and the delay in cash flow resulting from the Rochelle mechanical issues may exceed the cash flow from our current operations.  During 2014, our primary uses of financial resources are expected to be:

 

 

We believe we will be able to fund operations for the foreseeable future including our capital expenditures and other expenditure requirements based on our projections of funds generated from operations, cash available and accessing the debt and equity markets.   Since year-end 2013, we have also completed several transactions to improve our liquidity position and extended the maturities of some of our debt and other obligations.    The completion of these recent financing activities is designed to provide sufficient liquidity to replace the interruption in production at Rochelle.  These transactions include:

 

 

See Note 26 “Subsequent Events” for additional discussion of each of these transactions.

 

---

 

 

Note 2 – Summary of Significant Accounting Policies

 

Basis of Presentation and Use of Estimates

 

The accompanying financial statements have been prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) and have been presented on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.  In the opinion of management, all normal recurring adjustments considered necessary for a fair presentation have been included in these financial statements.  Certain amounts for prior periods have been reclassified to conform to the current presentation.

 

These accounting principles require management to use estimates, judgments and assumptions that affect the amounts of assets, liabilities, revenues and expenses reported herein.  While management regularly reviews its estimates, actual results could differ from those estimates.

 

Management believes it is reasonably possible that the following material estimates affecting the financial statements could change in the coming year:

 

Principles of Consolidation

 

The accompanying consolidated financial statements include all of the accounts of Endeavour and our consolidated subsidiaries.  All significant intercompany accounts and transactions have been eliminated.  Investments in entities over which we have significant influence, but not control, are carried at cost adjusted for equity in earnings or (losses) and distributions received.

 

Cash and Cash Equivalents

 

We consider all highly liquid instruments with an original maturity of 90 days or less at the time of purchase to be cash equivalents.

 

Restricted Cash

 

Restricted cash has historically included amounts held in escrow for drilling rig commitments, as collateral for lines of credit, and for acquisitions.

 

---

 

Inventories

 

Materials and supplies and oil inventories are valued at the lower of cost or market value (net realizable value).  Our inventories are stated on an average cost basis.

 

Full Cost Accounting for Oil and Gas Operations

 

Under the full cost method of accounting for oil and gas activities, all acquisition, exploration and development costs incurred for the purpose of finding oil and gas, are capitalized and accumulated in pools on a country-by-country basis.  Capitalized costs include the cost of drilling and equipping productive wells, such as the estimated costs of dismantling and abandoning these assets, dry hole costs, lease acquisition costs, seismic and other geological and geophysical costs, delay rentals, costs related to such activities, certain directly-related employee costs and a portion of interest expense.   Employee costs associated with production and other operating activities and general corporate activities are expensed in the period incurred.

 

Capitalized costs are limited on a country-by-country basis (the ceiling test).  Under the ceiling test, if the capitalized cost of the full cost pool, net of deferred taxes, exceeds the ceiling limitation, the excess is charged as an impairment expense.  The ceiling test limitation is calculated as the present value, discounted 10%, of:

 

We utilize a single cost center for each country where we have operations for amortization purposes.  Any sales or other conveyances of properties are treated as adjustments to the cost of oil and gas properties with no gain or loss recognized unless the operations are suspended in the entire cost center or the conveyance is significant in nature.    Proved properties are amortized on a country-by-country basis using the units of production method (“UOP”).  The amortization base in the UOP calculation includes the sum of proved property, net of accumulated DD&A, estimated future development costs (future costs to access and develop proved reserves), and asset retirement costs, less related salvage value.

 

Unproved property costs include the costs associated with unevaluated properties and properties under development and are not initially included in the full cost amortization base (where proved reserves exist) until the project is evaluated.  These costs include unproved leasehold acreage, seismic data, wells and production facilities in progress and wells pending determination, together with interest costs capitalized for these projects. Seismic data costs are associated with specific unevaluated properties where the seismic data is acquired for the purpose of evaluating acreage or trends covered by a leasehold interest owned by us.

---

 

 

Significant unproved properties are assessed periodically for possible impairment or reduction in value.  If a reduction in value has occurred, these property costs are considered impaired and are transferred to the related full cost pool.  Geological and geophysical costs included in unproved properties are transferred to the full cost amortization base along with the associated leasehold costs on a specific project basis. Costs associated with wells in progress and wells pending determination are transferred to the amortization base once a determination is made whether or not proved reserves can be assigned to the property.  Costs of dry holes are transferred to the amortization base immediately upon determination that the well is unsuccessful.  Unproved properties whose acquisition costs are not individually significant are aggregated and the portion of such costs estimated to be ultimately nonproductive, based on experience, are amortized to the full cost pool over an average holding period.

 

In countries where the existence of proved reserves has not yet been determined, unevaluated property costs remain capitalized in unproved property cost centers until proved reserves have been established, exploration activities cease or impairment and reduction in value occurs.  If exploration activities result in the establishment of a proved reserve base, amounts in the unproved property cost center are reclassified as proved properties and become subject to amortization and the application of the ceiling test.  When it is determined that the value of unproved property costs have been permanently diminished (in part or in whole) based on the impairment evaluation and future exploration plans, the unproved property cost centers related to the area of interest are impaired, and accumulated costs charged against earnings.

 

Other Property and Equipment

 

Other oil and gas assets, computer equipment and furniture and fixtures are recorded at cost, less accumulated depreciation.  The assets are depreciated using the straight-line method over their estimated useful lives of two to five years.

 

Capitalized Interest

 

We capitalize interest on expenditures for significant exploration and development projects while activities are in progress to bring the assets to their intended use.  Capitalized interest is calculated by multiplying our weighted-average interest rate on debt by the amount of qualifying costs and is limited to gross interest expense.

 

Business Combinations

 

Assets and liabilities acquired through a business combination are recorded at estimated fair value.  We use all available information to make these fair value determinations, including information commonly considered by our engineers in valuing individual oil and gas properties and sales prices for similar assets.  Estimated deferred taxes are based on available information

---

 

concerning the tax basis of the acquired company’s assets and liabilities and carry forwards at the merger date.

 

Any excess of the acquisition cost of the acquired business over the fair value amounts assigned to assets and liabilities is recorded as goodwill.  The amount of goodwill recorded in any particular business combination can vary significantly depending upon the fair values attributed to assets acquired and liabilities assumed relative to the total acquisition cost.

 

Goodwill and Intangible Assets

 

We assess the carrying amount of goodwill and other indefinite-lived intangible assets by testing the asset for impairment annually at year-end, or more frequently if events or changes in circumstances indicate that the asset might be impaired.  The impairment test requires allocating goodwill and all other assets and liabilities to reporting units.  The fair value of each reporting unit is determined and compared to the book value of the reporting unit.  An impairment loss is recognized to the extent that the carrying amount exceeds the reporting unit’s fair value.

 

Dismantlement, Restoration and Environmental Costs

 

We recognize liabilities for asset retirement obligations associated with tangible long-lived assets, such as producing well sites, offshore production platforms, and natural gas processing plants, with a corresponding increase in the related long-lived asset.  The asset retirement cost is depreciated along with the property and equipment in the full cost pool.  The asset retirement obligation is recorded at fair value and accretion expense, recognized over the life of the property, increases the liability to its expected settlement value.  If the fair value of the estimated asset retirement obligation changes, an adjustment is recorded for both the asset retirement obligation and the asset retirement cost.

 

Revenue Recognition

 

We use the entitlements method to account for sales of gas production.  We may receive more or less than our entitled share of production.  Under the entitlements method, if we receive more than our entitled share of production, the imbalance is treated as a liability at the market price at the time the imbalance occurred.  If we receive less than our entitled share, the imbalance is recorded as an asset at the lower of the current market price or the market price at the time the imbalance occurred.  Oil revenues are recorded when production is transported by pipeline or the production is shipped out of our storage tanks.  Oil revenues are recognized when production is sold to a purchaser at a fixed or determinable price, when delivery has occurred, title has transferred and collectability of the revenue is probable.

 

---

 

Significant Customers

 

Our sales in the U.K. are to a limited number of customers.  For the year ended December 31, 2013, our sales to Shell U.K. Limited accounted for more than 10% of revenue.  Our sales in the U.S. are sold through our arrangements with the operators of the fields, with the majority of the sales being to J-W Operating Company.

 

Derivative Instruments and Hedging Activities

 

From time to time, we may utilize derivative financial instruments to hedge cash flows from operations or to hedge the fair value of financial instruments.  We also have embedded derivatives related to our debt instruments and convertible preferred stock.

 

We may use derivative financial instruments with respect to a portion of our oil and gas production or a portion of our variable rate debt to achieve a more predictable cash flow by reducing our exposure to price fluctuations.  These transactions are likely to be swaps, collars or options and to be entered into with major financial institutions or commodities trading institutions.  Derivative financial instruments are intended to:

 

We record all derivatives at fair market value in our Consolidated Balance Sheets at the end of each period.  The accounting for the fair market value, and the changes from period to period, depends on the intended use of the derivative and the resulting designation.  This evaluation is determined at each derivative’s inception and begins with the decision to account for the derivative as a hedge, if applicable.  The accounting for changes in the fair value of a derivative instrument that is not accounted for as a hedge is included in other (income) expense as an unrealized gain or loss.  At December 31, 2013 and 2012, we had  no outstanding derivatives that were accounted for as a hedge.

 

Concentrations of Credit and Market Risk

 

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash deposits at financial institutions.  At various times during the year, we may exceed the federally insured limits.  To mitigate this risk, we place our cash deposits only with high credit quality institutions.  Management believes the risk of loss is minimal.

 

As an independent oil and gas producer, our revenue, profitability and future rate of growth are substantially dependent upon prevailing prices for oil and gas, which are dependent upon numerous factors beyond our control, such as economic, political and regulatory developments

---

 

and competition from other sources of energy.  The energy markets have historically been very volatile, and there can be no assurance that oil and gas prices will not be subject to wide fluctuations in the future.  A substantial or extended decline in oil and gas prices could have a material adverse effect on our financial position, results of operations, cash flows and our access to capital and on the quantities of oil and gas reserves that may be economically produced.

 

Foreign Currency Translation

 

The U.S. dollar is the functional currency for all of our existing operations, as a majority of all revenue and financing transactions in these operations are denominated in U.S. dollars.  For foreign operations with the U.S. dollar as the functional currency, monetary assets and liabilities are remeasured into U.S. dollars at the exchange rate on the balance sheet date.  Nonmonetary assets and liabilities are translated into U.S. dollars at historical exchange rates.  Income and expense items are translated at exchange rates prevailing during each period.  Adjustments are recognized currently as a component of foreign currency gain or loss and deferred income taxes.  To the extent that business transactions are not denominated in U.S. dollars, we are exposed to foreign currency exchange rate risk.

 

Income Taxes

 

We use the liability method of accounting for income taxes under which deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities, and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized as part of the provision for income taxes in the period that includes the enactment date.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of, or all of, the deferred tax assets will not be realized.

 

Share-Based Payments

 

We recognize all share-based payments to employees, including grants of employee stock options, based on their fair values.  The share-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as general and administrative expense over the employee’s requisite service period (generally the vesting period of the equity award).

 

It is our policy to use authorized but unissued shares of stock when stock options are exercised.  At December 31, 2013, we had approximately 1.8 million additional shares available for issuance pursuant to our existing stock incentive plans.

 

---

 

 

Note 3 – Business Combinations

 

On December 23, 2011, we entered into a Sale and Purchase Agreement (the “Purchase Agreement”), through our wholly owned subsidiary EEUK, with ConocoPhillips (U.K.) Limited, ConocoPhillips Petroleum Limited and ConocoPhillips (U.K.) Lambda Limited, subsidiaries of ConocoPhillips (collectively, the “Sellers”), to acquire their interest in three producing U.K. oil fields in the Central North Sea.

 

On May 31, 2012, we closed the Alba field portion of the acquisition, which consisted of an additional 23.43% interest in the Alba field.  This increased our total working interest in the Alba field to 25.68%.  The Alba Acquisition was closed for aggregate cash consideration of approximately $229.6 million.

 

Upon the closing of the Alba Acquisition, the net proceeds from the offering of our 2018 Notes were released from escrow.  We used approximately $205 million of the net proceeds from the sale of the Senior Notes due 2018 together with approximately $24 million of borrowings under our Revolving Credit Facility with Cyan, as administrative agent and the other lenders party thereto, to fund the cash consideration for the acquisition of the Alba field portion of the COP Acquisition.  Additional information on these related financing transactions is discussed in Note 10.

 

The acquisition of the additional interest in the Alba field was accounted for using the business combination method.  The following summarizes the allocation of the purchase price for the Alba Acquisition:

 

 

 

Goodwill was the excess of the consideration transferred over the net assets recognized and represents the future economic benefits arising from assets acquired that could not be individually identified and separately recognized.  The assessments of the fair values of oil and

---

 

gas properties acquired were based on projections of expected future net cash flows, discounted to present value.

 

 

Revenues and income from operations associated with the acquired interest in the Alba field for the period from May 31, 2012 through December 31, 2012 were $119.7 million and $13.7 million, respectively.

 

After substantial effort and extensions, we and the Sellers were unable to reach the unanimous agreement and consent required to transfer the interests in the two remaining U.K. oil fields and the Purchase Agreement terminated in accordance with its terms on December 14, 2012.  As previously disclosed, we paid a $10 million deposit in connection with the acquisition of the interests in the two remaining fields, which the Sellers retained.

 

 

Note 4 – Prepaid Expenses and Other Current Assets

 

Prepaid expenses and other current assets consisted of the following:

 

 

 

 

 

 

 

 

---

 

Note 5 – Property and Equipment

 

Property and equipment included the following:

 

 

 

The costs not subject to amortization include

 

These costs are transferred to the amortization base when it is determined whether or not proved reserves can be assigned to such properties.  This analysis is dependent upon well performance, results of infield drilling, approval of development plans, drilling results and development of identified projects and periodic assessment of reserves.  We expect acquisition costs and exploration costs excluded from amortization to be transferred to the amortization base over the next three years due to a combination of well performance and results of infield drilling relating to currently producing assets and the drilling and development of identified projects, such as the Rochelle field.  Because of the nature of offshore oil and gas activities, development activities, including sanctioning and regulatory approvals, may take a significant amount of time to implement.  Even though our expectation is that most costs not subject to amortization are to be transferred to the amortization base over the next three years, it is not uncommon for the cycle times to be longer.  We have one U.K. field, Columbus, where costs have been excluded from amortization for greater than five years; however, we continue to work on the development planning for the field.

 

---

 

The following is a summary of our oil and gas properties not subject to amortization as of December 31, 2013:

 

 

 

 

During 2013,  2012 and 2011, we capitalized $12.4 million, $17.9 million and $13.3 million, respectively, in certain directly related employee costs.  During 2013,  2012 and 2011, we capitalized $24.0 million, $26.9 million and $14.7 million, respectively, in interest.

 

During 2013,  2012 and 2011,  we recorded $9.6 million, $53.1 million and $65.7 million, respectively, of impairment through the application of the full cost ceiling test.  The primary reason for the 2013 impairment was the evaluation of certain of our U.S. assets not subject to amortization which we no longer intend to pursue and accordingly are included in the full cost pool.  We did not have an impairment of our U.K. oil and gas properties through the application of the full cost ceiling test at the end of 2013.  The 2012 impairment was primarily due to the decline in U.S. oil and gas prices.  The 2011 impairment was primarily related to declines in U.S. gas prices and the impact of our determination that the likely economic returns in the future would not warrant further investment in our test wells in the Alabama area.  Our decision to discontinue activities in that area resulted in the reclassification of related amounts as being evaluated for full cost accounting purposes.

 

Assets Acquisitions and Divestitures

 

Marcellus and Haynesville

 

On October 26, 2012, we completed a nonmonetary exchange with our domestic co-venturer whereby we exchanged our Bull Bayou Haynesville and Willow Springs Cotton Valley properties for all of the co-venturer’s upstream and midstream interests in the Pennsylvania Marcellus area.  In parallel, we secured a third party gas gathering agreement for the Daniel Project in Cameron County, Pennsylvania.  We operated and controlled the Marcellus assets while retaining a 50% position in our remaining producing Haynesville acreage.

 

On November 8, 2013, we closed on a purchase and sale agreement and formed a joint venture partnership with Samson Exploration LLC (“Samson”), which included a sale of 50% of our upstream and midstream assets in the Pennsylvania Marcellus area to Samson.  The agreement

---

 

provides for the joint development of the Marcellus assets and includes a financing component.  This joint venture provides the necessary capital for the next development phase in the core Daniel Field in Cameron County, Pennsylvania.

 

Business Combination

 

On May 31, 2012, we closed the Alba Acquisition, which consisted of an additional 23.43% interest in the Alba field.  This increased our total working interest in the Alba field to 25.68%.  The Alba Acquisition was closed for aggregate cash consideration of approximately $229.6 million.

 

 

Note 6 – Goodwill

 

In connection with several business acquisitions, we recorded goodwill for the excess of the purchase price over the value assigned to individual assets acquired and liabilities assumed.  Changes to goodwill for the year ended December 31, 2013 and 2012 were related to the Alba Acquisition as follows:

 

 

 

 

 

 

Note 7 – Other Assets

 

Other long-term assets consisted of the following at December 31:

 

 

 

 

Debt issuance costs and deferred issuance costs related to our reimbursement agreements are amortized over the life of the related obligation.

 

---

 

As discussed in Note 21, we are in litigation concerning the terminated acquisition of properties from SM Energy.  We paid $6.0 million in a deposit upon executing the acquisition agreement with SM Energy, and SM Energy has retained the deposit, which we believe we are entitled to recover.

 

 

Note 8 – Accrued Expenses and Other Current Liabilities

 

We had the following accrued expenses and other current liabilities outstanding:

 

 

 

 

 

 

 

Note 9 – Deferred Revenue

 

For certain of our U.K. fields, we sell production on a monthly basis; however, the production remains in the field’s storage tanks.  The inventory associated with these sales remains on our balance sheet and the revenue is deferred until the production is shipped out of our storage tanks.

 

In February and September 2013, we entered into forward sale agreements with one of our established purchasers for payments of approximately $22.5 million each.  This effectively hedged a portion of production from our U.K. North Sea assets by locking in pricing for in excess of 200,000 barrels of oil each, over a six month delivery period.  Payment for these agreements was received in March and September 2013.  The February forward sale commitment was fulfilled in June 2013 and the September forward sale commitment is expect to be fulfilled by the end of the first quarter of 2014.  The forward sale liabilities are included in deferred revenue until the purchaser takes possession of the inventory from the field’s storage tanks.

 

 

---

 

Note 10 – Debt Obligations

 

Our debt consisted of the following at December 31:

 

 

 

 

Senior Notes

 

On February 23, 2012, we closed the private placement of $350 million aggregate principal amount of 12% first priority notes due 2018 (the “First Priority Notes”) and $150 million aggregate principal amount of 12% second priority notes due 2018 (the “Second Priority Notes,” and, together with the First Priority Notes, the “2018 Notes”).  Each series of 2018 Notes issued in February 2012 was priced at 96% of par, at a yield to maturity of 12.975% for the First Priority Notes and 12.954% for the Second Priority Notes, for an aggregate $20 million discount.  We also paid approximately $21 million in other financing costs related to the 2018 Notes.

 

On May 31, 2012, concurrent with the closing of the Alba Acquisition, the net proceeds were used to fund the acquisition and repay all outstanding amounts under a senior term loan (“Senior Term Loan”).

 

On October 15, 2012 we completed a private placement of an additional $54 million aggregate principal amount of our First Priority Notes, due 2018, priced at 109% of par.  In connection with the offering of the First Priority Notes, we received net proceeds of $57.9 million.  The new first priority notes and those first priority notes initially issued in February 2012 are treated as a single class of debt securities under the same indenture.  We utilized a portion of the proceeds from the October 2012 offering to retire the $25 million outstanding under our 12% senior subordinated notes due 2014.  We used the remainder of the net proceeds to finance a portion of the construction, improvement and other capital costs related to our U.S. and U.K. properties.

 

Revolving Credit Facility

 

On April 12, 2012, we entered into a $100 million Revolving Credit Facility, with Cyan, as administrative agent, and borrowed $40 million, subsequently increased to $115 million.

 

---

 

On January 24, 2014, we repaid the balance outstanding under the Revolving Credit Facility with proceeds from the Term Loan Facility.  Following the repayment, the Revolving Credit Facility was terminated and all of the liens on the collateral securing our obligations were released.  For additional discussion of the Term Loan Facility, see Note 26 “Subsequent Events.”

 

5.5% Convertible Senior Notes

 

In July 2011, we issued $135 million aggregate principal amount of our 5.5% convertible senior notes due July 15, 2016 (the “5.5% Convertible Senior Notes”).  Interest on these notes is payable semiannually at a rate of 5.5% per annum.  The 5.5% Convertible Senior Notes are convertible into shares of our common stock at an initial conversion rate of 54.019 shares (equivalent to $18.51 per share) of common stock per $1,000 principal amount of the notes, subject to certain anti-dilution adjustments.  In addition, following certain Make-Whole Fundamental Changes, as defined, we will increase the conversion rate for a holder who elects to convert its 5.5% Convertible Senior Notes.

 

The 5.5% Convertible Senior Notes are unsecured but guaranteed by our existing material domestic subsidiaries. We may not redeem the 5.5% Convertible Senior Notes prior to their maturity.  The indenture governing the 5.5% Convertible Senior Notes provides for customary events of default.

 

If we undergo a “fundamental change” as defined, the holders of the 5.5% Convertible Senior Notes have the right, subject to certain conditions, to redeem the 5.5% Convertible Senior Notes and accrued interest.  The 5.5% Convertible Senior Notes may become immediately due upon the occurrence of certain events of default, as defined.

 

11.5% Convertible Bonds

 

In January 2008, we issued 11.5% convertible bonds (the “11.5% Convertible Bonds”) for gross proceeds of $40 million pursuant to a private offering to a sophisticated investor in Norway.  The net proceeds from the issuance of the 11.5% Convertible Bonds were used to repay a portion of our outstanding indebtedness.  The 11.5% Convertible Bonds currently bear interest at a rate of 11.5% per annum and 7.5%  per annum on and after March 31, 2014.  Interest is compounded quarterly and added to the outstanding principal balance each quarter.  The bonds have a maturity date of January 24, 2016.

 

The bonds are convertible into shares of our common stock at a conversion price of $16.52 per $1,000 of principal, which represents a conversion rate of approximately 61 shares of our common stock per $1,000 of principal.  The conversion price will be adjusted in accordance with the terms of the bonds upon occurrence of certain events, including payment of common stock dividends, common stock splits or issuance of common stock at a price below the then current

---

 

market price. The holders of the 11.5% Convertible Bonds may exercise a put right, and the occurrence of the conversion price reset if such put right is not exercised, on January 24, 2016.

 

If we undergo a “change of control” as defined, the holders of the bonds have the right, subject to certain conditions, to redeem the bonds and accrued interest.  The bonds may become immediately due upon the occurrence of certain events of default, as defined.

 

Two derivatives are associated with the conversion and change in control features of the 11.5% Convertible Bonds.  At December 31, 2013, the combined fair market value of these derivatives is $5.7 million, reflecting a $1.3 million increase during 2013 that was recorded in unrealized gains (losses) on derivatives.

 

Five Year Debt Maturities

 

Principal maturities of debt at December 31, 2013 are as follows:

 

 

 

 

Fair Value

 

The fair value of our outstanding debt obligations was $868.4 million and $869.5 million at December 31, 2013 and 2012, respectively.  The fair values of long-term debt were determined based upon external market quotes for our 2018 Notes and 5.5% Convertible Senior Notes and discounted cash flows for other debt, which results in a Level 3 fair-value measurement.

 

 

Note 11 – Income Taxes

 

The income (loss) before income taxes and the components of the income tax expense (benefit) recognized on the Consolidated Statement of Income are as follows:

 

---

 

 

 

 

 

---

 

Effective Tax Rate Reconciliation

 

The following table presents the principal reasons for the difference between our effective tax rates and the United States federal statutory income tax rate of 35%.

 

 

 

 

During 2013,  2012 and 2011, we incurred taxes primarily related to our operations in the U.K.  In 2013,  2012 and 2011, we had losses before taxes of $44.6 million, $91.4 million and $99.4 million, respectively, in the U.S. and we did not record any income tax benefits on these losses as there was no assurance that we could generate any future U.S. taxable earnings.  As a result, we  recorded a valuation allowance on the full amount of all deferred tax assets generated in the U.S.

 

---

 

Deferred Tax Assets and Liabilities

 

Deferred income taxes result from the net tax effects of temporary timing differences between the carrying amounts of assets and liabilities reflected on the financial statements and the amounts recognized for income tax purposes.  The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities are as follows at December 31:

 

 

 

 

Tax Attributes

 

At December 31, 2013, we had the following tax attributes available to reduce future income taxes:

 

 

 

 

---

 

As of December 31, 2013, the U.K. tax attributes shown above have been recognized for financial statement reporting purposes to reduce deferred tax liability.

 

Valuation Allowances and Unrecognized Tax Benefits

 

Recognition of the benefits of the deferred tax assets requires that we generate future taxable income.  In the U.S., there can be no assurance that we will generate any earnings or any specific level of earnings in future years.  Therefore, we have established a valuation allowance for deferred tax assets of approximately $103.0 million and $84.7 million as of December 31, 2013 and 2012, respectively, primarily related to our U.S. operations.  During 2013, the valuation allowance in the U.S. increased $18.3 million, $2.9 million for net revisions and $15.4 million due to net operating losses, and increased $.2 million for net operating losses in other jurisdictions.  During 2012, the valuation allowance in the U.S. increased $29.1 million due to net operating losses and decreased $3.0 million in other jurisdictions.  During 2011, the valuation allowance in the U.S. increased $24.6 million due to net operating losses and decreased $3.9 million in other jurisdictions.  For U.S. federal income tax purposes, certain limitations are imposed on an entity’s ability to utilize its net operating losses (“NOLs”) in future periods if a change of control, as defined for federal income tax purposes, has taken place.  In general terms, the limitation on utilization of NOLs and other tax attributes during any one year is determined by the value of an acquired entity at the date of the change of control multiplied by the then-existing long-term, tax-exempt interest rate.  We have determined that, for federal income tax purposes, a change of control occurred during 2004 and 2007, however, we do not believe such limitations will significantly impact our ability to utilize the NOL.  The timing of NOL utilization will be determined by our future net income. 

 

Uncertain Tax Positions

 

At December 31, 2013, we have an unrecognized tax benefit of $6.8 million relating to various U.K. tax matters.  Any interest and penalties that may be incurred as part of this liability would be recognized as a component of interest expense and other expense, respectively.  As of December 31, 2013, no interest or penalty expense had been incurred.

 

The following represents a reconciliation of the change in our unrecognized tax benefits, for the year ended December 31, 2013.

 

 

 

---

 

As of December 31, 2013, we believe that no current tax positions that have resulted in unrecognized tax benefits will significantly increase or decrease within the next year.  If recognized, a $1 million tax benefit would have resulted to impact our effective tax rate.

 

The following tax years remain subject to examination:

 

 

 

 

Foreign Earnings and Credits

 

As of December 31, 2013, we had de minimus unremitted earnings in our foreign subsidiaries.  If these unremitted earnings had been dividend to the U.S., the U.S. NOLs not subject to the limitations mentioned above would be fully available to offset any incremental U.S. federal income tax.  Further, the foreign tax credits associated with the unremitted earnings would be sufficient to offset any incremental U.S. tax liabilities associated with the dividend.

 

 

Note 12 – Monetary Production Payment

 

Our monetary production payment liability, net of repayments, consisted of the following at December 31, 2013:

 

 

 

 

During 2013, we entered into various monetary production payment arrangements (collectively  , the “Monetary Production Payments”) covering the proceeds of sale from a portion of EEUK’s entitlement to production from its interests in the certain fields located in the U.K. sector of the North Sea.  Pursuant to the Monetary Production Payments, our obligations will cease upon the earlier of the repayment of amounts outstanding or production from the applicable licences permanently ceasing.  We issued the Monetary Production Payments in the following manner:

 

---

 

 

Principal and interest payments are payable within 20 days after the end of each calendar quarter.  In January 2014, we made a principal payment of $5.0 million and payments for the next three quarters are expected to be $5.8 million each.  In January and April 2015, the principal payments will be $51.7 million each.  The final three payments range from $10 million to $18 million, with the final payment to be made in January 2016.

 

Our obligations under the Monetary Production Payments are secured by first priority liens over our interests in the applicable license and related joint operating agreements and sales proceeds accounts.  Our obligations are also secured by second priority liens over certain of our other licenses, joint operating agreements and assets.  The second priority liens are subordinated to the security granted to the holders of our revolving credit facility dated April 12, 2012 pursuant to an intercreditor agreement.

 

In connection with the initial Monetary Production Payment, we issued warrants to purchase a total of 3,440,000 shares of our common stock at an exercise price of $3.014 per share, expiring on April 30, 2018, and warrants to purchase a total of 560,000 shares of our common stock at an exercise price of $3.685 per share, expiring on May 21, 2018.  We have incurred $26.6 million in costs related to the issuance of the Monetary Production Payments, including $7.6 million related to the fair market value of the warrants issued.

 

Both warrant agreements are subject to customary anti-dilution provisions and include a cashless exercise provision entitling the investors to surrender a portion of the underlying common stock that has a value equal to the aggregate exercise price in lieu of paying cash upon exercise of a warrant.

 

 

Note 13 – Other Liabilities

 

Other liabilities included the following:

 

 

 

 

---

 

Our asset retirement obligations relate to obligation of the plugging and abandonment of oil and gas properties.  The asset retirement obligation is recorded at fair value and accretion expense, recognized over the life of the property, increases the liability to its expected settlement value.  If the fair value of the estimated asset retirement obligation changes, an adjustment is recorded for both the asset retirement obligation and the asset retirement cost.  The following table provides a rollforward of the asset retirement obligations for the year ended December 31, 2013 and 2012:

 

 

 

 

 

 

 

 

 

---

 

Note 14 –  Equity

The activity in shares of our common and preferred stock during 2013, 2012 and 2011 included the following:

 

 

 

 

Common Stock

 

The Common Stock is $0.001 par value common stock, and 125,000,000 shares are authorized.

 

In January 2013, in connection with our entry into the LOC Procurement Agreement, we issued warrants to purchase a total of 1,000,000 shares of our common stock at an exercise price of $7.31 per share to the investor.  The warrants expire on January 9, 2018 and are subject to customary anti-dilution provisions.  Additional information concerning the LOC Procurement Agreement can be found in Note 22.

 

In March 2013 we entered into warrant agreements through which we issued 3,440,000 warrants to purchase shares of our common stock at an exercise price of $3.014 per share, expiring on April 30, 2018, and warrants to purchase a total of 560,000 shares of our common stock at an exercise price of $3.685 per share, expiring on May 21, 2018.  The Warrant Agreements were entered into in connection with our Monetary Production Payment, additional discussion of which can be found in Note 12.  Both warrant agreements are subject to customary anti-dilution provisions and include a cashless exercise provision which entitles investors to surrender a

---

 

portion of the underlying common stock that has a value equal to the aggregate exercise price in lieu of paying cash upon exercise of a warrant.

 

In June 2012, we completed an underwritten public offering of 8.6 million shares of common stock at a price of $7.50 per common share ($7.13 per common share, net of underwriting discounts) for net proceeds of $60.8 million.

 

In May 2012, we entered into warrant agreements through which we issued certain investors warrants to purchase a total of 2,000,000 shares of our common stock at an exercise price of $10.50 per share.  The Warrant Agreements were entered into in connection with the May 31, 2012 reimbursement agreement (see Note 19 for additional discussion of this reimbursement agreement). The terms of each of the Warrant Agreements are substantially identical.  The warrants expire on January 24, 2016 and are subject to customary anti-dilution provisions.  We also agreed to provide the investors with customary resale registration rights as soon as reasonably practicable.

 

In March 2011, we completed an underwritten public offering of 11.5 million shares of common stock at a price of $11.00 per common share ($10.34 per common share, net of underwriting discounts) for net proceeds of $118.4 million.  In April 2011, we used a portion of the offering proceeds to redeem all $81.25 million of our outstanding 6% senior notes.

 

See Note 26 “Subsequent Events” for a discussion of common stock and warrants issued in 2014.

 

Series C Convertible Preferred Stock

 

We have 37,000 shares of Series C convertible preferred stock (the “Series C Preferred Stock”) outstanding, convertible into 4.2 million shares of common stock.  The Series C Preferred Stock is convertible into common stock at any time at the option of the holders at a conversion price of $8.75, plus accrued but unpaid dividends.  The Series C Preferred Stock ranks senior to any of our other existing or future shares of capital stock.  Dividends on the Series C Preferred Stock are:

The Series C Preferred Stock also participates on an as-converted basis with respect to any dividends paid on the common stock.

 

The Series C Preferred Stock is redeemable for a cash payment of an amount equal to 102% of the sum of the liquidation preference of $1,000 per share plus accrued but unpaid dividends.  If we call the Series C Preferred Stock for redemption, the holders have the right to convert their

---

 

shares into a newly issued preferred stock identical in all respects to the Series C Preferred Stock except that such newly issued preferred stock will not bear a dividend.

 

Upon the tenth anniversary of the initial issuance of the Series C Preferred Stock, we must redeem all of the Series C Preferred Stock for an amount equal to the Liquidation Preference plus accrued and unpaid dividends payable by us in cash or common stock at our election.  Issuance by us of common stock for such redemption is subject to the Equity Conditions and to the market value of the outstanding shares of common stock immediately prior to such redemption equaling at least $500 million.

 

In the event of a change of control of Endeavour, we will be required to offer to redeem all of the Series C Preferred Stock for the greater of: (i) the amount equal to which such holder would be entitled to receive had the holder converted such Series C Preferred Stock into common stock; (ii) 115% of the sum of the Liquidation Preference plus accrued and unpaid dividends; and (iii) the amount resulting in an internal rate of return to such holder of 15% from the date of issuance of such Series C Preferred Stock through the date that Endeavour pays the redemption price for such shares.

 

During 2011, holders of a portion of our Series C Preferred Stock converted 8,000 preferred shares, with a face value of $8 million, into 0.9 million shares of our common stock.

 

Series B Preferred Stock

 

In September 2002, we authorized and designated 500,000 shares of preferred stock, as Series B preferred stock par value $.001 per share (the “Series B Preferred Stock”).

 

The Series B Preferred Stock is entitled to dividends of 8% of the original issuing price per share per annum, which are cumulative prior to any dividends on the common stock and on parity with the payment of any dividend or other distribution on any other series of preferred stock that has similar characteristics.  The holders of each share of Series B Preferred Stock are entitled to be paid out of available funds prior to any distributions to holders of common stock in the amount of $100.00 per outstanding share plus all accrued dividends.  We may, upon approval of our Board, redeem all or a portion of the outstanding shares of Series B Preferred Stock at a cost of the liquidation preference and all accrued and unpaid dividends.

 

 

Note 15 – Stock-Based Compensation Arrangements

 

We grant restricted stock, performance units and stock options to employees and directors as incentive compensation.  The restricted stock and options generally vest over three years.  The vesting of these shares and options is dependent upon the continued service of the grantees with

---

 

Endeavour.  Upon the occurrence of a change in control, each outstanding share of restricted stock and stock option will immediately vest.

 

At December 31, 2013, total compensation cost related to nonvested awards not yet recognized was approximately $5.0 million and is expected to be recognized over a weighted average period of less than three years.  For the year ended December 31, 2013, we included approximately $1.2 million of stock-based compensation in capitalized G&A in property and equipment.

 

Stock Options

 

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model.  We have not granted any options during the last three years.  Information relating to stock options, including notional stock options, is summarized as follows:

 

 

 

 

Information relating to stock options outstanding at December 31, 2013 is summarized as follows:

 

 

 

 

---

 

Restricted Stock

 

At December 31, 2013, our employees and directors held 0.6 million restricted shares of our common stock that vest over the service period of up to three years.  The restricted stock awards were valued based on the closing price of our common stock on the measurement date, typically the date of grant, and compensation expense is recorded on a straight-line basis over the restricted share vesting period.

 

Status of the restricted shares as of December 31, 2013 and the changes during the year ended December 31, 2013 are presented below:

 

 

 

 

Non-Cash stock-based compensation is recorded in G&A expenses or capitalized G&A as follows:

 

 

 

 

Performance-Based Share Awards

 

Certain of our officers and employees receive a target number of performance shares under individual Performance Unit Award Agreements.  The performance shares will be earned as the relative total shareholder return ranking is measured among a designated peer group at the end of a three-year performance period.  Payouts will be based on a predetermined schedule at the end of the performance period.  The shares issued may range from 0% to 200% of the number of

---

 

Performance Units specified in the agreements. The fair value of each performance-based award is estimated on the date of grant using a Monte Carlo simulation model.

 

Status of the performance-based share awards as of December 31, 2013 and the changes during the year ended December 31, 2013 are presented below:

 

 

 

 

 

 

 

 

Note 16 – Earnings per Share

 

Basic income (loss) per common share is computed by dividing net income (loss) to common stockholders by the weighted average number of common shares outstanding for the period.  Diluted income (loss) per share includes the effect of our outstanding stock options, warrants and shares issuable pursuant to convertible debt, convertible preferred stock and certain stock incentive plans under the treasury stock method, if including such instruments is dilutive.

 

For each of the periods presented, shares associated with stock options, warrants, convertible debt, convertible preferred stock and certain stock incentive plans are not included when their inclusion would be antidilutive (i.e., reduce the net loss per share).  The common shares potentially issuable arising from these instruments excluded from weighted average diluted shares outstanding consisted of:

 

 

 

 

 

 

 

---

 

Note 17 – Supplementary Cash Flow Disclosures

 

Cash paid during the period for interest and income taxes was as follows:

 

 

 

 

The cash paid for income taxes for the year ended December 31, 2013 includes $17 million related to 2012 that was not payable until 2013.  In addition, we paid $40 million in 2013 of which $21.5 million we expect to be refunded during 2014.

 

Non-Cash Investing and Financing Transactions

 

During 2012, we completed a nonmonetary exchange of our Bull Bayou Haynesville and Willow Springs Cotton Valley properties for all of J-W’s upstream and midstream interests in the Pennsylvania Marcellus area.  The exchanged properties were recorded on a carryover basis.

 

As discussed in Note 12, in 2011, a combined 8,000 shares of our Series C Preferred Stock were converted into 0.9 million shares of our common stock. 

 

In 2013,  2012 and 2011, we recorded $7.1 million, $8.7 million and $12.8 million, respectively, in non-cash interest expense that was added to the principal balance of the 11.5% Convertible Bonds, the $50 million Subordinated Notes and the Senior Term Loan.

 

 

Note 18 – Financial Instruments

 

 

 

 

The carrying amounts reflected in the consolidated balance sheets for cash and equivalents, short-term receivables and short-term payables approximate their fair value due to the short maturity of the instruments.  The fair values of commodity derivative instruments and interest rate swaps were determined based upon quotes obtained from brokers.  The fair values of long-

---

 

term debt were determined based upon quotes obtained from brokers for our senior notes and discounted cash flows for our other debt.

 

 

Note 19 – Related Party Transactions

 

The Founding Partner and Chief Investment Officer, Ashok Nayyar, of Cyan Partners, LP became a member of our Board of Directors in September 2012.  In September 2012, we increased the amount available for borrowing under the Revolving Credit Facility to $125 million and borrowed $15 million of the additional capacity.  As of December 2013, we had utilized the full capacity under the Revolving Credit Facility.  In connection with the amendments to the Revolving Credit Facility during 2013, we agreed to pay a fee of $1.25 million to Cyan Partners, LP.  Mr. Nayyar resigned from our Board of Directors in March 2013.

 

 

Note 20 – Fair Value Measurements

 

We measure the fair value of financial assets and liabilities on a recurring basis, defining 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.  The fair value is based on assumptions that market participants would use when pricing an asset or liability, including assumptions about risk and the risks inherent in valuation techniques and the inputs to valuations.  This includes not only the credit standing of counterparties involved and the impact of credit enhancements but also the impact of our own nonperformance risk on our liabilities.  Fair value measurements are classified and disclosed in one of the following categories:

 

Level  1:Fair value is based on actively-quoted market prices, if available.

 

Level  2:In the absence of actively-quoted market prices, we seek price information from external sources, including broker quotes and industry publications.  Substantially all of these inputs are observable in the marketplace during the entire term of the instrument, can be derived from observable data, or supported by observable levels at which transactions are executed in the marketplace.

 

Level  3:If valuations require inputs that are both significant to the fair value measurement and less observable from objective sources, we must estimate prices based on available historical and near-term future price information and certain statistical methods that reflect our market assumptions.

 

We apply fair value measurements to certain assets and liabilities including commodity derivative instruments and embedded derivatives relating to conversion and change in control

---

 

features in certain of our debt instruments.  We seek to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. 

 

Financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement.  The following table summarizes the valuation of our investments and financial instruments by pricing levels as of December 31, 2013 and 2012:

 

 

 

 

We use a derivative valuation model to derive the value of our embedded derivative features.  Key inputs into this valuation model are our current stock price, risk-free interest rates, the stock volatility and our implied credit spread. The first three aforementioned inputs are based on observable market data and are considered Level 2 inputs while the last two aforementioned inputs are unobservable and thus require management’s judgment and are considered Level 3 inputs.  A similar 5% decrease or increase in the stock volatility has an inverse effect to the change in the liability and would result in an approximately $0.5 million decrease or increase, respectively. 

 

The following is a reconciliation of changes in fair value of net derivative assets and liabilities classified as Level 3:

 

 

 

 

---

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

Certain assets and liabilities are reported at fair value on a nonrecurring basis in our consolidated balance sheets.  The following methods and assumptions were used to estimate the fair values:

 

Goodwill - Goodwill is tested annually at year end for impairment.  The first step of that process is to compare the fair value of the reporting unit to which goodwill has been assigned to the carrying amount of the associated net assets and goodwill.  Significant Level 3 inputs may be used in the determination of the fair value of the reporting unit, including present values of expected cash flows from operations.

 

When we are required to measure fair value, and there is not a market observable price for the asset or liability, or a market observable price for a similar asset or liability, we generally utilize an income valuation approach.  This approach utilizes management’s best assumptions regarding expectations of projected cash flows, and discounts the expected cash flows using a commensurate risk adjusted discount rate.  Such evaluations involve a significant amount of judgment since the results are based on expected future events or conditions, such as sales prices; estimates of future oil and gas production; development and operating costs and the timing thereof; economic and regulatory climates and other factors.  Our estimates of future net cash flows are inherently imprecise because they reflect management’s expectation of future conditions that are often outside of management’s control.  However, assumptions used reflect a market participant’s view of long-term prices, costs and other factors, and are consistent with assumptions used in our business plans and investment decisions.

 

 

Note 21 – Derivative Instruments

 

We had embedded derivatives related to debt instruments at December 31, 2013 and 2012.  The fair market value of these derivative instruments is included in our balance sheet as follows:

 

 

 

 

 

---

 

The effect of the derivatives not designated as hedges on our results of operations was as follows:

 

 

 

 

 

 

 

Note 22 – Commitments and Contingencies

 

General

 

The oil and gas industry is subject to regulation by federal, state and local authorities.  In particular, oil and gas production operations and economics are affected by environmental protection statutes, tax statutes and other laws and regulations relating to the petroleum industry.  We believe we are in compliance with all federal, state and local laws, regulations applicable to Endeavour and its properties and operations, the violation of which would have a material adverse effect on us or our financial condition.

 

Commitments Related to Asset Retirement Obligations

 

We have several agreements related to abandonment liabilities for certain of our U.K. oil and gas properties.  Under these agreements, unaffiliated third parties pledged cash to secure letters of credit covering certain of our abandonment liabilities and we agreed to reimburse the pledged cash in the event that the letters of credit are drawn and pledged cash is utilized to satisfy the commitment.  We have no cash collateral associated with these agreements and the commitments under the agreements are not recorded as liabilities.  The associated abandonment obligations are recorded in other long-term liabilities as part of our asset retirement obligations.  Fees and expenses related to these agreements are included in “Letter of credit fees” in other expenses on our condensed consolidated statement of operations.

 

Decommissioning Security Agreements

 

Procurement Agreement

On January 9, 2013, we entered into a LOC Procurement agreement (the “Procurement Agreement”) with an unaffiliated third party entity, which matures on July 9, 2014.  The

---

 

Procurement Agreement was entered into in connection with the unaffiliated third party’s entry into a credit support arrangement with a providing bank.  Pursuant to this credit support arrangement, the third party pledged cash, contributed by one of our shareholders, to secure letters of credit in the amount of $33.0 million.  The letters of credit secure decommissioning obligations in connection with certain of our U.K. license agreements.

 

Under the Procurement Agreement, we agreed:

 

The Procurement Agreement contains customary representations, warranties and non-financial covenants.  We also issued warrants to purchase a total of 1,000,000 shares of our common stock at an exercise price of $7.31 per share to the investor.  The warrants expire on January 9, 2018 and are subject to customary anti-dilution provisions.

 

Concurrent with our entry into the LOC Procurement Agreement, we terminated the IVRRH Reimbursement Agreement dated May 23, 2012, which secured letters of credit.  Upon termination of the IVRRH Reimbursement Agreement, we paid all outstanding and accrued fees totaling approximately $3.8 million.

 

Concurrent our entry into the Combined Procurement Agreement on January 24, 2014, the LOC Procurement Agreement was terminated, and we paid all outstanding and accrued fees totaling approximately $0.201 million.  Additional discussion of the Combined Procurement Agreement and the LOC Procurement Agreement termination can be found in Note 26 “Subsequent Events.”

 

Reimbursement Agreements

 

During the second quarter of 2012, we entered into two reimbursement agreements related to abandonment liabilities for certain of our U.K. oil and gas properties.  Under these agreements, unaffiliated third parties pledged cash to secure letters of credit covering certain of our abandonment liabilities and we agreed to reimburse the pledged cash in the event that the letters of credit are drawn and pledged cash is utilized to satisfy the commitment.  We have no cash collateral associated with the reimbursement agreements and the commitments under the reimbursement agreements are not recorded as liabilities.  The associated abandonment obligations are recorded in other long-term liabilities as part of our asset retirement obligations.  Fees and expenses related to the reimbursement agreements are included in other expenses on our condensed consolidated statement of operations.

---

 

 

The first reimbursement agreement, covered approximately $33 million and was related to our decommissioning obligations at the IVRRH, Renee and Rubie (collectively “IVRRH”) fields where we are currently paying certain asset retirement costs.  In connection with this reimbursement agreement, we issued warrants to purchase two million shares of our common stock, with an exercise price of $10.50 per share, to the investors.  With the execution of the Procurement Agreement, on January 10, 2013, we terminated the IVRRH Reimbursement Agreement and paid all outstanding and accrued fees totaling approximately $3.8 million.

 

The second reimbursement agreement covers approximately $120 million related to our decommissioning obligations for the Alba field (the “Alba Reimbursement Agreement) and matures on June 30, 2014.  We pay a fee of 13% per year, payable quarterly, computed based on the outstanding amount of each letter of credit.  Our obligations under the Alba Reimbursement Agreement are secured on a pari passu basis with our obligations under the Revolving Credit Facility by a first lien on substantially all of our assets.  As of December 31, 2013, we do not expect to begin decommissioning activities for the Alba field for many years.  The timing of decommissioning activities will be determined by the ultimate performance and life of the reservoir, which is not expected to occur until 2029 or later.

 

With the execution of the Combined Procurement Agreement, on January 24, 2014, we terminated the Alba Reimbursement and paid all outstanding and accrued fees totaling approximately $ 122 million.  Additional discussion of the Combined Procurement Agreement and the termination of the Alba Reimbursement Agreement can be found in Note 26 “Subsequent Events.”

 

Terminated Acquisition of Marcellus Assets

 

On July 17, 2011, we entered into agreements with SM Energy Company and certain other sellers named therein (“SM Energy”) for the purchase of oil and gas leases, producing properties, geophysical data, a pipeline and related assets in the Marcellus shale play in Pennsylvania for aggregate consideration of approximately $110 million (the “SM Purchase Agreements”).  We terminated the agreements on December 14, 2011, based on our conclusion that (i) the title defects we identified, after analyzing SM Energy’s responses to the notice of defects and valuation of the defects; and (ii) the condition of the pipeline was not in compliance with applicable regulatory standards.

 

SM Energy filed a lawsuit against us in Texas state court on December 20, 2011 alleging that we breached the SM Purchase Agreements by terminating them and refusing to close on the transactions.  SM Energy seeks the award of unspecified actual damages, including costs and reasonable attorney’s fees, and specific performance.  On January 17, 2012, we filed an answer and counterclaim denying the allegations and seeking the return of our $6 million deposit, which we believe we are entitled to recover pursuant to the terms of the SM Purchase Agreements, and

---

 

for the damages that we suffered as a result of SM Energy’s misrepresentations.  The case is presently scheduled for trial to commence in the second quarter of 2014.  We intend to contest the case vigorously.

 

Operating Leases

 

At December 31, 2013, we have leases for office space and equipment with lease payments as follows:

 

 

 

 

 

 

Note 23 – Segment and Geographic Information

 

We have determined we have one reportable operating segment being the acquisition, exploration and development of oil and gas properties.  Our operations are conducted in geographic areas as follows:

 

 

 

 

 

 

 

 

---

 

Note 24 – Quarterly Financial Data (Unaudited)

 

 

 

 

 

 

 

 

Note 25 –  Guarantor Subsidiaries

 

Certain of our wholly-owned domestic subsidiaries have, jointly and severally, fully and unconditionally guaranteed the 2018 Notes.  Pursuant to SEC regulations, we have presented in columnar format the condensed consolidating financial information for Endeavour International Corporation, the guarantor subsidiaries on a combined basis, and all non-guarantor subsidiaries on a combined basis.

 

The subsidiary guarantees are unsecured obligations of each subsidiary guarantor and rank equally in right of payment with all senior indebtedness of that subsidiary guarantor and senior in right of payment to all subordinated indebtedness of that subsidiary guarantor.  The subsidiary guarantees are effectively subordinated to any secured indebtedness of the subsidiary guarantor with respect to the assets securing the indebtedness.  In addition, the subsidiary guarantees may be released in certain customary circumstances, including (i) the sale of all or substantially all of

---

 

the properties or assets of a guarantor, (ii) the sale of the capital stock of a guarantor, (iii) the designation of a guarantor as an “Unrestricted Subsidiary,” (iv) upon legal defeasance of the 2018 Notes or satisfaction and discharge of the indentures governing the 2018 Notes, (v) upon the liquidation or dissolution of the guarantor or (vi) if the guarantor ceases to guarantee other of our indebtedness and ceases to be a material subsidiary, each of which is subject to important limitations in the indentures governing the 2018 Notes.

 

Condensed consolidating financial statements for our guarantor subsidiaries and non-guarantor subsidiaries are presented in the following tables: 

 

---

 

 

 

 

---

 

 

 

 

 

 

 

 

---

 

 

 

 

 

---

 

 

 

 

 

---

 

 

 

---

 

 

 

Note 26– Subsequent Events

 

Term Loan Facility

 

On January 24, 2014, we entered into a credit agreement for a $255 million senior secured first lien term loan facility (“Term Loan Facility”) whereby the lenders advanced $125 million and the Combined Procurement Agreement, discussed below.  The proceeds of the credit agreement were used to repay the outstanding amounts under our Revolving Credit Facility.  The repayment included a prepayment fee and accrued interest of approximately $2.0 million.  Subsequent to the repayment, the Revolving Credit Facility was terminated and all of the liens on our collateral obligations were released.  For additional discussion of the Revolving Credit Facility, see Note 10 “Debt Obligations.”

 

The Term Loan Facility bears quarterly interest of LIBOR plus 7.00% annually (provided LIBOR equals at least 1.25% annually) and will mature on the earlier of (a) November 30, 2017 and (b) the date 91 days prior to the maturity of the company’s 5.5% convertible senior notes due 2016 and 11.5% convertible notes due 2016, provided the notes have not been converted, cancelled, extinguished, extended or refinanced prior to that date with a maturity date prior to March 1, 2018.

 

Borrowings under the Term Loan Facility are unconditionally guaranteed by us and each of our current and future restricted subsidiaries.  The credit agreement contains covenants and provisions with respect to events of default that are substantially similar to the covenants in the indentures governing our 2018 Notes including, but not limited to, restrictions on our ability to: (i) pay distributions or repurchase or redeem the our capital stock or subordinated debt; (ii) make certain investments; (iii) incur additional indebtedness (iv) create or incur certain liens; (v) sell assets; (vi) consolidate, merge or transfer all or substantially all of our assets; (vii) enter into agreements that restrict distributions from our restricted subsidiaries to the Company; (viii) engage in transactions with affiliates; and (ix) create unrestricted subsidiaries.  In addition, the Term Loan Facility contains various financial and technical covenants, including:

 

 

---

 

Entry into Procurement Agreement

 

On January 24, 2014, we also entered into a letter of credit procurement agreement (the “Combined Procurement Agreement”) with an unaffiliated third party (Payee), where we agreed to reimburse the Payee for any expense incurred by it in connection with the posting of cash collateral to secure letters of credit issued for our account in the amount of approximately £78 million (approximately $130 million as of January 24, 2014).  The letters of credit secure decommissioning obligations in connection with certain of our U.K. licences and have been outstanding and unchanged since 2006.  The Combined Procurement Agreement was entered into to replace the Alba Reimbursement Agreement and the LOC Procurement Agreement.

 

Due to a change in the U.K. tax treatment for decommissioning, we have amended our Decommissioning Securities Agreement for the Alba field.  The new tax law, which allows companies to treat decommissioning on an after-tax basis (including PRT), enables us to reduce our current letter of credit amount on the Alba field from $120 million to approximately $55 million.

 

Under the Combined Procurement Agreement, we agreed to pay a quarterly fee computed at a rate of LIBOR plus 7.00% per year (provided that LIBOR shall equal at least 1.25% per year) on aggregate balance of posted cash collateral.

 

Similar to the Term Loan Facility, posted cash collateral under the Combined Procurement Agreement was issued with an original issue discount of 98.5% and matures on the earlier of (a) November 30, 2017 and (b) the date 91 days prior to the maturity of the Company’s 5.5% convertible senior notes due 2016 and 11.5% convertible notes due 2016, if such notes have not been converted, cancelled, extinguished, extended or refinanced in full prior to such date, with a resulting maturity date not earlier than March 1, 2018.  The Combined Procurement Agreement contains customary representations, warranties and non-financial covenants.  We and each of our current and future restricted subsidiaries have unconditionally guaranteed EEUK’s obligations under the Combined Procurement Agreement.

 

Securities Purchase Agreement

 

In February 2014, we entered into a securities purchase agreement (the “Securities Purchase Agreement”) relating to the issuance of up to $55 million in common stock, warrants and convertible notes.  We closed on an initial $30 million in late February and early March 2014, comprised of:

 

---

 

The purchasers also have a  90-day option (the “Purchasers’ Option”) to purchase up to $25,000,000 of additional common stock, warrants and convertible debt on the same terms as the initial issuance.   To the extent the issuance of additional securities would result in the issuance of over 20% of the Company’s outstanding common stock, such issuance will be subject to the receipt of stockholder approval in accordance with applicable New York Stock Exchange rules.  The Purchasers’ Option may be extended in connection with the receipt of stockholder approval at the our 2014 annual meeting, in certain circumstances.

 

The 6.5% Convertible Notes will mature one day following the earlier of (i) November 30, 2017 and (ii) 91 days prior to the maturity date of our outstanding 5.5% Convertible Senior Notes due 2016 and our 11.5% Convertible Bonds due 2016, if such securities have not been converted, cancelled or extinguished prior to such date or extended or refinanced in full prior to such date with a resulting maturity date not earlier than March 1, 2018.  Interest is payable on the 6.5% Convertible Notes on quarterly, commencing on June 1, 2014.  The notes are subject to customary events of default.

 

The 6.5% Convertible Notes are:

 

 

 

---

 

Note 27 - Supplemental Oil and Gas Disclosures (Unaudited)

 

 

 

 

---

 

 

 

 

 

---

 

 

 

 

 

---

 

Oil and Gas Reserves

 

Proved reserves are estimated quantities of oil, gas and natural gas liquids that geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions. Proved developed reserves are proved reserves that can reasonably be expected to be recovered through existing wells with existing equipment and operating methods.  The reserve volumes presented are estimates only and should not be construed as being exact quantities.  These reserves may or may not be recovered and may increase or decrease as a result of our future operations and changes in economic conditions.  Our oil and gas reserves were audited by independent reserve engineers at December 31, 2013,  2012 and 2011.  Total proved reserves decreased from 25.7 MMBOE at December 31, 2012 to 23.5 MMBOE at December 31, 2013, primarily due to production sold during the year.

 

 

 

 

 

 

 

 

 

 

---

 

 

 

 

 

 

---

 

 

 

 

Standardized Measure of Discounted Future Net Cash Flows

 

Future cash inflows and future production and development costs are determined by applying average 12-month pricing for the year.  Oil, gas and condensate prices are escalated only for fixed and determinable amounts under provisions in some contracts.  Estimated future income taxes are computed using current statutory income tax rates where production occurs.  The resulting future net cash flows are reduced to present value amounts by applying a 10% annual discount factor.

 

---

 

At December 31, 2013 and 2012, the prices used to determine the estimates of future cash inflows  were as follows:

 

 

 

 

Estimated future cash inflows are reduced by estimated future development, production, abandonment and dismantlement costs based on year-end cost levels, assuming continuation of existing economic conditions, and by estimated future income tax expense.  Income tax expense, both U.S. and foreign, is calculated by applying the existing statutory tax rates, including any known future changes, to the pretax net cash flows giving effect to any permanent differences and reduced by the applicable tax basis.  The effect of tax credits is considered in determining the income tax expense.

 

The standardized measure of discounted future net cash flows is not intended to present the fair market value of our oil and gas reserves.  An estimate of fair value would also take into account, among other things, the recovery of reserves in excess of proved reserves, anticipated future changes in prices and costs, an allowance for return on investment and the risks inherent in reserve estimates.

 

---