UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10‑Q

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

For the quarterly period ended September 30, 2017

OR

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

For the transition period from                 to

Commission File Number: 001‑38019

ENERGY XXI GULF COAST, INC.

(Exact name of registrant as specified in its charter)

(713) 351-3000

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ☑    No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes ☑    No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer” “accelerated filer” “smaller reporting company” and “emerging growth company” in Rule 12b‑2 of the Exchange Act. (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) if the Exchange Act. ◻

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

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.     Yes ☑    No ☐

As of November 2, 2017, there were 33,221,427 shares outstanding of the registrant’s common stock, par value $0.01 per share.

ENERGY XXI GULF COAST, INC.

TABLE OF CONTENTS

GLOSSARY OF TERMS

Bankruptcy Terms

On April 14, 2016 (the “Petition Date”), Energy XXI Ltd (“EXXI Ltd”), an exempt company incorporated under the laws of Bermuda and predecessor of Reorganized EGC (as defined below), Energy XXI Gulf Coast, Inc., then an indirect wholly-owned subsidiary of EXXI Ltd (“EGC”), EPL Oil & Gas Inc., then an indirect wholly-owned subsidiary of EXXI Ltd (“EPL”) and certain other indirect wholly-owned subsidiaries of EXXI Ltd filed voluntary petitions for reorganization in the United States Bankruptcy Court for the Southern District of Texas, Houston Division seeking relief under the provisions of chapter 11 of Title 11 of the United States Code.

In connection therewith, EXXI Ltd and its subsidiaries completed a series of internal reorganization transactions pursuant to which EXXI Ltd transferred all of its remaining assets to EGC (the “Reorganized EGC”). On December 30, 2016 (the “Emergence Date”), the entities emerged from bankruptcy and shares of common stock and common stock warrants of Reorganized EGC were distributed to creditors of the Debtors (defined below) pursuant to the Plan (defined below). In accordance with Accounting Standards Codification (“ASC”) 852, Reorganizations (“ASC 852”), the Reorganized EGC was required to apply fresh start accounting upon EXXI Ltd’s emergence from bankruptcy and it evaluated transaction activity between the Emergence Date and December 31, 2016 and concluded that an accounting convenience date of December 31, 2016 (the “Convenience Date”) was appropriate.

As used throughout this quarterly report on Form 10‑Q for the quarter ended September 30, 2017 (this “Quarterly Report”), references to “Reorganized EGC,” the “Company,” “we,” “our,” “Successor,” “Successor Company” or similar terms when used in reference to the period subsequent to the emergence from the bankruptcy refer to Reorganized EGC, the new parent entity and successor issuer of EXXI Ltd pursuant to Rule 12g‑3(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). References in this Quarterly Report to “EXXI Ltd,” “we,” “our,” “Predecessor,” “Predecessor Company” or similar terms when used in reference to the periods prior to the emergence from the bankruptcy refer to EXXI Ltd, the predecessor and former parent entity that was dissolved upon the completion of the Bermuda Proceeding (as defined below). References in this Quarterly Report to “EGC” refer to EGC in the periods prior to the emergence from the bankruptcy during which it was the indirect wholly-owned operating subsidiary of EXXI Ltd.

Below is a list of additional terms relating to the bankruptcy as used throughout this Quarterly Report:

Bankruptcy Code means title 11 of the United States Code, as amended and in effect during the pendency of the Chapter 11 Cases.

Bankruptcy Court means the United States Bankruptcy Court for the Southern District of Texas, Houston Division.

Bankruptcy Petitions means the Debtors’ voluntary petitions for reorganization in the Bankruptcy Court seeking relief under the provisions of Chapter 11 under the caption In re Energy XXI Ltd, et al., Case No. 16‑31928.

Bermuda Proceeding means the official liquidation proceeding for EXXI Ltd under the laws of Bermuda commenced pursuant to the winding-up petition before the Bermuda Court and completed as of June 29, 2017.

Bermuda Court means the Supreme Court of Bermuda, Commercial court.

Chapter 11 means chapter 11 of the Bankruptcy Code.

Chapter 11 Cases means the Debtors’ procedurally consolidated and jointly administered Chapter 11 cases in the Bankruptcy Court.

Confirmation Order means the order dated December 13, 2016 entered by the Bankruptcy Court approving and confirming the Plan pursuant to section 1129 of the Bankruptcy Code.

Debtors means, collectively, the following: Anglo-Suisse Offshore Pipeline Partners, LLC, Delaware EPL of Texas, LLC, Energy Partners Ltd., LLC, Energy XXI GOM, LLC, EGC, Energy XXI Holdings, Inc., Energy XXI, Inc., Energy XXI Leasehold, LLC, EXXI Ltd, Energy XXI Natural Gas Holdings, Inc., Energy XXI Offshore Services, Inc., Energy XXI Onshore, LLC, Energy XXI Pipeline, LLC, Energy XXI Pipeline II, LLC, Energy XXI Services, LLC, Energy XXI Texas Onshore, LLC, Energy XXI USA, Inc., EPL of Louisiana, L.L.C., EPL, EPL Pioneer Houston, Inc., EPL Pipeline,

L.L.C., M21K, LLC, MS Onshore, LLC, Natural Gas Acquisition Company I, LLC, Nighthawk, L.L.C., and Soileau Catering, LLC.

Emergence Date means December 30, 2016.

Convenience Date means December 31, 2016.

Petition Date means April 14, 2016.

Plan means the Debtors’ Second Amended Proposed Joint Chapter 11 Plan of Reorganization (as amended, modified, or supplemented from time to time).

Reorganized Debtors means the Debtors after completing the series of internal reorganization transactions in accordance with the Plan, pursuant to which, among other things, EXXI Ltd transferred all of its remaining assets to Reorganized EGC.

Industry Terms

In addition, below is a list of terms that are common to our industry and where applicable used throughout this Quarterly Report:

Completion refers to the work performed and the installation of permanent equipment for the production of natural gas and/or crude oil from a recently drilled or recompleted well.

Costs and expenses include direct and indirect expenses, including general and administrative expenses, incurred to manage, operate and maintain wells and related equipment and facilities.

Development well is a well drilled within the proved area of an oil or gas reservoir to the depth of a stratigraphic horizon known to be productive.

Dry Well is an exploratory, development or extension well that proves to be incapable of producing either oil or gas in sufficient quantities to justify completion as an oil or gas well.

Exploitation is drilling wells in areas proven to be productive.

Exploratory well is a well drilled to find and produce oil or gas in an unproved area, to find a new reservoir in a field previously found to be productive of oil or gas in another reservoir, or to extend a known reservoir. Generally, an exploratory well is any well that is not a development well or a service well.

Field is an area consisting of a single reservoir or multiple reservoirs all grouped on or related to the same individual geological structural feature and/or stratigraphic condition. For a complete definition of a field, refer to Rule 4‑10(a)(8) of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”).

Formation is a stratum of rock that is recognizable from adjacent strata consisting mainly of a certain type of rock or combination of rock types with thickness that may range from less than two feet to hundreds of feet.

Gathering and transportation is the cost of moving crude oil from several wells into a single tank battery or major pipeline.

Gross acres or gross wells are the total acres or wells in which a working interest is owned.

Horizon is a zone of a particular formation or that part of a formation of sufficient porosity and permeability to form a petroleum reservoir.

Lease operating or well operating expenses are expenses incurred to operate the wells and equipment on a producing lease.

Net acreage and net oil and gas wells are obtained by multiplying gross acreage and gross oil and gas wells by the fractional working interest owned in the properties.

Oil includes crude oil, condensate and NGLs.

Pipeline facility fee is the straight line lease expense attributable to certain real and personal property constituting a subsea pipeline gathering system located in the shallow Gulf of Mexico shelf and storage and onshore processing facilities at Grand Isle, Louisiana (“GIGS”).

Plugging and abandonment refers to the sealing off of fluids in the strata penetrated by a well so that the fluids from a stratum will not escape into another or to the surface. Regulations of many states and the federal government require the plugging of abandoned wells.

Production costs are costs incurred to operate and maintain our wells and related equipment and facilities. For a complete definition of production costs, please refer to Rule 4‑10(a)(20) of Regulation S-X as promulgated by the SEC.

Productive well is an exploratory, development or extension well that is not a dry well.

Proved area refers to the part of a property to which proved reserves have been specifically attributed.

Proved reserves are those quantities of oil and gas, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible, from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations, prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. For a complete definition of proved reserves, refer to Rule 4‑10(a)(22) of Regulation S-X as promulgated by the SEC.

Proved developed reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. For a complete definition of proved developed oil and gas reserves, refer to Rule 4‑10(a)(6) of Regulation S-X as promulgated by the SEC.

Proved undeveloped reserves are reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. For a complete definition of proved undeveloped oil and gas reserves, refer to Rule 4‑10(a)(314) of Regulation S-X as promulgated by the SEC.

Reservoir refers to a porous and permeable underground formation containing a natural accumulation of producible oil and/or gas that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs.

Seismic is an exploration method of sending energy waves or sound waves into the earth and recording the wave reflections to indicate the type, size, shape and depth of subsurface rock formations. 2‑D seismic provides two-dimensional information and 3‑D seismic provides three-dimensional pictures.

Unevaluated properties refers to properties for which a determination has not been made as to whether the property contains  proved reserves.

Working interest is the operating interest that gives the owner the right to drill, produce and conduct operating activities on the property and a share of production.

Workover refers to the operations on a producing well to restore or increase production and such costs are expensed. If the operations add new proved reserves, such costs are capitalized.

Zone is a stratigraphic interval containing one or more reservoirs.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

Certain statements and information in this Quarterly Report may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The words “believe,” “expect,” “anticipate,” “plan,” “intend,” “foresee,” “should,” “would,” “could” or other similar expressions are intended to identify forward-looking statements, which are generally not historical in nature. These forward-looking statements are based on certain assumptions and analyses made by the Company in light of its experience and perception of historical trends, current conditions and expected future developments as well as other factors the Company believes are appropriate under the circumstances and their potential effect on us. While management believes that these forward-looking statements are reasonable, such statements are not guarantees of future performance and the actual results or developments anticipated may not be realized or, even if substantially realized, may not have the expected consequences to or effects on the Company’s business or results. Our forward-looking statements involve significant risks and uncertainties (some of which are beyond our control) and assumptions that could cause actual results to differ materially from our historical experience and our present expectations or projections. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to those summarized below:

For additional information regarding known material factors that could cause our actual results to differ from our projected results, please read (1) Part I, “Item 1A. Risk Factors” in our transition report on Form 10‑K for the six month transition period ended December 31, 2016 (the “2016 Transition Report”); (2) Part II, “Item 1A. Risk Factors” in this Quarterly Report; (3) our reports and registration statements filed from time to time with the SEC; and (4) other public announcements we make from time to time.

Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statements after the date upon which they are made, whether as a result of new information, future events or otherwise.

PART I – FINANCIAL INFORMATION

ITEM 1.   Unaudited Consolidated Financial Statements

ENERGY XXI GULF COAST, INC.

CONSOLIDATED BALANCE SHEETS

(In Thousands, except share information)

See accompanying Notes to Consolidated Financial Statements.

ENERGY XXI GULF COAST, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, except per share information)

(Unaudited)

See accompanying Notes to Consolidated Financial Statements.

ENERGY XXI GULF COAST, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

See accompanying Notes to Consolidated Financial Statements.

ENERGY XXI GULF COAST, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 — Organization

Nature of Operations

Energy XXI Gulf Coast, Inc. (“EGC”), a Delaware corporation, was incorporated on February 7, 2006. Prior to emergence from the Chapter 11 Cases, EGC was an indirect wholly-owned operating subsidiary of Energy XXI Ltd (“EXXI Ltd”). We are headquartered in Houston, Texas and have historically engaged in the acquisition, exploration, development and operation of oil and natural gas properties onshore in Louisiana and Texas and offshore in the Gulf of Mexico Shelf (“GoM Shelf”), which is an area in less than 1,000 feet of water.

Emergence from Chapter 11

On April 14, 2016, EXXI Ltd, an exempt company incorporated under the laws of Bermuda and predecessor of the Reorganized EGC (as defined below), EGC, EPL Oil & Gas Inc., then an indirect wholly-owned subsidiary of EXXI Ltd (“EPL”) and certain other indirect wholly-owned subsidiaries of EXXI Ltd filed voluntary petitions for reorganization in the Bankruptcy Court seeking relief under the provisions of Chapter 11.

On December 13, 2016, the Bankruptcy Court entered the Confirmation Order and on December 30, 2016, the Debtors emerged from bankruptcy.

On the Emergence Date, the Debtors satisfied the conditions to effectiveness, the Plan became effective in accordance with its terms and the Debtors emerged from Chapter 11 Cases. In connection therewith, EXXI Ltd and its subsidiaries completed a series of internal reorganization transactions pursuant to which EXXI Ltd transferred all of its remaining assets to EGC (the “Reorganized EGC”), as the new parent entity. Accordingly, Reorganized EGC succeeded to the entire business and operations previously consolidated for accounting purposes by EXXI Ltd. In accordance with Accounting Standards Codification (“ASC”) 852, Reorganizations (“ASC 852”), the Reorganized EGC applied fresh start accounting upon the Predecessor’s emergence from bankruptcy and it evaluated transaction activity between the Emergence Date and December 31, 2016 and concluded that an accounting convenience date of December 31, 2016 (the “Convenience Date”) was appropriate.

For reporting purposes, the pre-reorganization predecessor reflects the business that was transferred to the Reorganized EGC. The financial statements of the pre-reorganization predecessor are EXXI Ltd’s consolidated financial statements.

Our common stock began trading on the NASDAQ Global Select Market (“NASDAQ”) under the symbol “EXXI” at the opening of business on February 28, 2017.

Note 2 – Summary of Significant Accounting Policies and Recent Accounting Pronouncements

Principles of Consolidation and Reporting. The accompanying consolidated financial statements on September 30, 2017 include the accounts of Reorganized EGC and its wholly-owned subsidiaries and for the prior periods, the accompanying consolidated financial statements include the accounts of EXXI Ltd and its wholly-owned subsidiaries and have been prepared in accordance with accounting principles generally accepted in the U.S. (“U.S. GAAP”). All intercompany accounts and transactions are eliminated in consolidation. Our interests in oil and natural gas exploration and production ventures and partnerships are proportionately consolidated. The Predecessor’s consolidated financial statements for the prior periods include certain reclassifications, including a $3.6 million and $12.3 million reclassification from lease operating expenses to gathering and transportation expenses and a $10.2 million and $30.5 million reclassification from gathering and transportation expenses to pipeline facility fee expense for the three and nine months ended September 30, 2016, respectively, to conform to the current presentation. Those reclassifications did not have any impact on the Predecessor’s previously reported consolidated result of operations or cash flows.

For periods subsequent to filing the Bankruptcy Petitions, we have prepared the Predecessor’s consolidated financial statements in accordance with ASC 852.  ASC 852 requires that the financial statements distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business.

Correction of Immaterial Errors. Our unaudited consolidated financial statements include certain adjustments that pertain to prior periods. For the three months ended September 30, 2017, impairment of oil and natural gas properties includes a non-cash credit of $2.4 million related to the utilization of incorrect capitalized asset retirement costs within the first quarter 2017 full cost ceiling test computation and oil sales includes $2.0 million of additional revenue relating to prior periods.  Additionally, the nine months ended September 30, 2017 includes non-cash credit adjustments to reorganization items of $3.8 million to adjust the fresh start accounting opening balance sheet related to asset retirement obligations and other property, plant and equipment, a credit adjustment to oil sales of $1.6 million for additional revenue related to 2016, and non-cash adjustments of $0.7 million for other immaterial errors.  The amounts are not deemed material with respect to the prior year, the previous quarters in 2017, or the anticipated results for fiscal year 2017.

Fresh-start Accounting. Upon emergence from bankruptcy, in accordance with ASC 852 related to fresh-start accounting, Reorganized EGC became a new entity for financial reporting purposes. Upon adoption of fresh-start accounting, our assets and liabilities were recorded at their fair values as of the Convenience Date. The effects of the Plan and the application of fresh-start accounting were reflected in our consolidated balance sheet as of December 31, 2016 and the related adjustments thereto were recorded in the consolidated statement of operations of the Predecessor as reorganization items in the 2016 Transition Report. Accordingly, Reorganized EGC’s consolidated financial statements as of and subsequent to December 31, 2016 are not and will not be comparable to the Predecessor consolidated financial statements prior to the Convenience Date. Our consolidated financial statements and related footnotes are presented with a black line division which delineates the lack of comparability between amounts presented for the three and nine months ended September 30, 2017 and comparable prior periods. Although our accounting policies are the same as that of our Predecessor’s, our financial results for future periods following the application of fresh-start accounting will be different from historical trends, and the differences may be material.

Use of Estimates. The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates of proved reserves are key components of our depletion rate for our proved oil and natural gas properties and the full cost ceiling test limitation. The Predecessor’s proved reserves quantities of 86.6 MMBOE as of June 30, 2016 were estimated and compiled by its internal reservoir engineers and audited by Netherland, Sewell & Associates, Inc., independent oil and gas consultants (“NSAI”). As of December 31, 2016, proved reserves quantities of 121.9 MMBOE were independently estimated and compiled by our internal reservoir engineers. Pursuant to the terms of our Exit Facility, a third party engineer report is required annually, with the first report due by May 31, 2017 and we engaged NSAI to provide that report.  The first NSAI report was delivered by us on May 23, 2017, and NSAI estimated our proved reserves quantities of 109.4 MMBOE as of March 31, 2017 in accordance with the guidelines established by the SEC. Other items subject to estimates and assumptions include fair value estimates used in fresh start accounting; accounting for acquisitions and dispositions; carrying amounts of property, plant and equipment; asset retirement obligations; deferred income taxes; valuation of derivative financial instruments; reorganization items and liabilities subject to compromise, among others. Accordingly, our accounting estimates require the exercise of judgment by management in preparing such estimates. While we believe that the estimates and assumptions used in preparation of our consolidated financial statements are appropriate, actual results could differ from those estimates, and any such differences may be material.

Interim Financial Statements. The accompanying consolidated financial statements have been prepared in accordance with U.S. GAAP 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 U.S. GAAP for complete financial statements. In the opinion of management, all adjustments of a normal and recurring nature considered necessary for a fair presentation have been included in the accompanying consolidated financial statements. The results of operations for the interim period are not necessarily indicative of the results that will be realized for the entire fiscal year. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the 2016 Transition Report.

Recent Accounting Pronouncements. In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014‑09, Revenue from Contracts with Customers (“ASU 2014‑09”), as a new Accounting Standards Codification (ASC) Topic, ASC 606. ASU 2014‑09 is effective for us beginning in the first quarter of 2018. In May 2016, the FASB issued ASU 2016-11, which rescinds certain SEC guidance in the related ASC,

including guidance related to the use of the "entitlements" method of revenue recognition used by EGC.  We have developed a project plan for the implementation of ASC 606 in the first quarter of 2018. Based on our assessment to date of revenue contracts with customers against the requirements of the standard, we have not identified any changes to the timing of revenue recognition based on the requirements of ASC 606 that would have a material impact on our consolidated financial statements. We plan to adopt ASC 606 using the modified retrospective method that requires application of the new standard prospectively from the date of adoption with a cumulative effect adjustment, if any, recorded to retained earnings as of January 1, 2018.

In February 2016, the FASB issued ASU No. 2016‑02, Leases  (“ASU 2016‑02”), to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. To meet that objective, the FASB amended the FASB Accounting Standards Codification and created Topic 842, Leases. The guidance in this ASU supersedes Topic 840, Leases. The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for public entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. In the normal course of business, we enter into capital and operating lease agreements to support our operations. We are in the initial stages of evaluating the provisions of ASU 2016‑02 to determine the quantitative effects it will have on our consolidated financial statements and related disclosures. We believe the adoption and implementation of this ASU could have a material impact on our balance sheet resulting from an increase in both assets and liabilities relating to our leasing activities.

In March 2016, the FASB issued ASU No. 2016‑09 (“ASU 2016‑09”), Compensation - Stock Compensation, to reduce complexity and enhance several aspects of accounting and disclosure for share-based payment transactions, including the accounting for income taxes, award forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU 2016‑09 was effective for annual and interim periods beginning after December 15, 2016, with earlier application permitted. Our adoption of ASU 2016‑09 on January 1, 2017 had no effect on our consolidated financial position, results of operations or cash flows.

In June 2016, the FASB issued ASU No. 2016‑13, Credit Losses, Measurement of Credit Losses on Financial Instruments (“ASU 2016‑13”). ASU 2016‑13 significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. The standard will replace today’s incurred loss approach with an expected loss model for instruments measured at amortized cost. Entities will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. This ASU is effective for public entities for annual and interim periods beginning after December 15, 2019. Early adoption is permitted for all entities for annual periods beginning after December 15, 2018, and interim periods therein. We have not yet determined the effect of this standard on our consolidated financial position, results of operations or cash flows.

In August 2016, the FASB issued ASU No. 2016‑15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (“ASU 2016‑15”). The new guidance in ASU 2016‑15 is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The new standard is effective for public entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted provided that all of the amendments are adopted in the same period. The guidance requires application using a retrospective transition method. We do not expect the adoption of ASU 2016‑15 will have a material impact on our statement of cash flows and related disclosures.

In November 2016, the FASB issued ASU No. 2016‑18, Statement of Cash Flows (Topic 230): Restricted Cash (ASU 2016‑18). ASU 2016‑18 requires amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows. This ASU will be effective for annual and interim periods beginning after December 15, 2017, with earlier application permitted. We do not expect the adoption of ASU 2016‑18 will have a material impact on our statement of cash flows and related disclosures.

Note 3 – Property and Equipment

Property and equipment consists of the following (in thousands):

Under the full cost method of accounting, at the end of each financial reporting period, we compare the present value of estimated future net cash flows from proved reserves (computed using the unweighted arithmetic average of the first-day-of-the-month historical price, net of applicable differentials, for each month within the previous 12‑month period discounted at 10%, plus the lower of cost or fair market value of unevaluated properties and excluding cash flows related to estimated abandonment costs associated with developed properties) to the net capitalized costs of oil and natural gas properties, net of related deferred income taxes. We refer to this comparison as a “ceiling test.”  If the net capitalized costs of these oil and natural gas properties exceed the estimated discounted future net cash flows, we are required to write-down the value of our oil and natural gas properties to the amount of the discounted cash flows.  For the nine months ended September 30, 2017, our ceiling test computations resulted in cumulative impairments of our oil and natural gas properties of $40.8  million, which are primarily the result of a $44.1 million ceiling impairment recorded during the first quarter of 2017.  During the first quarter of 2017, we incurred an impairment primarily due to the difference in the present value of estimated future net cash flows from proved reserves as of March 31, 2017 prepared by NSAI compared with the present value of estimated future net cash flows from proved reserves as of December 31, 2016 prepared by our internal reservoir engineers. The primary non-commodity price factors contributing to the difference between the NSAI March 31, 2017 SEC reserve report and the internally-prepared December 31, 2016 SEC reserve report are: (i) technical reassessments, (ii) higher capital costs and (iii) production during the first quarter of 2017. The impact of those factors was partially offset by higher SEC average commodity prices for both crude oil and natural gas. If oil and natural gas prices decline or our costs increase, we may incur further impairment to our full cost pool.

Costs associated with unevaluated properties, all of which were recorded as part of fresh start accounting, are transferred to evaluated properties either (i) ratably over a period of the related field’s proved reserve life, or (ii) upon determination as to whether there are any proved reserves related to the unevaluated properties or the costs are impaired or capital costs associated with the development of these properties will not be available.  For the nine months ended September 30, 2017, the costs associated with unevaluated properties decreased by $157 million, of which $105.2 million was transferred to evaluated properties due to the forward price outlook and management intent making certain unevaluated properties uneconomical and the remaining $51.8 million was the ratable amortization to the evaluated properties.

Note 4 – Long-Term Debt

As of September 30, 2017 and December 31, 2016 our outstanding debt consisted of the following (in thousands):

Exit Facility

Pursuant to the Plan, on the Emergence Date, the Company, as Borrower, and the other Reorganized Debtors entered into a secured Exit Facility which matures on December 30, 2019. The Exit Facility is secured by mortgages on at least 90% of the value of our and our subsidiary guarantors’ proved developed producing reserves as well as our total proved reserves. The Exit Facility consists of two facilities: (i) a term loan facility (the “Exit Term Loan”) resulting from the conversion of the remaining drawn amount plus accrued default interest, fees and expenses under the Debtors’ Second Amended and Restated First Lien Credit Agreement (the “Prepetition Revolving Credit Facility”) of approximately $74 million and (ii) a revolving credit facility (the “Exit Revolving Facility”) resulting from the conversion of the former EGC tranche of the Prepetition Revolving Credit Facility which provides, subject to the limitations noted below, for the making of revolving loans and the issuance of letters of credit.

Interest on the outstanding amount of the Exit Term Loan, at the Company’s option, will accrue at an interest rate equal to either: (i) the Alternative Base Rate (as defined in the Exit Facility) plus 3.5% per annum or (ii) the one-month LIBO Rate (as defined in the Exit Facility) plus 4.5% per annum. Interest on the Exit Term Loan bearing interest at the Alternative Base Rate will be payable quarterly; interest on the Exit Term Loan bearing interest at the LIBO Rate will be payable monthly.

On the Emergence Date, the aggregate credit capacity under the Exit Revolving Facility was approximately $227.8 million, all of which was utilized to maintain in effect outstanding letters of credit, including $225 million of letters of credit issued in favor of ExxonMobil to secure certain plugging and abandonment obligations related to assets in the GoM. On April 26, 2016, pursuant to the redetermination of our plugging and abandonment liabilities with ExxonMobil, it was agreed that subsequent to the Predecessor Company’s emergence from the Chapter 11 proceedings, the letters of credit issued in favor of ExxonMobil would be reduced to $200 million from the existing amount of $225 million and, on March 13, 2017, the letters of credit issued in favor of ExxonMobil were reduced to $200 million. Each existing letter of credit may be renewed or replaced (in each case, in an outstanding amount not to exceed the outstanding amount of the existing letter of credit).

Following the reduction of $25 million in the letters of credit issued in favor of ExxonMobil, the credit capacity under the Exit Revolving Facility was permanently reduced by 50% of the $25 million reduction in the letters of credit, or $12.5 million. The remaining 50%, or $12.5 million, of such aggregate reduction is available for borrowing, under specific circumstances, as revolving loans subject to a maximum for all such loans of (i) $25 million prior to the date the borrowing base is initially determined and (ii) the borrowing base, on and after the date the borrowing base is initially determined. The borrowing base will be initially determined at a date elected by the Company, and will be redetermined semi-annually thereafter. Currently, the Company has not elected a date for the initial borrowing base determination.

The Company must make a mandatory prepayment of the revolving loans and, if necessary, cash collateralize the outstanding letters of credit if a reduction in the revolving credit capacity would cause the revolving credit exposure to exceed the revolving credit capacity. On or after the determination of the borrowing base, the Company must also make a mandatory prepayment of the revolving loans and, if necessary, cash collateralize the outstanding letters of credit not in favor of ExxonMobil if a borrowing base deficiency arises.

The Exit Facility contains covenants and events of default customary for reserve-based lending facilities. In addition, for each fiscal quarter ending on and after March 31, 2018, the Company must maintain a Current Ratio (as

defined in the Exit Facility) of no less than 1.00 to 1.00 and a First Lien Leverage Ratio (as defined in the Exit Facility) of no greater than 4.00 to 1.00 calculated on a trailing four quarter basis.

Furthermore, for each fiscal quarter ending on and after March 31, 2018, if the Asset Coverage Ratio (as defined in the Exit Facility) is less than 1.50 to 1.00, the Company must make a mandatory prepayment of the Exit Term Loan in an amount equal to the lesser of (i) 7.5% of the aggregate outstanding principal amount of the Exit Term Loan on the Emergence Date and (ii) the then outstanding principal amount of the Exit Term Loan. Based upon the Company’s current expectations with respect to its capital resources, capital expenditures, results from operations and commodity prices, the Company believes that it is reasonably likely that it will be required to make a mandatory prepayment with respect to each fiscal quarter beginning with the quarter ending March 31, 2018. In that case, the first such payment of approximately $5.55 million would be required to be paid during the fiscal quarter ending June 30, 2018. Any such mandatory prepayment would not, in and of itself, constitute a default under the Exit Facility.

Interest on the outstanding amount of revolving loans borrowed under the Exit Revolving Facility, at the Company’s option, will accrue at an interest rate equal to either (i) the Alternative Base Rate plus 3.5% per annum or (ii) the one, three or six month LIBO Rate plus 4.5% per annum. Interest on revolving loans that bear interest at the Alternative Base Rate will be payable quarterly; interest on revolving loans that bear interest at the LIBO Rate will be payable at the end of each interest period or, if an interest period exceeds three months, at the end of every three months. The stated amount of each letter of credit issued under the Exit Revolving Facility accrues fees at the rate of 4.5% per annum. There is an issuance fee of 0.25% per annum charged on the stated amount of each letter of credit issued after the Emergence Date.

Unused credit capacity under the Exit Revolving Facility will accrue a commitment fee of 0.50% payable quarterly in arrears.

The Exit Facility is guaranteed by substantially all of the wholly-owned subsidiaries of the Company, subject to customary exceptions, and is secured by first priority security interests on substantially all assets of each Reorganized Debtor guarantor. Under the Exit Facility, the borrower will not declare or make a restricted payment, or make any deposit for any restricted payment. Restricted payments include declaration or payment of dividends.

The Company on March 3, 2017, entered into an amendment to the Exit Facility (the “Amendment”). The Amendment, among other things, included updates necessary to reflect the Company changing its fiscal year end from June 30 to December 31. As a result, the Company must now deliver a December 31 reserve report prepared by a third-party engineer by March 1 of each year (or by May 31 with respect to 2017 only) and a reserve report prepared by the Company’s engineers by September 1 of each year. Further, a second amendment and waiver to the Exit Facility (the “Second Amendment”) was entered into by the Company on April 24, 2017. The Second Amendment amended the requirement of the “as of” date from January 1, 2017 to April 1, 2017, only with respect to the first reserve report prepared by a third-party reservoir engineer. Additionally, the Amendment also revised the calculation of: (i) the net present value of the future net revenues expected to accrue to the proved reserves of the Company and its subsidiaries and (ii) the asset coverage ratio, which are calculated by removing the effects of derivative agreements with any counterparties that are not lenders under the Exit Facility. Furthermore, the requirement for the Company and its subsidiaries to have mortgages covering at least 90% of the total value of their proved reserves was amended to require the mortgages to cover at least 90% of the revised net present value of the proved reserves.

As of September 30, 2017, we had approximately $74 million in borrowings and $202.8 million in letters of credit issued under the Exit Facility.

4.14% Promissory Note

In September 2012, the Predecessor entered into a promissory note of $5.5 million to acquire other property and equipment.  In accordance with the Plan, on the Emergence Date, all outstanding obligations under the promissory note were reinstated.  Under this note, which is secured by such other property and equipment, we were required to make monthly payments of approximately $52,000 and were to pay one lump-sum payment of $3.3 million at maturity in October 2017. This note carried an interest rate of 4.14% per annum.  This note was repaid in full on September 29, 2017.

Interest Expense

For the three and nine months ended September 30, 2017, we incurred interest expense of $3.7 million and $11.1 million, respectively, on our Exit Facility.   For the three months ended September 30, 2016, the Predecessor incurred interest expense of $4.8 million primarily on its Prepetition Revolving Credit Facility and for the nine months ended September 30, 2016, the Predecessor incurred total interest expense of $217 million, of which, $16.7 million relates to Prepetition Revolving Credit Facility, $130.4 million relates to 11% second lien notes, $25.1 million relates to senior notes having interest rates in the range of 7.5% to 9.25%, $44.3 million relates to 3% senior convertible notes and $0.5 million relates to derivative instruments financing and other.

Note 5 – Asset Retirement Obligations

The following table describes the changes to our asset retirement obligations (in thousands):

*The downward revisions were primarily due to changes in estimated timing of settlements of the plugging and abandonment liabilities,  resulting from updated estimates as to when the associated wells would cease to be economic.

Note 6 – Derivative Financial Instruments

We enter into derivative transactions to reduce exposure to fluctuations in the price of crude oil and natural gas with multiple investment-grade rated counterparties, primarily financial institutions, to reduce the concentration of exposure to any individual counterparty. We have historically used various instruments, including financially settled crude oil and natural gas puts, put spreads, swaps, costless collars and three-way collars in our derivative portfolio.  With a costless collar, the counterparty is required to make a payment to us if the settlement price for any settlement period is below the floor price of the collar, and we are required to make a payment to the counterparty if the settlement price for any settlement period is above the cap price for the collar. In a fixed price swap contract, the counterparty is required to make a payment to us if the settlement price for any settlement period is below the swap fixed price, and we are required to make a payment to the counterparty if the settlement price for any settlement period is above the swap fixed price.

Derivative financial instruments are recorded at fair value and included as either assets or liabilities in the accompanying consolidated balance sheets. Any gains or losses resulting from changes in fair value of our outstanding derivative financial instruments and from the settlement of derivative financial instruments are recognized in earnings and included in (loss) gain on derivative financial instruments as a component of revenues in the accompanying consolidated statements of operations.

Most of our crude oil production is sold at Heavy Louisiana Sweet. We have historically included contracts indexed to NYMEX-WTI, ICE Brent futures and Argus-LLS futures in our derivative portfolio to closely align and manage our exposure to the associated price risk.

On March 14, 2016, the fourteenth amendment to the Prepetition Revolving Credit Facility became effective and required us to unwind certain derivative transactions and use the proceeds therefrom to repay amounts of outstanding loans to EPL under the Prepetition Revolving Credit Facility, and for such repayments to then result in an automatic and permanent reduction in EXXI Ltd’s borrowing base. Accordingly, on March 15, 2016, EXXI Ltd unwound and monetized all of its outstanding crude oil and natural gas contracts and $50.6 million was applied to reduce amounts outstanding under the Prepetition Revolving Credit Facility.

The energy markets have historically been very volatile, and there can be no assurances that crude oil and natural gas prices will not be subject to wide fluctuations in the future. While the use of derivative arrangements helps to limit the downside risk of adverse price movements, they may also limit future gains from favorable price movements.

As of September 30, 2017, we had the following open crude oil derivative positions:

The fair values of derivative instruments in our consolidated balance sheets were as follows (in thousands):

The following table presents information about the components of the (loss) gain on derivative financial instruments (in thousands).

We monitor the creditworthiness of our counterparties who are also a part of our bank lending group. However, we are not able to predict sudden changes in counterparties’ creditworthiness. In addition, even if such changes are not sudden, we may be limited in our ability to mitigate an increase in counterparty credit risk. Possible actions would be to transfer our position to another counterparty or request a voluntary termination of the derivative contracts resulting in a cash settlement. Should one of our financial counterparties not perform, we may not realize the benefit of some of our derivative instruments under lower commodity prices and could incur a loss. As of September 30, 2017, we had no collateral deposits with our counterparties.

Note 7 – Income Taxes

On the Emergence Date, the Predecessor Company engaged in several internal restructuring transactions that: (i) assigned all of Predecessor’s assets (directly or indirectly) to EGC, and (ii) separated EXXI Ltd, Energy XXI (US Holdings) Limited (Bermuda), Energy XXI, Inc., and Energy XXI USA from EGC. This had the effect, among other things, of isolating the original parent-level equity ownership and certain intercompany loans (the “Intercompany Loans”) from EGC. Then, pursuant to the Plan, the prepetition notes other than the 4.14% promissory note of $5.5 million, the Prepetition Revolving Credit Facility and 100% of the EGC stock owned by Energy XXI USA, Inc., were cancelled. Additionally, new EGC shares and warrants were issued to former creditors as set out in the Plan. Absent an exception, a debtor recognizes Cancellation of Indebtedness Income (“CODI”) upon discharge of its outstanding indebtedness for an amount of consideration that is less than its adjusted issue price. The Internal Revenue Code of 1986, as amended (the “Tax Code”) provides that a debtor in a bankruptcy case (such as the Chapter 11 Cases) may exclude CODI from taxable income but must reduce certain of its tax attributes by the amount of any CODI realized as a result of the Plan (the “Tax Attribute Reduction Rules”). The amount of CODI realized by a taxpayer is the adjusted issue price of any indebtedness discharged less the sum of (i) the amount of cash paid, (ii) the issue price of any new indebtedness issued and (iii) the fair market value of any other consideration, including equity, issued. As a result of the market value of equity upon emergence from the Chapter 11 Cases, the amount of CODI realized was approximately $2,600 million, which reduced the Company’s U.S. net operating loss (“NOL”) carryovers of $403 million to zero, and further reduced the Company’s tax basis in producing properties (subject to future recovery through tax DD&A deductions) and its investment in the stock of EPL by $2,197 million. This reduction in tax attributes occurred on the Convenience Date, the first day of the Company’s first tax year subsequent to the Emergence Date, as one effect of the Plan was to terminate the Predecessor’s fiscal income tax reporting period on the Emergence Date.

As a result of the fresh start accounting, virtually all historic deferred tax assets and liabilities were eliminated, including the accrued outbound 30% withholding tax on the Intercompany Loans from the Predecessor’s Bermuda parent, as these obligations were extinguished in the Plan and are not obligations of the Successor entities. With the NOL carryover being reduced by the Tax Attribute Reduction Rules, the principal deferred tax assets and liabilities of the Successor after fresh-start accounting relate to our oil and gas properties. The remaining tax bases of our oil and natural gas properties are less than their respective book carrying values as determined in fresh-start accounting such that we have recorded a deferred tax liability for those properties. We have recorded a deferred tax asset for the asset retirement obligation (which has no tax basis and will be tax deductible or result in additional tax basis in assets when settled) and other items that exceed the deferred tax liability for oil and natural gas properties. As such, we recorded a valuation allowance of $174.5 million at December 31, 2016, which results in no net deferred tax asset or liability appearing on our statement of financial position. We recorded this valuation allowance at this date after an evaluation of all available evidence (including our recent history of Predecessor losses) that led to a conclusion that based upon the more-likely-than-not standard of the accounting literature, these deferred tax assets were unrecoverable.

Tax Code Sections 382 and 383 provide an annual limitation with respect to the ability of a corporation to utilize its tax attributes, including as the tax basis in certain assets (net unrealized built-in-losses), against future U.S. taxable income in the event of a change in ownership. The Company’s emergence from the Chapter 11 Cases was considered a change in ownership for purposes of Tax Code Section 382. The limitation under the Tax Code is based on the value of the loss corporation as of the Convenience Date, which reflects value after giving effect to the Plan’s steps. However, this and prior ownership changes and resulting annual limitation will have limited, if any, effect on the Company’s NOLs since all of the NOLs were extinguished by the Tax Attribute Reduction Rules. There is the possibility of deferral of recognition of certain portions of tax DD&A by the Tax Attribute Reduction Rules that would affect the timing of offsetting future taxable income, but would not affect income tax expense. No cash income taxes were paid during the period ended September 30, 2017, and, based upon current commodity pricing and planned development activity, no cash income taxes have been paid or are expected to be paid or owed for the year ending December 31, 2017.

We have estimated our effective income tax rate (benefit) for the year to be zero, as we are forecasting a pre-tax loss at this time. We do not believe that our net deferred tax assets are realizable in the future on a more-likely-than-not basis at this time; as such, we have increased our valuation allowance by $10 million in the quarter ended September 30, 2017 to reflect the tax effect of this loss. This $10 million third quarter valuation allowance increase, when coupled with the $28 million first and second quarter valuation allowance increase, results in a valuation allowance of $213 million at September 30, 2017, after adjustments of $3 million for changes in estimate to the Fresh Start valuation allowance based on subsequent tax filings for pre-Effective Date periods with the Internal Revenue Service.

A post-Emergence Date pre-tax NOL of approximately $50 million resulting from our post-Emergence Date losses represents our only NOL carryforwards. This post-Emergence Date NOL is not subject to limitation in future usage by the ownership changes rules of Tax Code section 382 or the Tax Attribute Reduction Rules resulting from the Plan, but this NOL cannot be carried back to pre-Emergence Date years to create a cash income tax refund.  If, however, the Company were to experience post-Emergence changes in stock ownership of greater than 50% within any three-year look back period, this post-Emergence NOL would be subject to Tax Code section 382 limitations based upon stock value and other factors at such time. 

Our 2016 tax return reflecting the required reduction in tax attribute carryforwards due to CODI from the discharge (eliminating all pre-discharge NOLs and reducing the tax basis in remaining assets of the Successor) will be filed in the fourth quarter of 2017 as the Company used additional time to file these returns granted by the Internal Revenue Service as a result of Hurricane Harvey.

Note 8 – Stockholders’ Equity

On the Emergence Date, the Company’s certificate of incorporation and bylaws were amended and restated in their entirety. Under our certificate of incorporation, the total number of all shares of capital stock that we are authorized to issue is 110 million shares, consisting of 100 million shares of the Company’s common stock, par value $0.01 per share, and 10 million shares of preferred stock, par value $0.01 per share.

On the Emergence Date, the Company entered into a registration rights agreement (the “Registration Rights Agreement”) with certain holders representing 10% or more of the Company’s common stock outstanding on that date or who acquire 10% or more of the Company’s common stock outstanding within six months of the Emergence Date (the “Holders”). The Registration Rights Agreement provided resale registration rights for the Holders’ Registerable Securities (as defined in the Registration Rights Agreement). On February 28, 2017, in accordance with the requirements of the Registration Rights Agreement, the Company filed a registration statement on Form S‑3 relating to the resale of an aggregate of 9,272,285 shares of our common stock, which may be offered for sale from time to time by the selling stockholders named in Form S‑3 prospectus. The number of shares the selling stockholders may sell consists of 9,049,929 shares of common stock that are currently issued and outstanding and 222,356 shares of common stock that they may receive if they exercise their warrants. The selling stockholders acquired all of the shares of common stock and warrants covered by the Form S‑3 prospectus in a distribution pursuant to Section 1145 under the United States Bankruptcy Code in connection with our plan of reorganization that became effective on the Emergence Date. We are not selling any shares of common stock under the Form S‑3 prospectus and will not receive any proceeds from the sale of common stock by the selling stockholders. The registration statement on Form S‑3 was declared effective as of March 23, 2017.

On February 28, 2017, pursuant to our satisfaction of all the listing requirements, our common stock began trading on NASDAQ under the symbol “EXXI” at the opening of business.

As of September 30, 2017, we had issued 9,833 shares of our common stock upon accelerated vesting of restricted stock units granted to a former board member and 33,221,427 shares of common stock and 2,119,889 warrants were outstanding.

Note 9 – Supplemental Cash Flow Information

The following table presents our supplemental cash flow information (in thousands):