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Table of Contents

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

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

 

For the quarterly period ended: June 30, 2010

 

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

 

Commission file number 0-02517

 

TOREADOR RESOURCES CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware

 

75-0991164

(State or other jurisdiction

of incorporation)

 

(I.R.S. Employer

Identification Number)

 

c/o Toreador Holding SAS

9 rue Scribe

75009 Paris, France

(Address of principal executive office)

 

Registrant’s telephone number, including area code: +33 1 47 03 34 24

 

Indicate by check mark whether the Registrant (i) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (ii) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

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

 

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

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller Reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

As of June 30, 2010, there were 25,761,158 shares of common stock, par value $.15625 per share, outstanding.

 

 

 



Table of Contents

 

TOREADOR RESOURCES CORPORATION

 

TOREADOR RESOURCES CORPORATION

 

TABLE OF CONTENTS

 

 

 

Page

PART I. FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements (unaudited)

 

 

 

 

 

Condensed Consolidated Balance Sheets — June 30, 2010 and December 31, 2009

1

 

 

 

 

Condensed Consolidated Statements of Operations — for the three months ended June 30, 2010 and 2009

2

 

 

 

 

Condensed Consolidated Statements of Operations — for the six months ended June 30, 2010 and 2009

3

 

 

 

 

Condensed Consolidated Statement of Changes in Stockholder’s Equity — June 30, 2010

4

 

 

 

 

Condensed Consolidated Statements of Cash Flows — for the six months ended June 30, 2010 and 2009

5

 

 

 

 

Notes to Condensed Consolidated Financial Statements

6

 

 

 

Item 2.

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

23

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

41

 

 

 

Item 4.

Controls and Procedures

42

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

43

 

 

 

Item 1A.

Risk Factors

43

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

43

 

 

 

Item 6.

Exhibits

43

 

 

 

 

SIGNATURES

44

 

i



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1.     FINANCIAL STATEMENTS (UNAUDITED)

 

TOREADOR RESOURCES CORPORATION

 

CONDENSED CONSOLIDATED BALANCE SHEETS

 

 

 

June 30,
2010

 

December 31,
2009

 

 

 

(Unaudited)

 

 

 

 

 

(In thousands, except share and per share data)

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents (Note 2)

 

$

56,049

 

$

8,712

 

Accounts receivable (Note 2)

 

2,603

 

3,126

 

Income tax receivable (Note 8)

 

 

245

 

Other

 

3,028

 

3,593

 

Total current assets

 

61,680

 

15,676

 

 

 

 

 

 

 

Oil and natural gas properties, net

 

 

 

 

 

Oil and natural gas properties, gross

 

99,505

 

116,435

 

Accumulated depletion, depreciation and amortization

 

(36,630

)

(41,814

)

Oil and natural gas properties, net

 

62,875

 

74,621

 

 

 

 

 

 

 

Investments

 

200

 

200

 

Goodwill (Note 15)

 

3,384

 

3,973

 

Other assets

 

3,033

 

2,685

 

 

 

 

 

 

 

Total assets

 

$

131,172

 

$

97,155

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

10,592

 

$

12,491

 

Deferred lease payable — current portion

 

110

 

107

 

Derivatives (Note 13)

 

72

 

886

 

Current portion of long-term debt (Note 5)

 

32,385

 

32,385

 

Income taxes payable (Note 8)

 

5,543

 

 

Total current liabilities

 

48,702

 

45,869

 

 

 

 

 

 

 

Long-term accrued liabilities

 

329

 

385

 

Deferred lease payable, net of current portion

 

386

 

442

 

Asset retirement obligations (Note 6)

 

5,915

 

6,733

 

Deferred income tax liabilities

 

13,927

 

15,358

 

Long-term debt (Notes 5 and 14)

 

34,973

 

22,231

 

Total liabilities

 

104,232

 

91,018

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.15625 par value, 30,000,000 shares authorized; 25,761,158 and 22,106,955 shares issued

 

4,025

 

3,454

 

Additional paid-in capital

 

198,601

 

170,895

 

Accumulated deficit

 

(177,600

)

(176,578

)

Accumulated other comprehensive income

 

4,448

 

10,900

 

Treasury stock at cost, 721,027 shares for 2009 and 2010

 

(2,534

)

(2,534

)

Total stockholders’ equity

 

26,940

 

6,137

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

131,172

 

$

97,155

 

 

The accompanying notes are an integral part of these financial statements.

 

1



Table of Contents

 

TOREADOR RESOURCES CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

 

Three Months Ended
June 30,

 

 

 

2010

 

2009

 

 

 

(Unaudited)

 

 

 

(In thousands, except per share data)

 

Revenues and other income:

 

 

 

 

 

Sales and other operating revenue

 

$

5,946

 

$

4,504

 

Other income (Note 16)

 

15,000

 

121

 

Total revenues and other income

 

20,946

 

4,625

 

Operating costs and expenses:

 

 

 

 

 

Lease operating expense

 

3,138

 

1,776

 

Exploration expense

 

1,055

 

146

 

Depreciation, depletion and amortization

 

673

 

1,469

 

Accretion on discounted assets and liabilities (Notes 5 and 6)

 

31

 

123

 

General and administrative

 

2,837

 

5,703

 

Gain on oil and gas derivative contracts (Note 13)

 

(783

)

 

Total operating costs and expenses

 

6,951

 

9,217

 

Operating income (loss)

 

13,995

 

(4,592

)

Other (expense) income:

 

 

 

 

 

Foreign currency exchange gain (loss)

 

(83

)

(653

)

Gain on early extinguishment of debt (Note 5)

 

 

3,370

 

Interest expense, net of interest capitalized (Note 5)

 

(1,011

)

(546

)

Total other income (expense)

 

(1,094

)

2,171

 

Income (loss) before taxes from continuing operations

 

12,901

 

(2,421

)

Income tax (benefit) provision (Note 8)

 

6,351

 

(691

)

Income (loss) from continuing operations, net of income taxes

 

6,550

 

(1,730

)

Income (loss) from discontinued operations, net of income taxes (Note 12)

 

(247

)

4,612

 

Net income available to common shares

 

$

6,303

 

$

2,882

 

 

 

 

 

 

 

Basic income (loss) available to common shares per share:

 

 

 

 

 

From continuing operations, net of income taxes

 

$

0.27

 

$

(0.09

)

From discontinued operations, net of income taxes

 

(0.01

)

0.23

 

 

 

$

0.26

 

$

0.14

 

 

 

 

 

 

 

Diluted income (loss) available to common shares per share:

 

 

 

 

 

From continuing operations, net of income taxes

 

$

0.27

 

$

(0.09

)

From discontinued operations, net of income taxes

 

(0.01

)

0.23

 

 

 

$

0.26

 

$

0.14

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

Basic

 

24,640

 

20,416

 

Diluted

 

24,658

 

20,416

 

 

The accompanying notes are an integral part of these financial statements.

 

2



Table of Contents

 

TOREADOR RESOURCES CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

 

Six Months Ended
June 30,

 

 

 

2010

 

2009

 

 

 

(Unaudited)

 

 

(In thousands, except per share data)

Revenues and other income

 

 

 

 

 

Sales and other operating revenue

 

$

11,456

 

$

7,892

 

Other income (Note 16)

 

15,000

 

121

 

Total revenues and other income

 

26,456

 

8,013

 

Operating costs and expenses:

 

 

 

 

 

Lease operating expense

 

4,378

 

3,564

 

Exploration expense

 

1,075

 

610

 

Depreciation, depletion and amortization

 

1,677

 

3,010

 

Accretion on discounted assets and liabilities (Notes 5 and 6)

 

87

 

238

 

General and administrative

 

7,842

 

10,707

 

Gain on oil and gas derivative contracts (Note 13)

 

(814

)

 

Total operating costs and expenses

 

14,245

 

18,129

 

Operating income (loss)

 

12,211

 

(10,116

)

Other (expense) income:

 

 

 

 

 

Foreign currency exchange gain (loss)

 

(77

)

(557

)

(Loss) gain on the early extinguishment of debt (Note 5)

 

(4,256

)

3,370

 

Interest expense, net of interest capitalized (Note 5)

 

(1,720

)

(1,391

)

Total other (expense) income

 

(6,053

)

1,422

 

Income (loss) before taxes from continuing operations

 

6,158

 

(8,694

)

Income tax (benefit) provision (Note 8)

 

6,351

 

(769

)

Income (loss) from continuing operations, net of income taxes

 

(193

)

(7,925

)

Loss from discontinued operations, net of income taxes (Note 12)

 

(822

)

(69

)

Net loss available to common shares

 

$

(1,015

)

$

(7,994

)

 

 

 

 

 

 

Basic income (loss) available to common shares per share:

 

 

 

 

 

From continuing operations, net of income taxes

 

$

(0.01

)

$

(0.39

)

From discontinued operations, net of income taxes

 

(0.03

)

(0.00

)

 

 

$

(0.04

)

$

(0.39

)

 

 

 

 

 

 

Diluted income (loss) available to common shares per share:

 

 

 

 

 

From continuing operations, net of income taxes

 

$

(0.01

)

$

(0.39

)

From discontinued operations, net of income taxes

 

(0.03

)

(0.00

)

 

 

$

(0.04

)

$

(0.39

)

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

Basic

 

23,958

 

20,271

 

Diluted

 

23,958

 

20,271

 

 

The accompanying notes are an integral part of these financial statements.

 

3



Table of Contents

 

TOREADOR RESOURCES CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

 

 

 

Common
Stock
(Shares)

 

Common
Stock
($)

 

Additional
Paid-in
Capital

 

Accumulated
deficit

 

Accumulated
Other
Comprehensive
Income (loss)

 

Treasury
Stock
(Shares)

 

Treasury
Stock
($)

 

Total
Stockholders’
Equity

 

Balance at December 31, 2009

 

22,107

 

$

3,454

 

$

170,895

 

$

(176,578

)

$

10,900

 

(721

)

$

(2,534

)

$

6,137

 

Exercise of stock options

 

5

 

 

15

 

 

 

 

 

 

15

 

Return of stock options exercised

 

 

1

 

 

 

 

 

 

 

1

 

Issuance of restricted stock

 

199

 

31

 

(31

)

 

 

 

 

 

 

Issuance of common stock

 

3,450

 

539

 

28,786

 

 

 

 

 

 

29,325

 

Amortization of deferred stock compensation

 

 

 

1,553

 

 

 

 

 

 

1,553

 

Net loss

 

 

 

 

(1,015

)

 

 

 

 

(1,015

)

Foreign currency translation adjustment

 

 

 

 

 

(6,452

)

 

 

 

(6,452

)

Tax effect of restricted stock

 

 

 

(87

)

 

 

 

 

 

(87

)

Payment of equity issuance costs

 

 

 

(2,489

)

 

 

 

 

 

(2,489

)

Other

 

 

 

(41

)

(7

)

 

 

 

(48

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2010

 

25,761

 

$

4,025

 

$

198,601

 

$

(177,600

)

$

4,448

 

(721

)

$

(2,534

)

$

26,940

 

 

The accompanying notes are an integral part of these financial statements.

 

4



Table of Contents

 

TOREADOR RESOURCES CORPORATION

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

Six Months Ended
June30,

 

 

 

2010

 

2009

 

 

 

(Unaudited)

 

 

 

(In thousands)

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(1,015

)

$

(7,994

)

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation, depletion and amortization

 

1,677

 

3,010

 

Accretion on discounted assets and liabilities

 

87

 

238

 

Amortization of deferred debt issuance costs

 

98

 

975

 

Stock based compensation

 

2,204

 

2,831

 

Deferred income taxes liabilities

 

(1,431

)

(437

)

Impairment of oil and natural gas properties

 

 

5,300

 

Gain on sale of properties and equipment

 

 

(121

)

Gain on sale of properties and other assets in Romania

 

 

(5,846

)

Loss (gain) on early extinguishment of debt — convertible notes

 

4,256

 

(3,370

)

Loss on early extinguishment of debt — revolving credit facility

 

 

4,881

 

Unrealized gain on commodity derivatives

 

(814

)

 

Decrease (increase) in accounts receivable

 

523

 

(121

)

Decrease in income taxes receivable

 

245

 

 

 

Decrease (increase) in other current assets

 

565

 

(2,883

)

Decrease (increase) in other assets

 

348

 

(86

)

(Decrease) increase in accounts payable and accrued liabilities

 

(1,899

)

1,289

 

Decrease in deferred lease payable

 

(53

)

 

Increase (decrease) in income taxes payable

 

5,543

 

(4,087

)

Decrease in long-term accrued liabilities

 

(56

)

 

Net cash provided by (used in) operating activities

 

10,278

 

(6,421

)

Cash flows from investing activities:

 

 

 

 

 

Proceeds from sale of property and equipment

 

 

121

 

Additions to property and equipment

 

(252

)

(990

)

Restricted cash

 

 

 

1,928

 

Proceeds from sale of oil and gas properties

 

 

50,000

 

Net cash (used in) provided by investing activities

 

(252

)

51,059

 

Cash flows from financing activities:

 

 

 

 

 

Repayment of convertible notes (Note 5)

 

(22,231

)

(12,661

)

Repayment of revolving credit facility (Note 5)

 

 

(36,372

)

Issuance of convertible notes

 

31,631

 

 

 

Deferred debt issuance costs

 

(1,936

)

 

 

Proceeds from issuance of common stock, net of equity issuance costs of $2,489 (Note 9)

 

26,836

 

 

 

Proceeds from exercise of stock options

 

15

 

 

 

Other

 

 

(82

)

Net cash provided by (used in) financing activities

 

34,315

 

(49,115

)

Net increase (decrease) in cash and cash equivalents

 

44,341

 

(4,477

)

Effects of foreign currency translation on cash and cash equivalents

 

2,996

 

1,206

 

Cash and cash equivalents, beginning of period

 

8,712

 

19,457

 

Cash and cash equivalents, end of period

 

$

56,049

 

$

16,186

 

Supplemental disclosures:

 

 

 

 

 

Cash paid during the period for interest, net of interest capitalized

 

$

1,180

 

$

1,787

 

Cash paid during the period for income taxes

 

$

7

 

$

4,032

 

 

The accompanying notes are an integral part of these financial statements.

 

5



Table of Contents

 

TOREADOR RESOURCES CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

NOTE 1 - BASIS OF PRESENTATION

 

The consolidated financial statements of Toreador Resources Corporation and subsidiaries (“Toreador,” “we,” “us,” “our,” or the “Company”) included herein have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). They reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the interim periods, on a basis consistent with the annual audited financial statements. All such adjustments are of a normal recurring nature, unless noted herein. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures contained herein are adequate to make the information presented not misleading. These interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, which was filed with the SEC on March 16, 2010. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.

 

We are a Delaware corporation that was incorporated in 1951. Our common stock is traded on the NASDAQ Global Market under the trading symbol TRGL. Our offices in the United States are located at 13760 Noel Road, Suite 1100, Dallas, TX, 75240-1383 (telephone number: (214) 559-3933). Our principal executive offices are located at c/o Toreador Holding SAS, 9 rue Scribe, 75009 Paris, France (telephone number: +33 1 47 03 34 24). Our website address is www.toreador.net.

 

Unless otherwise noted, amounts reported in tables are in thousands, except per unit data.

 

Revenue Recognition

 

Our French crude oil production accounts for substantially all of our sales. We sell our French crude oil to Total (“TOTAL”), and recognize the related revenues when the production is delivered to TOTAL’s refinery, typically via truck. At the time of delivery to the plant, title to the crude oil transfers to TOTAL. The terms of the contract with TOTAL state that the price received for oil sold will be the arithmetic mean of all average daily quotations of Dated Brent published in Platt’s Oil Market Wire for the month of production less a specified differential per barrel. The pricing of oil sales is done on the first day of the month following the month of production. In accordance with the terms of the contract, payment is made within six working days of the date of issue of the invoice. The contract with TOTAL is automatically extended for a period of one year unless either party cancels it in writing no later than six months prior to the beginning of the next year.

 

We recognize revenue for our remaining production when the quantities are delivered to or collected by the respective purchaser. Title to the produced quantities transfers to the purchaser at the time the purchaser collects or receives the quantities. Prices for such production are defined in sales contracts and are readily determinable based on certain publicly available indices. The purchasers of such production have historically made payment for crude oil and natural gas purchases within thirty and sixty days of the end of each production month, respectively. We periodically review the difference between the dates of production and the dates we collect payment for such production to ensure that receivables from those purchasers are collectible. Taxes associated with production are classified as lease operating expense.

 

Gain on sales of proved and unproved properties are only recognized when there is no uncertainty about the recovery of costs applicable to interests retained or where there is no substantial obligation for future performance by the Company. Losses on properties sold are recognized when incurred. Any gain or loss is reflected in “Other Income”.

 

6



Table of Contents

 

New Accounting Pronouncements

 

In January 2010, the FASB issued guidance that clarifies and requires new disclosures about fair value measurements. The clarifications and requirement to disclose the amounts and reasons for significant transfers between Level 1 and Level 2, as well as significant transfers in and out of Level 3 of the fair value hierarchy, were adopted by the Company in the first quarter of 2010. The new guidance also requires that purchases, sales, issuances, and settlements be presented gross in the Level 3 reconciliation and that requirement is effective for fiscal years beginning after December 15, 2010 and for interim periods within those years, with early adoption permitted. Adoption of the guidance which only amends the disclosures requirements did not have significant impact on our financial statements.

 

In February 2010, the FASB issued 2010-09, Amendments to Certain Recognition and Disclosure Requirements (“ASU 2010-09”). ASU 2010-09 amends ASC 855, Subsequent Events, by removing the requirement for an SEC filer to disclose the date through which subsequent events have been evaluated. Management’s responsibility to evaluate subsequent events through the date of issuance remains unchanged. The Company adopted amendments to the Codification resulting from ASU 2010-09 on February 24, 2010. As ASU 2010-09 relates specifically to disclosures, the adoption of this standard had no impact on our condensed consolidated financial condition, results of operations or cash flows.

 

On July 21, 2010, the FASB issued ASU 2010-20, Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (“ASU 2010-20”). ASU 2010-20 amend existing disclosure guidance to require entities to provide extensive new disclosures in their financial statements about their financing receivables, including credit risk exposures and the allowance for credit losses. ASU 2010-20 is effective for fiscal and interim periods beginning after December 15, 2010. The Company will review the requirements under the standards to determine what impacts, if any, the adoption of the standard would have on our condensed consolidated financial statements.

 

NOTE 2 - CONCENTRATION OF CREDIT RISK AND ACCOUNTS RECEIVABLE

 

Financial instruments that potentially subject us to a concentration of credit risk consist principally of cash and cash equivalents, accounts receivable, and our hedging and derivative financial instruments. We place our cash with high-credit quality financial institutions. We currently sell oil to one customer, TOTAL. Substantially all of our accounts receivable are due from the purchaser of oil production. We place our hedging and derivative financial instruments with financial institutions and other firms that we believe have high credit ratings.

 

We periodically review the collectability of accounts receivable and record an allowance for doubtful accounts on those amounts which are, in our judgment, unlikely to be collected. We have not had any significant credit losses in the past and we believe our accounts receivable are fully collectable with the exception of the current allowance.

 

Accounts receivable consisted of the following:

 

 

 

June 30,
2010

 

December 31,
2009

 

Oil and natural gas sales receivables

 

$

2,144

 

$

2,054

 

Recoverable VAT

 

138

 

778

 

Other accounts receivable

 

321

 

294

 

 

 

$

2,603

 

$

3,126

 

 

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NOTE 3 — EARNINGS (LOSS) PER COMMON SHARE

 

The following table reconciles the numerators and denominators of the basic and diluted earnings (loss) per common share computation:

 

 

 

Three Months Ended
June 30,

 

 

 

2010

 

2009

 

Basic earnings (loss) per share:

 

 

 

 

 

Numerator:

 

 

 

 

 

Income (loss) from continuing operations, net of income tax

 

$

6,550

 

$

(1,730

)

Income (loss) from discontinued operations, net of income tax

 

(247

)

4,612

 

Net income (loss) available to common shareholders

 

$

6,303

 

$

2,882

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Weighted average common shares outstanding

 

24,640

 

20,416

 

 

 

 

 

 

 

Basic earnings (loss) available to common shareholders per share from:

 

 

 

 

 

Continuing operations

 

$

0.27

 

$

(0.09

)

Discontinued operations

 

(0.01

)

0.23

 

 

 

0.26

 

$

0.14

 

 

 

 

 

 

 

Diluted earnings (loss) per share:

 

 

 

 

 

Numerator:

 

 

 

 

 

Loss from continuing operations, net of income tax

 

$

6,550

 

$

(1,730

)

Income (loss) from discontinued operations, net of income tax

 

(247

)

4,612

 

Net income (loss) available to common shareholders

 

$

6,303

 

$

2,882

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Weighted average common shares outstanding

 

24,658

 

20,416

 

Conversion of notes payable

 

(1)

(1)

Diluted shares outstanding

 

24,658

 

20,416

 

 

 

 

 

 

 

Diluted earnings (loss) available to common shareholders per share from:

 

 

 

 

 

Continuing operations

 

$

0.27

 

$

(0.09

)

Discontinued operations

 

(0.01

)

0.23

 

 

 

0.26

 

$

0.14

 

 


(1)

Conversion of the Company’s 5.00% Convertible Senior Notes due 2025 would be anti-dilutive and the Company’s 8.00%/7.00% Convertible Senior Notes due 2025 are not eligible for conversion in 2010 (subject to certain terms and conditions under the Indenture dated as of February 1, 2010) therefore, there are no dilutive shares.

 

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Six Months Ended
June 30,

 

 

 

2010

 

2009

 

Basic loss per share:

 

 

 

 

 

Numerator:

 

 

 

 

 

Loss from continuing operations, net of income tax

 

$

(193

)

$

(7,925

)

Loss from discontinued operations, net of income tax

 

(822

)

(69

)

Net loss available to common shareholders

 

$

(1,015

)

$

(7,994

)

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Weighted average common shares outstanding

 

23,958

 

20,271

 

 

 

 

 

 

 

Basic Income (loss) available to common shareholders per share from:

 

 

 

 

 

Continuing operations

 

$

(0.01

)

$

(0.39

)

Discontinued operations

 

(0.03

)

(0.00

)

 

 

$

(0.04

)

$

(0.39

)

 

 

 

 

 

 

Diluted loss per share:

 

 

 

 

 

Numerator:

 

 

 

 

 

Income (loss) from continuing operations, net of income tax

 

$

(193

)

$

(7,925

)

Loss from discontinued operations, net of income tax

 

(822

)

(69

)

Net loss available to common shareholders

 

$

(1,015

)

$

(7,994

)

 

 

 

 

 

 

Denominator:

 

 

 

 

 

Weighted average common shares outstanding

 

23,958

 

20,271

 

Conversion of notes payable

 

(1)

(1)

Diluted shares outstanding

 

23,958

 

20,271

 

 

 

 

 

 

 

Diluted Income (loss) available to common shareholders per share from:

 

 

 

 

 

Continuing operations

 

$

(0.01

)

$

(0.39

)

Discontinued operations

 

(0.03

)

(0.00

)

 

 

$

(0.04

)

$

(0.39

)

 


(1)

Conversion of the 5.00% Convertible Senior Notes would be anti-dilutive and the 8/7.00% New Convertible Senior Notes are not eligible for conversion in 2010 (subject to certain terms and conditions under the Indenture dated as of February 1, 2010) therefore, there are no dilutive shares.

 

NOTE 4 — COMPREHENSIVE INCOME (LOSS)

 

The following table presents the components of comprehensive income (loss), net of related tax:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net income (loss)

 

$

6,303

 

$

2,882

 

$

(1,015

)

$

(7,994

)

Foreign currency translation adjustment

 

(1,753

)

3,808

 

(6,452

)

(2,255

)

Comprehensive income (loss)

 

$

4,550

 

$

6,690

 

$

(7,467

)

$

(10,249

)

 

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NOTE 5 — LONG-TERM DEBT

 

Long-term debt consisted of the following:

 

 

 

June 30,
2010

 

December 31,
2009

 

Convertible senior notes

 

$

67,358

 

$

54,616

 

 

 

 

 

 

 

Less: current portion

 

(32,385

)

(32,385

)

 

 

 

 

 

 

Total long-term debt

 

$

34,973

 

$

22,231

 

 

Secured Revolving Facility with the International Finance Corporation

 

On December 28, 2006, we entered into a loan and guarantee agreement with International Finance Corporation. The loan and guarantee agreement provided for a $25 million facility which was a secured revolving facility with a maximum facility amount of $25 million which maximum facility amount would have increased to $40 million when the projected total borrowing base amount exceeds $50 million. The $25 million facility was funded on March 2, 2007. The loan and guarantee agreement also provided for an unsecured $10 million facility which was funded on December 28, 2006.  Both the $25 million facility and the $10 million facility were to fund our operations in Turkey and Romania.

 

On March 3, 2009, we repaid and retired the facilities with the International Finance Corporation. The total amount of the payment was $36.4 million, which comprised $30 million principal, $5.9 million additional compensation due under the credit facility as a result of our repayment (such additional compensation calculated under the terms of the credit facility as a percentage of the Company’s earnings before interest, tax, depreciation, amortization and exploration expense) and $500,000 for accrued interest and fees.  As a result of the early extinguishment, we recorded a loss of $4.9 million for the period ended March 31, 2009, which was recorded in discontinued operations.

 

5.00% CONVERTIBLE SENIOR NOTES DUE OCTOBER 1, 2025

 

On September 27, 2005, we issued $75 million of Convertible Senior Notes due October 1, 2025 (the “5.00% Convertible Senior Notes”) to qualified institutional buyers pursuant to Rule 144A of the Securities Act of 1933, as amended (the “Securities Act”). The Company also granted the initial purchasers the option to purchase an additional $11.25 million aggregate principal amount of 5.00% Convertible Senior Notes to cover over-allotments. The over-allotment option was exercised on September 30, 2005. The total principal amount of 5.00% Convertible Senior Notes issued was $86.25 million and total net proceeds were approximately $82.2 million. We incurred approximately $4.1 million of costs associated with the issuance of the 5.00% Convertible Senior Notes; these costs have been recorded in other assets on the balance sheet and are being amortized to interest expense using the straight-line interest rate method (which approximates effective interest method) over the term of the 5.00% Convertible Senior Notes.

 

The net proceeds were used for general corporate purposes, including funding a portion of the Company’s 2005 and 2006 exploration and development activities.

 

The 5.00% Convertible Senior Notes bear interest at a rate of 5.00% per annum and can be converted into common stock at an initial conversion rate of 23.3596 shares of common stock per $1,000 principal amount of 5.00% Convertible Senior Notes (equivalent to a conversion price of approximately $42.81 per share), subject to adjustment in an event of, among other things, a fundamental change (as defined in the indenture). We may redeem the 5.00% Convertible Senior Notes, in whole or in part, on or after October 6, 2008, and prior to October 1, 2010, for cash at a redemption price equal to 100% of the principal amount of 5.00% Convertible Senior Notes to be redeemed, plus any accrued and unpaid interest, if the closing price of our common stock exceeds 130% of the conversion price over a specified period. On or after October 1, 2010, we may redeem the 5.00% Convertible Senior Notes, in whole or in part, at a redemption price equal to 100% of the principal amount of 5.00% Convertible Senior Notes to be redeemed, plus any accrued and unpaid interest, irrespective of the price of its common stock. Holders may convert their 5.00% Convertible Senior Notes at any time prior to the close of business on the business day

 

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immediately preceding their stated maturity, and holders may, upon the occurrence of certain fundamental changes, or on October 1, 2010, October 1, 2015, and October 1, 2020, require us to repurchase all or a portion of their 5.00% Convertible Senior Notes for cash in an amount equal to 100% of the principal amount of such 5.00% Convertible Senior Notes, plus any accrued and unpaid interest.

 

During 2008 the Company repurchased $6 million, face value, of the 5.00% Convertible Senior Notes on the open market for $5.3 million. In 2009 the Company repurchased $25.7 million face value of the 5.00% Convertible Senior Notes on the open market for $21.3 million, resulting in a gain on the early extinguishment of debt of $3.4 million after writing off deferred loan costs of approximately $1 million.  On February 1, 2010, Toreador consummated an exchange transaction (the “Convertible Notes Exchange”). In the Convertible Notes Exchange, in exchange for (a) $22,231,000 principal amount of our outstanding 5.00% Convertible Senior Notes and (b) $9.4 million cash, we issued $31,631,000 aggregate principal amount of our 8.00%/7.00% Convertible Senior Notes, or the New Convertible Senior Notes, and paid accrued and unpaid interest on the Old Notes.  As of June 30, 2010, $32.4 million principal aggregate amount of the 5.00% Convertible Senior Notes was outstanding. We intend to continue to buy back a portion of the currently outstanding Notes in the open market or in privately negotiated transactions, subject to market conditions, applicable legal requirements and other factors.

 

As the debt instruments exchanged in the Convertible Notes Exchange have substantially different terms, the Company recognized the exchange of the 5.00% Convertible Senior Notes as extinguishment of debt. As a result, for the six months ended June 30, 2010, the Company recognized a loss of $4.3 million including write off of loan original fee of $822,000 for the debt extinguishment. The New Convertible Senior Notes are recorded at a fair value of $35,065,000 on the date of exchange. The accretion expense on the Convertible Notes Exchange, which was determined using fair market value of the New Convertible Senior Notes, will be amortized to income over their term. The accretion impact (positive) of $91,322 was recorded for the period ended June 30, 2010.

 

8.00%/7.00% CONVERTIBLE SENIOR NOTES DUE OCTOBER 1, 2025

 

On February 1, 2010, Toreador consummated the Convertible Notes Exchange. In the Convertible Notes Exchange, in exchange for (a) the Old Notes and (b) $9.4 million cash, we issued $31,631,000 aggregate principal amount of (the New Convertible Senior Notes) and paid accrued and unpaid interest on the Old Notes. We incurred approximately $1.9 million of costs associated with the issuance of the New Convertible Senior Notes; these costs have been recorded in other assets on the balance sheets and are being amortized to interest expense using the straight-line interest method (which approximates effective interest method) over the term of the New Convertible Senior Notes.

 

The New Convertible Senior Notes are senior unsecured obligations of the Company, ranking equal in right of payment with the Company’s 5.00% Convertible Senior and future unsubordinated indebtedness. The New Convertible Senior Notes will mature on October 1, 2025 and pay annual cash interest at 8.00% from February 1, 2010 until January 31, 2011 and at 7.00% per annum thereafter. Interest on the New Convertible Senior Notes will be payable on February 1 and August 1 of each year, beginning on August 1, 2010.

 

The New Convertible Senior Notes are convertible prior to February 1, 2011 only if an event of default occurs and is continuing under the terms of the indenture, upon a change of control (as defined in the indenture) and to the extent the Company elects to redeem the New Convertible Senior Notes in a Provisional Redemption (as defined below). The New Convertible Senior Notes are convertible at any time on or after February 1, 2011 and before the close of business on October 1, 2025.

 

The New Convertible Senior Notes are convertible into shares of our common stock at an initial conversion rate of 72.9927 shares of common stock per $1,000 principal amount of New Convertible Senior Notes (which is equivalent to an initial conversion price of $13.70 per share), subject to adjustment upon certain events. Under the terms of the indenture governing the New Convertible Senior Notes, if on or before October 1, 2010, we sold shares of our common stock in an equity offering or an equity-linked offering (other than for compensation), for cash consideration per share such that 120% of the issuance price was less than the conversion price of the New Convertible Senior Notes then in effect, the conversion price was to be reduced to an amount equal to 120% of such offering price. As a result of our February 2010 public offering, the conversion rate of the New Convertible Senior Notes adjusted to 98.0392 shares of common stock per $1,000 principal amount of New Convertible Senior Notes (which is equivalent to a conversion price of approximately $10.20 per share).  Pursuant to the indenture, the

 

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conversion price of the New Convertible Senior Notes will not be further adjusted under such provision because the proceeds from the public offering were in excess of $20 million.

 

The New Convertible Senior Notes may be redeemed in whole or in part at the Company’s option prior to October 1, 2013, in cash at a redemption price equal to one hundred percent (100%) of the principal amount of the New Convertible Senior Notes redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date plus a make-whole payment, if the closing sale price of the Company’s common stock has exceeded 200% of the conversion price then in effect for at least twenty (20) trading days in any consecutive thirty (30)-trading day period ending on the trading day prior to the date of mailing of the relevant notice of redemption (a “Provisional Redemption”).  The New Convertible Senior Notes may be redeemed in whole or in part at the Company’s option on or after October 1, 2013 for cash at a redemption price equal to 100% of the principal amount of the New Convertible Senior Notes redeemed, plus any accrued and unpaid interest to, but excluding, the redemption date.  In addition, upon the occurrence of certain fundamental changes, or on each of October 1, 2013, October 1, 2015 and October 1, 2020, a holder may require the Company to repurchase all or a portion of the New Convertible Senior Notes in cash for 100% of the principal amount of the New Convertible Senior Notes to be purchased, plus any accrued and unpaid interest to, but excluding, the purchase date.

 

Pursuant to the indenture, the Company and its subsidiaries may not incur debt other than Permitted Indebtedness. “Permitted Indebtedness” includes (i) the New Convertible Senior Notes; (ii) the 5.00% Convertible Senior Notes or any indebtedness of the Company that serves to refund or refinance the 5.00% Convertible Senior Notes (“Refinancing Debt”), so long as the principal amount of the Refinancing Debt does not exceed the outstanding principal amount of the 5.00% Convertible Senior Notes; (iii) indebtedness incurred by the Company or its subsidiaries not to exceed the sum of (i) the product of (x) $7.00 and (y) the number of barrels of proved plus probable reserves and (ii) cash equivalents less the aggregate principal amount of the New Convertible Senior Notes outstanding less the aggregate principal amount of the 5.00% Convertible Senior Notes less any Refinancing Debt; (iv) indebtedness that is nonrecourse to the Company or any of its subsidiaries used to finance projects or acquisitions, joint ventures or partnerships, including acquired indebtedness (“Nonrecourse Debt”); and (v) certain other customary categories of permitted debt. In addition, the Company may not permit its total consolidated net debt as of any date to exceed the product of (x) $7.00 and (y) the number of barrels of proved plus probable reserves other than for Nonrecourse Debt. The proved plus probable reserves underlying any Nonrecourse Debt for which debt has been incurred as permitted debt pursuant to clause (iv) above will be excluded from the proved plus probable reserves calculation for the purposes of the above debt covenants.

 

DEBT ISSUANCE COSTS

 

The Company has elected to amortize straight-line (which approximates the effective interest method) the costs associated with the issuance of its convertible senior notes over the term of the issuances (i.e., 2025 for both the 5.00% Convertible Senior Notes and the 8/7% Convertible Senior Notes) and not at the first puttable dates of these callable debts. The unamortized debt issuance costs included in other assets amounted to $3.0 million and $2.1 million as of June 30, 2010 and December 31, 2009, respectively.

 

NOTE 6 — ASSET RETIREMENT OBLIGATIONS

 

We account for our asset retirement obligations in accordance with ASC 410, “Asset Retirement and Environmental Obligations”, which requires us to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, we either settle the obligation for its recorded amount or incur a gain or loss upon settlement.

 

The following table summarizes the changes in our asset retirement liability during the six months ended June 30, 2010 and for the year ended December 31, 2009:

 

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Six Months
Ended June 30,
2010

 

Year Ended
December 31,
2009

 

Asset retirement obligation at January 1

 

$

6,733

 

$

6,037

 

Asset retirement accretion expense

 

179

 

507

 

Foreign currency exchange loss (gain)

 

(997

)

189

 

Property additions

 

 

 

Property dispositions

 

 

 

Asset retirement obligation at the end of the period

 

$

5,915

 

$

6,733

 

 

NOTE 7 — GEOGRAPHIC OPERATING SEGMENT INFORMATION

 

We have operations in only one industry segment, the oil and natural gas exploration and production industry. We are structured along geographic operating segments or regions, and currently have operations in the United States and France and had operations in Hungary in 2009.

 

The following tables provide the geographic operating segment data required by ASC 280, “Segment Reporting”.

 

Three Months Ended June 30, 2010

 

 

 

United States

 

France

 

Total

 

 

 

Revenues and other income

 

$

6

 

$

20,940

 

$

20,946

 

 

 

Costs and expenses

 

1,430

 

5,521

 

6,951

 

 

 

Operating income (loss)

 

$

(1,424

)

$

15,419

 

$

13,995

 

 

 

 

Three Months Ended June 30, 2009

 

 

 

United States

 

France

 

Hungary

 

Total

 

Revenues and other income

 

$

75

 

$

4,429

 

$

121

 

$

4,625

 

Costs and expenses

 

4,587

 

4,160

 

470

 

9,217

 

Operating income (loss)

 

$

(4,512

)

$

269

 

$

349

 

$

(4,592

)

 

 

 

Six Months Ended June 30, 2010

 

 

 

 

 

United States

 

France

 

Total

 

 

 

Revenues and other income

 

$

9

 

$

26,447

 

$

26,456

 

 

 

Costs and expenses

 

4,299

 

9,946

 

14,245

 

 

 

Operating income (loss)

 

$

(4,290

)

16,501

 

$

12,211

 

 

 

 

 

 

Six Months Ended June 30, 2009

 

 

 

United States

 

France

 

Hungary

 

Total

 

Revenues and other income

 

$

154

 

$

7,738

 

$

121

 

$

8,103

 

Costs and expenses

 

9,395

 

7,824

 

910

 

18,129

 

Operating income (loss)

 

$

(9,241

)

$

(86

)

$

(789

)

$

(10,116

)

 

 

 

Total Assets (1)

 

 

 

United States

 

France

 

 

 

 

 

Continuing Operations

 

Total

 

June 30, 2010

 

$

36,681

 

$

94,491

 

$

131,172

 

 

 

 

 

 

 

 

 

December 31, 2009

 

$

6,552

 

$

90,603

 

$

97,155

 

 


(1)         All intercompany accounts and transactions are eliminated in consolidation.

 

NOTE 8 — INCOME TAXES

 

At June 30, 2010, we recorded a $5.5 million income tax payable as we expect to owe income tax within the next 12 months. For the six months ended June 30, 2010 and 2009 we paid income taxes of approximately

 

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$7,000 and $4 million respectively, related to French taxable income. As of June 30, 2010, our French operations recorded a $6.3 million tax provision, and the U.S. operations recorded a tax provision of $17,349 which resulted in a consolidated tax payable of $6.4 million.

 

We have adopted ASC 740 “Income Taxes”, formerly FIN No. 48, “Accounting for Uncertainty in Income Taxes”, on January 1, 2007. There are no tax positions for which a material change in the unrecognized tax benefit is reasonably possible in the next 12 months.

 

The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits within its global operations in income tax expense. During the six months ended June 30, 2010, the Company recognized $0 in potential interest and penalties associated with uncertain tax positions. To the extent interest and penalties are not assessed with respect to uncertain tax positions, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision.

 

In addition to U.S. federal tax returns, we file several state and foreign tax returns, many of which remain open for examination for five years.

 

NOTE 9 — CAPITAL

 

For the six months ended June 30, 2010, the Company issued 199,563 shares of stock to employees and directors, of which 132,733 shares were immediately vested in accordance with the terms of the grants and 5,000 stock options were exercised under the terms of the option agreements.  There were no forfeitures of restricted stock and stock options for the six months ended June 30, 2010.

 

On February 12, 2010, we completed a registered underwritten public offering of 3,450,000 shares of common stock, including 450,000 shares of common stock acquired by the underwriters from us to cover over-allotment options. The net proceeds to Toreador from the offering were approximately $26.8 million, after deducting underwriting discounts, commissions and estimated offering expenses. We intend to use the net proceeds, together with cash on hand, to satisfy payment obligations arising from the holders’ exercise, if any, of their right on October 1, 2010 to require the Company to repurchase its 5.00% Convertible Senior Notes and for general corporate purposes, which may include working capital, capital expenditures and acquisitions.  See “5.00% Convertible Senior Notes Due October 1, 2025” in Note 5. As of June 30, 2010, $32.4 million principal aggregate amount of the 5.00% Convertible Senior Notes was outstanding.  Pending such use, we have invested the net proceeds in mutual and money market funds and/or bank certificates of deposit.

 

NOTE 10 — CAPITALIZED INTEREST

 

We capitalize interest on major projects that require an extended period of time to complete. Capitalized interest for the three months ended June 30, 2010 and 2009 was $0 and $118,000 respectively. Capitalized interest for the six months ended June 30, 2010 and 2009 was $0 and $237,000, respectively.

 

NOTE 11 — COMMITMENTS AND CONTINGENCIES

 

In 2005, two separate incidents occurred offshore Turkey in the Black Sea, which resulted in the sinking of two caissons (the “Fallen Structures”) and the loss of three natural gas wells. The Company has not been requested to or ordered by any governmental or regulatory body to remove the caissons. Therefore, the Company believes that the likelihood of receiving such a request or order is remote and no liability has been recorded. In connection with the Company’s sale of its 26.75% interest in the SASB to Petrol Ofisi in March 2009 and its sale of Toreador Turkey to Tiway Oil (“Tiway”) in October 2009, the Company agreed to indemnify Petrol Ofisi and Tiway, respectively, against and in respect of any claims, liabilities and losses arising from the Fallen Structures. The Company has also indemnified a third-party vendor for any claims made related to these incidents.

 

On October 16, 2003, we entered into an agreement (the “Netherby Agreement”) with Phillip Hunnisett and Roy Barker (“Hunnisett and Barker”), pursuant to which Hunnisett and Barker agreed to post the collateral required by the Turkish government for Madison Oil Turkey Inc. (a Liberian company later reincorporated in the Cayman

 

14



Table of Contents

 

Islands as Toreador Turkey Limited) to retain its 36.75% interest in relation to eight offshore exploration SASB licenses in exchange for a 1.5% gross overriding royalty interest (the “Overriding Royalty”) on the net value to Madison Oil Turkey of all future production, if any, deriving from Madison’s interest in such SASB licenses. Since March 2009, we have corresponded with Hunnisett and Barker regarding a dispute over the compensation payable by us to Hunnisett and Barker under the Netherby Agreement as a result of Toreador Turkey’s sale of a 26.75% interest in the SASB licenses to Petrol Ofisi in March 2009 (the “Netherby Payment Amount”). Hunnisett and Barker have contended that the Netherby Payment Amount could be up to $10.4 million; however, we do not believe that Hunnisett and Barker are entitled to such amount. There has been subsequent correspondence regarding a dispute as to whether an agreement between the parties had been reached regarding the Netherby Payment Amount; Hunnisett and Barker’s contention is that such agreed Netherby Payment Amount was $7.2 million. We do not believe that any such agreement was reached, and we do not believe that Hunnisett and Barker are entitled to such amount. We intend to vigorously defend ourselves against any claim for payment of an amount in excess of the amount to which we believe that Hunnisett and Barker are entitled. We have since completed the sale of Toreador Turkey Ltd., including with it Toreador Turkey’s remaining 10% interest in the SASB license, to Tiway.  In connection with the sales referred to above, we agreed to indemnify Petrol Ofisi and Tiway against and in respect of any and all claims, liabilities, and losses arising from the Overriding Royalty. As of June 30, 2010, we had accrued approximately $880,000 as a contingent liability for these claims, with the expense included in discontinued operations.

 

On June 17, 2009, The Scowcroft Group, Inc. (“Scowcroft”) filed a complaint in the U.S. District Court for the District of Columbia against us. The complaint alleged that we breached a contract (the “Scowcroft Contract”) between Scowcroft and us relating to the sale of our interests in the SASB and that Scowcroft was entitled to a success fee thereunder as a result of the sale of our interests in the SASB to Petrol Ofisi in March 2009. The complaint also alleged unjust enrichment/quantum meruit and fraud. Scowcroft sought damages in the amount of $2 million plus interest, costs and expenses. On April 30, 2010, Toreador and Scowcroft executed a settlement agreement (the “Settlement Agreement”), pursuant to which Toreador agreed to pay Scowcroft $495,000 and, subject to receipt of such payment, Scowcroft agreed to take actions to dismiss the suit and the parties agreed to a mutual release with respect to claims relating to the Scowcroft Contract.  On April 30, 2010, Toreador made the settlement payment and the parties filed a stipulation of dismissal of the action. As of June 30, 2010, $657,000 has been expensed in discontinued operations consequently, consisting of the settlement amount and associated legal costs.

 

On January 25, 2010, we received a claim notice from Tiway under the Share Purchase Agreement, dated September 30, 2009, among us, Tiway Oil BV and Tiway relating to the sale of Toreador Turkey Ltd. in respect of a third-party claim asserted by Petrol Ofisi against Toreador Turkey Ltd. in the amount of TRY 7.6 million ($5.1 million), for which Tiway alleges we are liable for an estimated TRY 2.1 million ($1.4 million). No formal legal evaluation can be made at this time as to the extent of the Company’s liability, if any.  A hearing on this matter was held on July 20, 2010, and the Court has appointed three experts.  The next hearing is scheduled for on November 2, 2010.

 

From time to time, we are named as a defendant in other legal proceedings arising in the normal course of business. In our opinion, the final judgment or settlement, if any, which may be awarded with any suit or claim would not have a material adverse effect on our financial position.

 

NOTE 12 — DISCONTINUED OPERATIONS

 

In the fourth quarter of 2008 and during the first quarter of 2009, Toreador farmed out or sold all of its working interests in Romania to three different companies and closed its office; thus, we no longer have any operational involvement in Romania. This resulted in a gain of $5.8 million, which was recorded in the first quarter of 2009.

 

On March 3, 2009 we completed the sale of a 26.75% interest in the South Akcakoca Sub-Basin (SASB) project associated licenses located in the Black Sea offshore Turkey, to Petrol Ofisi for $55 million. In accordance with the revised assignment announced on February 3, 2009, $50 million of the proceeds was paid by Petrol Ofisi on

 

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March 3, 2009, and the remaining $5 million was paid on September 1, 2009. There was no gain or loss resulting from this sale.

 

On September 30, 2009, the Company entered into a Share Purchase Agreement (the “Share Purchase Agreement”) with Tiway Oil BV, a company organized under the laws of the Netherlands (“Tiway”), and Tiway Oil AS, a company organized under the laws of Norway, pursuant to which the Company agreed to sell 100% of the outstanding shares of Toreador Turkey Ltd. to Tiway for total consideration consisting of: (1) a cash payment of $10.5 million to be paid at closing, (2) exploration success payments dependent upon certain future commercial discoveries as provided in the Share Purchase Agreement, up to a maximum aggregate consideration of $40 million, and (3) future quarterly 10% pre-tax net profit interest payments if a field goes into production that was discovered by an exploration well drilled within four years of closing on certain of the licenses then still held by Tiway. The sale of Toreador Turkey Ltd. was completed on October 7, 2009 and resulted in a gain of $1.8 million.

 

On September 30, 2009, the Company entered into a Quota Purchase Agreement (the “Quota Purchase Agreement”) with RAG (Rohöl Aufsuchungs Aktiengesellschaft), a corporation organized under the laws of Austria (“RAG”), pursuant to which the Company agreed to sell 100% of its equity interests in Toreador Hungary Limited to RAG for total consideration consisting of (1) a cash payment of $5.4 million (€ 3.7 million) paid at closing, (2) $435,000 (€ 300,000), which was held back subject to a post-closing adjustment and was paid to us on November 5, 2009 and (3) a contingent payment of $2.9 million (€2 million) to be paid upon post-transaction completion of agreements relating to certain assets of Toreador Hungary. The sale of Toreador Hungary was completed on September 30, 2009 and resulted in a loss of $4.1 million.

 

The results of operations of assets in Romania, Turkey and Hungary have been presented as discontinued operations in the accompanying consolidated statement of operations.  Results for these assets reported as discontinued operations were as follows:

 

 

 

Three Months
Ended
June 30,

 

Six Months
Ended
June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Revenue and other income

 

 

 

 

 

 

 

 

 

Sales and other operating revenue

 

$

 

$

1,551

 

$

 

$

2,913

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

Lease operating expense

 

 

237

 

 

503

 

Exploration expense

 

 

32

 

 

230

 

Depreciation, depletion and amortization

 

 

 

 

 

Accretion on discounted assets and liabilities

 

 

 

 

 

Impairment of oil and natural gas properties

 

 

 

 

5,300

 

General and administrative expense

 

161

(1)

732

 

657

(1)

1,524

 

Gain on sale of properties and other assets in Romania

 

 

 

 

(5,846

)

Total operating costs and expenses

 

161

 

1,001

 

657

 

1,711

 

Operating income (loss)

 

(161

)

550

 

(657

)

1,202

 

Other income (expense)

 

 

 

 

 

 

 

 

 

Foreign currency exchange gain

 

 

3,752

 

 

3,319

 

Loss on early extinguishment of debt — revolving credit facility

 

 

 

 

(4,881

)

Other expense

 

86

 

 

165

 

 

Interest expense, net of interest capitalized

 

 

310

 

 

291

 

Income (loss) before income taxes

 

(247

)

4,612

 

(822

)

(69

)

Income tax benefit

 

 

 

 

 

Net income (loss) from discontinued operations

 

$

(247

)

$

4,612

 

$

(822

)

$

(69

)

 


(1) Residual exit costs.

 

NOTE 13 — DERIVATIVES

 

We periodically utilize derivative instruments such as futures and swaps for purposes of hedging our exposure to fluctuations in the sales price of crude oil. In December 2009, we entered into futures and swap contracts for approximately 15,208 Bbls per month for the months of January 2010 through December 2010.  This

 

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resulted in a net unrealized derivative fair value gain of $783,000 at June 30, 2010. Presented in the table below is a summary of the contracts entered into for 2010:

 

Type

 

Period

 

Barrels

 

Floor

 

Ceiling

 

Unrealized gain for the
three months ended
June 
30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Collar

 

January 1, 2010 – December 31, 2010

 

182,500

 

$

 68.00

 

$

 81.00

 

$

783

 

 

NOTE 14 — FAIR VALUE MEASUREMENTS

 

The carrying amounts of financial instruments including cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued liabilities approximate fair value at June 30, 2010 and December 31, 2009, due to the short-term nature or maturity of the instruments.

 

Long-term debt approximated fair value based on the quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same maturities.

 

On June 30, 2010, the 5.00% Convertible Senior Notes, which had a book value of $35.0 million, were trading at $95.2, which would equal a fair market value of approximately $31 million

 

On December 31, 2009, the 5.00% Convertible Senior Notes, which had a book value of $54.6 million, were trading at or near par value, which would equal a fair market value of approximately $54.6 million.

 

On June 30, 2010, the New Convertible Senior Notes, which had a book value of $31.6 million, were trading at $100.265, which would equal a fair market value of approximately $31.7 million.

 

ASC 820 “Fair value measurements and disclosures”, formerly SFAS No. 157, establishes a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three levels. The fair value hierarchy gives the highest priority to quoted market prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). Level 2 inputs are inputs, other than quoted prices included within Level 1, which are observable for the asset or liability, either directly or indirectly.

 

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:

 

Asset Impairments - The Company reviews a proved oil and gas property for impairment when events and circumstances indicate a possible decline in the recoverability of the carrying value of such property. We estimate the undiscounted future cash flows expected in connection with the property and compare such undiscounted future cash flows to the carrying amount of the property to determine if the carrying amount is recoverable. If the carrying amount of the property exceeds its estimated undiscounted future cash flows, the carrying amount of the property is reduced to its estimated fair value. Fair value may be estimated using comparable market data, a discounted cash flow method, or a combination of the two. In the discounted cash flow method, estimated future cash flows are based on management’s expectations for the future and include estimates of future oil and gas production, commodity prices based on commodity futures price strips as of the date of the estimate, operating and development costs, and a credit risk-adjusted discount rate.

 

The impairment charge in Turkey of $5.3 million which is recorded in discontinued operations for the period ended June 30, 2009, is a result of a decline in the fair market value of the Company’s interest in South Akcakoca Sub-Basin asset. The fair market value declined at June 30, 2009 due to a 25.00% reduction in the posted sales price of natural gas produced in Turkey announced on May 1, 2009.

 

Goodwill - We account for goodwill in accordance with FASB Accounting Standards Codification No. 350 Intangibles-Goodwill and Other”  (“ASC 350”). Under ASC 350, goodwill and indefinite-lived intangible assets are not amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment.

 

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Asset Retirement Obligations — The initial measurement of asset retirement obligations at fair value is calculated using cash flows techniques and based on internal estimates of future retirement costs associated with oil and gas properties. Significant Level 3 inputs used in the calculation of asset retirement obligations include plugging costs and reserve lives. A reconciliation of the Company’s asset retirement obligation is presented in Note 6.

 

Effective January 1, 2008, we adopted the authoritative guidance that applies to all financial assets and liabilities required to be measured and reported on a fair value basis. Beginning January 1, 2009, we also applied the guidance to non-financial assets and liabilities. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The guidance requires disclosure that establishes a framework for measuring fair value expands disclosure about fair value measurements and requires that fair value measurements be classified and disclosed in one of the following categories:

 

Level 1:

Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. We consider active markets as those in which transactions for the assets or liabilities occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

 

 

Level 2:

Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability. This category includes those derivative instruments that we value using observable market data. Substantially all of these inputs are observable in the marketplace throughout the full term of the derivative instrument, can be derived from observable data or supported by observable levels at which transactions are executed in the market place. Instruments in this category include non-exchange traded derivatives such as over-the-counter commodity price swaps, certain investments and interest rate swaps.

 

 

Level 3:

Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources (i.e., supported by little or no market activity). Our valuation models for derivative contracts are primarily industry-standard models (i.e., Black-Scholes) that consider various inputs including: (a) quoted forward prices for commodities, (b) time value, (c) volatility factors, (d) counterparty credit risk and (e) current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Level 3 instruments primarily include derivative instruments, such as basis swaps, commodity price collars and floors and accrued liabilities. Although we utilize third -party broker quotes to assess the reasonableness of our prices and valuation techniques, we do not have sufficient corroborating market evidence to support classifying these assets and liabilities as Level 2.

 

Measurement information for assets that are measured at fair value on a non-recurring basis was as follows:

 

 

 

 

 

Fair Value Measurements Using

 

 

 

Description

 

Fair Value
Measurement

 

Quoted
Prices
in
Active
Markets
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Total
Impairment
Loss

 

 

 

(in thousands)

 

Six Months Ended June 30, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

8.00/7.00% Convertible Senior Notes

 

$

35,065

 

 

 

$

35,065

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30, 2009

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Impaired oil and natural gas properties

 

$

14,986

 

 

 

$

14,986

 

$

(5,300

)

 

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The following table summarizes the valuation of our investments and financial instrument assets (liabilities) measured on a recurring basis at fair value by pricing levels:

 

 

 

Fair Value Measurement Using

 

 

 

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

 

 

 

 

 

 

 

 

 

 

As of June 30, 2010:

 

 

 

 

 

 

 

 

 

Oil derivative contracts

 

$

 

$

 

$

72

 

$

72

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

 

$

 

$

72

 

$

72

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2009:

 

 

 

 

 

 

 

 

 

Oil derivative contracts

 

$

 

$

 

$

886

 

$

886

 

 

 

$

 

$

 

$

886

 

$

886

 

 

The table below summarizes the change in carrying values associated with Level 3 financial instruments:

 

 

 

Six months ended
June 30, 2010

Oil Derivative
Contracts

 

Year ended
December 31, 2009

Oil Derivative
Contracts

 

Balance at beginning of period

 

$

886

 

$

 

Unrealized (gain) loss

 

(814

)

886

 

 

 

 

 

 

 

Balance at end of period

 

$

72

 

$

886

 

 

NOTE 15 — IMPAIRMENT OF ASSETS

 

We evaluate producing property costs for impairment and reduce such costs to fair value if the sum of expected undiscounted future cash flows is less than net book value pursuant to FASB ASC 360 “Property, plant and Equipment”, formerly Statement of Financial Accounting Standard No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“Statement 144”). We assess impairment of non-producing leasehold costs and undeveloped mineral and royalty interests periodically on a field-by-field basis. We charge any impairment in value to expense in the period incurred. For the three months ended June 30, 2010, there was no impairment charge for our continuing operations and discontinued operations.

 

The impairment charge in Turkey of $5.3 million, as of June 30, 2009, was a result of a decline in the fair market value of the Company’s interest in South Akcakoca Sub-Basin asset. The fair market value declined at June 30, 2009 due to a 25.00% reduction in the posted sales price of natural gas produced in Turkey announced on May 1, 2009.

 

NOTE 16 — AGREEMENT WITH HESS

 

On May 10, 2010, Toreador Energy France S.C.S. (“TEF”), a company organized under the laws of France and an indirect subsidiary of Toreador Resources Corporation, a Delaware corporation (the “Company”), entered into an Investment Agreement (the “Investment Agreement”) with Hess Oil France S.A.S. (“Hess”), a company organized under the laws of France and a wholly owned subsidiary of Hess Corporation, a Delaware corporation, pursuant to which (x) Hess becomes a 50% holder of TEF’s working interests in its awarded and pending exploration permits in the Paris Basin, France (the “Permits”) subject to fulfillment of Work Program (as described in (y) (2) hereafter) and (y) (1) Hess must make a $15 million upfront payment to TEF, (2) Hess will have the right to invest up to $120 million in fulfillment of a two-phase work program (the “Work Program”) and (3) TEF would

 

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be entitled to receive up to a maximum of $130 million of success fees based on reserves and upon the achievement of an oil production threshold, each as described more fully below.

 

The Ministère de l’Ecologie, de l’Energie, du Développement Durable et de la Mer (Ministry of Ecology, Energy, Sustainable Development and the Sea) in France granted first-stage approval on June 25, 2010. An application for the grant to Hess of title on the permits is expected to be filed shortly with the government.

 

Pursuant to the Investment Agreement, subject to such government approval, TEF has transferred 50% of its working interest in each Permit to Hess (collectively, the “Transfer Working Interests”) and, on June 10, 2010, Hess paid TEF $15 million plus VAT, i.e., an aggregate amount of $17.9 million, on June 10, 2010.

 

Under the terms of the Investment Agreement, Phase 1 of the Work Program is expected to consist of an evaluation of the acreage underlying the Permits and the drilling of six wells. The parties have agreed to use reasonable endeavors to spud the first well by December 1, 2010, the second well by the March 31, 2011 and the third well by June 30, 2011.  If Hess does not spend $50 million in fulfillment of the Work Program within 30 months of receipt of government approval (“Phase 1”), Hess must promptly transfer back to TEF the Transfer Working Interests.

 

Under the terms of the Investment Agreement, if Hess spends $50 million in Phase 1, Hess will have the option to proceed to Phase 2 of the Work Program. If Hess elects not to proceed to Phase 2 of the Work Program, Hess must promptly transfer back to TEF a percentage of the Transfer Working Interests determined with reference to the amount of money spent by Hess in fulfillment of the Work Program during Phase 1.

 

Under the terms of the Investment Agreement, if Hess elects to proceed, Phase 2 of the Work Program is expected to consist of appraisal and development activities, depending on the results of the work in Phase 1. If Hess does not spend $70 million (less money spent by Hess in fulfillment of the Work Program in excess of $50 million in Phase 1) in fulfillment of the Work Program within 36 months (“Phase 2”), Hess must promptly transfer back to TEF a percentage of the Transfer Working Interests determined with reference to the amount of money spent by Hess in fulfillment of the Work Program during Phase 1. Following Phase 2, TEF and Hess will bear the costs of subsequent exploration, appraisal and development activities in accordance with individual participation agreements governing the joint operations on each Permit.

 

Under the terms of the Investment Agreement, Hess agrees to pay TEF: (x) a success fee based on proved developed oil reserves (as defined by Rule 4-10(a) of Regulation S-X), up to a maximum of $80 million and (y) a success fee if oil production exceeds an agreed threshold, up to a maximum of $50 million, each of which is subject to reduction under certain circumstances.

 

Under the terms of the Investment Agreement, TEF and Hess have designated an area of mutual interest within the Paris Basin (the “AMI”). If either party acquires or applies for a working interest in an exploration permit or exploitation concession within the AMI, such party would be required to offer to the other party 50% of such interest on the same terms and conditions.

 

As a result of the Investment Agreement, the Company has recorded the upfront payment of $15 million in other income for the three months period ended June 30, 2010, since this revenue is not subject to any further obligation or performance by the Company nor is it depending on any approval.

 

NOTE 17 — PENSION, POST-RETIREMENT, AND POST-EMPLOYMENT OBLIGATIONS

 

Provisions for employee retirement obligations amounted to $245,000 and $0 for the six months ended June 30, 2010 and June 30, 2009, respectively. Pension benefits, which only consist in retirement indemnities, have been defined only for the Company’s French subsidiaries.

 

NOTE 18 — STOCK COMPENSATION PLANS

 

We have granted stock options to key employees and outside directors of Toreador as described below.

 

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In May 1990, we adopted the 1990 Stock Option Plan (“1990 Plan”). The 1990 Plan, as amended and restated, provides for grants of up to 1,000,000 stock options to employees and directors at exercise prices greater than or equal to market on the date of the grant.

 

In December 2001, we adopted the 2002 Stock Option Plan (“2002 Plan”). The 2002 Plan provides for grants of up to 500,000 stock options to employees and outside directors at exercise prices greater than or equal to market on the date of the grant.

 

In September 1994, we adopted the 1994 Non-employee Director Stock Option Plan (“1994 Plan”). The 1994 Plan, as amended and restated, provides for grants of up to 500,000 stock options to non-employee directors of Toreador at exercise prices greater than or equal to market on the date of the grant.

 

The Board of Directors grants options under our plans periodically. Generally, option grants are exercisable in equal increments over a three-year period, and have a maximum term of 10 years.

 

A summary of stock option transactions is as follows:

 

 

 

2010

 

2009

 

 

 

SHARES

 

WEIGHTED
AVERAGE
EXERCISE
PRICE

 

SHARES

 

WEIGHTED
AVERAGE
EXERCISE
PRICE

 

Outstanding at January 1

 

67,370

 

$

7.78

 

248,370

 

$

6.77

 

Granted

 

 

 

 

 

Exercised

 

(5,000

)

$

3.10

 

(31,000

)

$

3.67

 

Forfeited

 

 

 

 

(150,000

)

$

6.96

 

Outstanding at the end of the period

 

62,370

 

$

8.15

 

67,370

 

$

7.78

 

Exercisable at the end of the period

 

62,370

 

$

8.15

 

67,370

 

$

7.78

 

 

The intrinsic value of the options exercised at June 30, 2010 was zero.  For the six months ended June 30, 2010 and for the year ended December 31, 2009 we received cash from stock option exercises of $15,500 and $113,875, respectively.  As of June 30, 2010, all outstanding options were 100% vested.  As of June 30, 2010 and December 31, 2009, the total compensation cost related to non-vested stock options not yet recognized was zero.

 

The following table summarizes information about the fixed price stock options outstanding at June 30, 2010:

 

 

 

Number Outstanding

 

Number Exercisable

 

 

 

Exercise Price

 

Shares

 

Intrinsic
Value
(in thousands)

 

Shares

 

Intrinsic
Value
(in thousands)

 

Weighted Average Remaining
Contractual Life in Years

 

 

 

 

 

 

 

 

 

 

 

 

 

3.12

 

620

 

$

1

 

620

 

$

1

 

0.22

 

3.12

 

3,800

 

9

 

3,800

 

9

 

0.22

 

5.50

 

200

 

0

 

200

 

0

 

3,82

 

5.50

 

40,250

 

0

 

40,250

 

0

 

3.82

 

13.75

 

7,500

 

(62

)

7,500

 

(62

)

4,38

 

16.90

 

10,000

 

(114

)

10,000

 

(114

)

4.89

 

 

 

62,370

 

$

(165

)

62,370

 

$

(165

)

2.89

 

 

In May 2005, the Company’s stockholders approved the Toreador Resources Corporation 2005 Long-Term Incentive Plan (the “Plan”). At the Company’s 2010 Annual Meeting of Stockholders, the stockholders of the Company approved an amendment to the Plan which increased the authorized number of shares of Company

 

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common stock available under the Plan from 1,750,000 shares to 3,250,000 shares. Thus, the Plan, as amended, authorizes the issuance of up to 3,250,000 shares of the Company’s common stock to key employees, key consultants and outside directors of the Company.  At June 30, 2010 the Board of Directors has authorized a total of 199,561 shares of restricted stock to be granted to employees and non-employee directors. The compensation cost is measured by the difference between the quoted market price of the stock at the date of grant and the price, if any, to be paid by an employee and is recognized as an expense over the period the recipient performs related services. The restricted stock grants vest immediately or over up to a four-year period (depending on the grant), and the weighted average price of the stock on the date of the grants was $9.67 for the six months ended June 30, 2010. Stock compensation expense of $1.1 million is included in the Statement of Operations for the three months ended June 30, 2010 and stock compensation expense of $2.2 million is included in the Statement of Operations for the six months ended June 30, 2010, which represents the cost recognized from the date of the grants through June 30, 2010.  During the first half 2010, 242,034 shares vested having a fair value of approximately $1.98 million on the date of vesting. As of June 30, 2010, the total compensation cost related to non-vested restricted stock grants not yet recognized is approximately $3 million. This amount will be recognized as compensation expense over the next 36 months.

 

On June 30, 2010, there were 19,906,610 remaining shares available for grant under the plans collectively.

 

The following table summarizes the changes in outstanding restricted stock grants along with their related grant-date fair values for the year ended June 30, 2010:

 

 

 

Shares

 

Weighted Average
Grant-Date

Fair Value

 

Non-vested at December 31,2009

 

378,130

 

$

10.25

 

Shares granted

 

199,561

 

$

9.67

 

Shares vested

 

(242,034

)

$

9.51

 

Shares forfeited

 

 

 

Non-vested at June 30, 2010

 

335, 657

 

$

10.92

 

 

NOTE 19 — SUBSEQUENT EVENTS

 

The Company evaluated its June 30, 2010 financial statements for subsequent events through the date the financial statements were available to be issued.

 

To cover Lundin International (“Lundin”)  against any claim by a third party arising from drilling works executed by Toreador Energy France SCS (“TEF”)  as operator on the Mairy permit before the transfer of title on such permit will have been formally accepted by the French government, TEF executed on August 6, 2010 an indemnification and guarantee agreement for a maximum aggregate amount of  €50 million first demand guarantee in favor of Lundin. Any claim under the guarantee shall be accompanied by a written statement of Lundin mentioning liability or claim for damages made by a third party against Lundin due to works done by TEF on the Mairy permit from February 15, 2010 up to transfer of title, with supportive documents therefor.

 

The title to the Mairy permit was awarded to Lundin, TEF and EnCore (E&P) Ltd jointly in August 2007. Earlier this year Lundin communicated its desire to withdraw from the permit on which no drilling works had been performed and consequently assigned its working interest of 40% in equal parts to TEF and EnCore (E&P) Ltd.  TEF subsequently assigned half of its now 50% working interest to Hess Oil France SAS by virtue of the Investment Agreement.

 

Under French mining law, all titleholders are held jointly and severally responsible for all damages, claims, etc. relating to works on the permit. Works on the permit, if any, will not start before the second half of 2011.

 

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ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion is intended to assist you in understanding our business and results of operations together with our present financial condition. This section should be read in conjunction with our Consolidated Financial Statements and the accompanying notes included elsewhere in this Quarterly Report on Form 10-Q, as well as our Annual Report on Form 10-K for the year ended December 31, 2009, which was filed with the SEC on March 16, 2010.  Certain prior-year amounts have been reclassified and adjusted to present the operations of Turkey, Hungary and Romania as discontinued operations.

 

DISCLOSURES REGARDING FORWARD-LOOKING STATEMENTS

 

Certain matters discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report may constitute “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and, as such, may involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. When used in this report, the words “anticipates,” “estimates,” “plans,” “believes,” “continues,” “expects,” “projections,” “forecasts,” “intends,” “may,” “might,” “will,” “would,” “could,” “should,” and similar expressions are intended to be among the statements that identify forward-looking statements. The factors that may affect our expectations regarding our operations include, among others, the following:

 

·                       our ability to raise necessary capital in the future;

·                       our ability to maintain or renew our existing exploration permits or exploitation concessions or obtain new ones;

·                       the effect of our indebtedness on our financial health and business strategy;

·                       our ability to execute our business strategy and be profitable;

·                       our ability to replace oil reserves;

·                       a change in the SEC position on our calculation of proved reserves;

·                       the loss of the current purchaser of our oil production;

·                       results of our hedging activities;

·                       the loss of senior management or key employees;

·                       political, legal and economic risks associated with having international operations;

·                       disruptions in production and exploration activities in the Paris Basin;

·                       currency fluctuations;

·                       failure to maintain adequate internal controls;

·                       indemnities granted by us in connection with dispositions of our assets;

·                       unfavorable results of legal proceedings;

·                       assessing and integrating acquisition prospects;

·                       declines in prices for crude oil;

·                       our ability to compete in a highly competitive oil and gas industry;

·                       our ability to obtain equipment and personnel;

·                       extensive regulation, including environmental regulation, to which we are subject;

·                       terrorist activities;

·                       our success in development, exploitation and exploration activities;

·                       reserves estimates turning out to be inaccurate; and

·                       differences between the present value and market value of our reserves.

 

In addition to these factors, important factors that could cause actual results to differ materially from our expectations (“Cautionary Statements”) are disclosed under “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, filed with the SEC on March 16, 2010, which are incorporated by reference herein.

 

All written and oral forward-looking statements attributable to us are expressly qualified in their entirety by the Cautionary Statements.  We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.

 

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EXECUTIVE OVERVIEW

 

We are an independent energy company engaged in the exploration and production of crude oil with interests in developed and undeveloped oil properties in the Paris Basin, France. We are currently focused on the development of our conventional fields and the exploitation of the prospective shale oil play within our Paris Basin acreage position.

 

We currently operate solely in the Paris Basin, which covers approximately 170,000 km2 of northeastern France, centered 50 to 100 km east and south of Paris. At June 30, 2010, we held interests in approximately 683,000 gross exploration acres. According to Gaffney, Cline & Associates Ltd, an independent petroleum and geological engineering firm, or Gaffney Cline, as of December 31, 2009, our proved reserves were 5.8 MBbls, our proved plus probable reserves were 9.1 MBbls and our proved plus probable plus possible reserves were 14.3 MBbls. Our production for 2009 averaged approximately 900 bbl/d from two conventional oilfield areas in the Paris Basin the Neocomian Complex and Charmottes fields. As of June 30, 2010, production from these oil fields represented substantially all of our sales and operating revenue. We intend to maintain production from these mature assets using suitable enhanced oil recovery techniques. In addition to this production base, we have identified several additional conventional exploration targets. We received well results on the La Garenne, the first of these targets, in January 2010. Following a more detailed analysis of the data, we intend to formulate a development plan for the field by the end of the third quarter of 2010.

 

We are also currently focused on exploiting our shale oil acreage in the Paris Basin. Our current priority is to execute with our strategic partner, Hess Oil France S.A.S., a proof of concept program by drilling, by completing and testing pilot wells, subject to approval of drilling by the French government

 

Operations Update

 

La Garenne Well

 

We began drilling on the La Garenne well on November 12, 2009. The well confirmed a five-meter reservoir within a 50-meter oil column in the target Dogger formation. Based on our continued evaluation of the well results, we believe the well confirms a porous and hydrocarbon-bearing reservoir with a localized low-permeability area at the crest of the structure.   We completed production testing of the well in January 2010, and the results were inconclusive. The well flowed only limited quantities from one of its two horizons in the Dogger. We intend to formulate a development plan for La Garenne following a more detailed analysis. We expect that the vertical well drilled will be used as a water disposal or an injection well in the development of this field.

 

Strategic Partner Process

 

In November 2009, our Board of Directors retained RBC Capital Markets to assist the Board’s Strategic Committee in the review of various strategic alternatives. The approach we principally focused on was to identify a potential partner to assist us, through a farm-out agreement or other means, in exploiting our shale oil acreage in the Paris Basin. As a result, on May 10, 2010, Toreador Energy France S.C.S. (“TEF”), a company organized under the laws of France and an indirect subsidiary of the Company, entered into an Investment Agreement (the “Investment Agreement”) with Hess Oil France S.A.S. (“Hess”), a company organized under the laws of France and a wholly owned subsidiary of Hess Corporation, a Delaware corporation, pursuant to which (x) Hess may become a 50% holder of TEF’s working interests in its awarded and pending exploration permits in the Paris Basin, France (the “Permits”) and (y) (1) Hess must make a $15 million upfront payment to TEF, (2) Hess will have the right to invest up to $120 million in fulfillment of a two-phase work program (the “Work Program”) and (3) TEF would be entitled to receive up to a maximum of $130 million of success fees based on reserves and upon the achievement of an oil production threshold.

 

The Ministère de l’Ecologie, de l’Energie, du Développement Durable et de la Mer (Ministry of Ecology, Energy, Sustainable Development and the Sea) in France granted first-stage approval on June 25, 2010. An application for the grant to Hess of title on the permits is expected to be filed shortly with the government.

 

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Pursuant to the Investment Agreement, subject to such government approval, TEF has transferred 50% of its working interest in each Permit to Hess (collectively, the “Transfer Working Interests”). Pursuant to the Investment Agreement, Hess made the $15 million upfront payment (plus applicable VAT of $2.9 million) to TEF on June 10, 2010.

 

This payment has been recognized as revenue in “other income” since this revenue is not subject to any further obligation or performance by the Company nor is it depending on any approval.

 

Share Repurchase Program

 

On May 27, 2010, the Board of Directors authorized a share repurchase program for the repurchase of up to $5 million of shares of Toreador common stock in the open market or in private transactions at the discretion of management over the next 12 months.  The Company has no obligation to repurchase shares under the program, and the program may be suspended at any time.  As of June 30, 2010, no shares of Toreador common stock have been repurchased pursuant to the share repurchase program.

 

Strategy

 

The primary components of our strategy are:

 

·       Focus on France.  All of our oil assets are currently located in France, having disposed of our interests in Turkey, Romania and Hungary in 2009. We believe we can leverage our substantial acreage position and our experience and industry relationships in France to grow the Company.

 

·       Capture, develop and accelerate conventional prospects.   We have identified a number of conventional oil prospects, which we intend to evaluate for potential development, beginning with La Garenne.

 

·       Target the prospective unconventional oil resource play.  We are currently working with Hess on our proof of concept program and potential development of our Paris Basin shale oil acreage position.

 

·       Continue to focus on operational costs.  Since the beginning of 2009, we have improved operational efficiencies, and we intend to reduce general and administrative costs and continue to focus on maintaining efficient operations.

 

·       Seek and maintain optimal capital structure.  We expect the proceeds from the February 2010 share offering to enable us to reduce our debt, and we intend to maintain a conservative capital structure over time.

 

Financial Summary

 

For the six months ended June 30, 2010:

 

·                  Revenues from continuing operations were $26.5 million.

 

·                  Operating costs from continuing operations were $14.2 million.

 

·                  Loss from discontinued operations, net of income taxes, was $822,000.

 

·                  Net loss available to common shares was $1.0 million.

 

·                  Production was 161 MBOE.

 

At June 30, 2010, we had:

 

·                  Cash  and cash equivalents of $56 million.

 

·                  A current ratio (current assets/current liabilities) of 1.27 to 1.

 

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·                  A debt to equity ratio of 3.87 to 1.

 

LIQUIDITY AND CAPITAL RESOURCES

 

This section should be read in conjunction with Note 5 to Notes to Consolidated Financial Statements included in this filing.

 

Liquidity

 

The Company’s liquidity depends on cash flow from operations and existing cash resources.  As of June 30, 2010, we had cash and cash equivalents of $56 million, a current ratio of approximately 1.27 to 1 and a debt to equity ratio of 3.87 to 1. For the three months ended June 30, 2010, we had an operating income of $14.0 million.  We had sales and operating revenue of $5.9 million and $15.0 million of other income representing the upfront payment from Hess under the Investment Agreement.  We had no capital expenditures. The Company does not currently have a credit facility and intends to rely on its cash balance to meet its immediate cash requirements.

 

Our cash flow from operations is highly dependent upon the prices received from our oil production, which are dependent on numerous factors beyond our control.  Accordingly, significant changes to oil prices are likely to have a material impact on our financial condition, results of operation, cash flows and revenue.  Oil prices have been very volatile over the first half of 2010, and we expect, will continue to be, volatile for the remainder of the fiscal year 2010.  In order to reduce our exposure to crude oil price fluctuations, we have entered into a collar contract for approximately 15,208 Bbls per month for the months of January 2010 through December 2010 for which the floor price is $68.00 per bbl, and the ceiling price is $81.00 per bbl.

 

On February 1, 2010, we consummated an exchange transaction (the “Convertible Notes Exchange”). In the Convertible Notes Exchange, in exchange for (a) $22,231,000 principal amount of our outstanding 5.00% Convertible Senior Notes (the “Old Notes”) and (b) $9.4 million cash, we issued $31,631,000 aggregate principal amount of our 8.00%/7.00% Convertible Senior Notes (the “New Convertible Senior Notes”) and paid accrued and unpaid interest on the Old Notes.   See “ 5.00% Convertible Senior Notes Due October 1, 2025” and “ 8.00%/7.00% Senior Convertible Notes Due October 1, 2025” for further details.

 

On February 12, 2010, we completed a registered underwritten public offering of 3,450,000 shares of common stock, including 450,000 shares of common stock acquired by the underwriters from us to cover over-allotment options. The net proceeds to Toreador from the offering were approximately $26.8 million, after deducting underwriting discounts, commissions and estimated offering expenses. We intend to use the net proceeds, together with cash on hand, to satisfy payment obligations arising from the holders exercise, if any, of their right on October 1, 2010 to require the Company to repurchase up to $32.4 million of the 5.00% Convertible Senior Notes and for general corporate purposes, which may include working capital, capital expenditures and acquisitions. Pending such use, we have invested the net proceeds in mutual and money market funds, bank certificates of deposit and/or government securities.

 

We currently have no mandatory capital expenditures in 2010; however, we are currently evaluating a development plan for the La Garenne field. In addition, under French law, each of our exploration permits and exploitation concessions require that we commit to expenditures of a certain amount over the period of the applicable permit or concession. Though we consider these amounts discretionary, such expenditures would be required to renew such permits.

 

We believe we will have sufficient cash flow from operations and cash on hand to meet all of our 2010 obligations, including to repurchase the $32.4 million outstanding 5.00% Convertible Senior Notes on October 1, 2010 if the holders exercise their right to require the Company to do so. See “5.00% Convertible Senior Notes Due October 1, 2025”.

 

The Company has elected to amortize straight-line (which approximates the effective interest method) the costs associated with the issuance of its convertible senior notes over the term of the issuance (i.e., 2025 for both the 5.00% Convertible Senior Notes and the 8.00%/7.00% Convertible Senior Notes) and not at the first puttable dates of these callable debts.

 

Depending on the results of the repurchase option offered to the 5.00% Convertible Senior Notes by holders, on October 1, 2010, we will reconsider this accounting policy election.

 

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5.00% CONVERTIBLE SENIOR NOTES DUE OCTOBER 1, 2025

 

On September 27, 2005, we issued $75 million of Convertible Senior Notes due October 1, 2025 (the “5.00% Convertible Senior Notes”) to qualified institutional buyers pursuant to Rule 144A of the Securities Act of 1933, as amended (the “Securities Act”). The Company also granted the initial purchasers the option to purchase an additional $11.25 million aggregate principal amount of 5.00% Convertible Senior Notes to cover over-allotments. The over-allotment option was exercised on September 30, 2005. The total principal amount of 5.00% Convertible Senior Notes issued was $86.25 million and total net proceeds were approximately $82.2 million. We incurred approximately $4.1 million of costs associated with the issuance of the 5.00% Convertible Senior Notes; these costs have been recorded in other assets on the balance sheet and are being amortized to interest expense using the straight-line interest rate method (which approximates effective interest method) over the term of the 5.00% Convertible Senior Notes.

 

The net proceeds were used for general corporate purposes, including funding a portion of the Company’s 2005 and 2006 exploration and development activities.

 

The 5.00% Convertible Senior Notes bear interest at a rate of 5.00% per annum and can be converted into common stock at an initial conversion rate of 23.3596 shares of common stock per $1,000 principal amount of 5.00% Convertible Senior Notes, subject to adjustment (equivalent to a conversion price of approximately $42.81 per share). We may redeem the 5.00% Convertible Senior Notes, in whole or in part, on or after October 6, 2008, and prior to October 1, 2010, for cash at a redemption price equal to 100% of the principal amount of 5.00% Convertible Senior Notes to be redeemed, plus any accrued and unpaid interest, if the closing price of our common stock exceeds 130% of the conversion price over a specified period. On or after October 1, 2010, we may redeem the 5.00% Convertible Senior Notes, in whole or in part, at a redemption price equal to 100% of the principal amount of 5.00% Convertible Senior Notes to be redeemed, plus any accrued and unpaid interest, irrespective of the price of its common stock. Holders may convert their 5.00% Convertible Senior Notes at any time prior to the close of business on the business day immediately preceding their stated maturity, and holders may, upon the occurrence of certain fundamental changes, or on October 1, 2010, October 1, 2015, and October 1, 2020, require us to repurchase all or a portion of their 5.00% Convertible Senior Notes for cash in an amount equal to 100% of the principal amount of such 5.00% Convertible Senior Notes, plus any accrued and unpaid interest.  As of June 30, 2010, there was $32.4 million of the 5.00% Convertible Senior Notes outstanding.

 

During 2008 the Company repurchased $6 million, face value, of the 5.00% Convertible Senior Notes on the open market for $5.3 million. In 2009 the Company repurchased $25.7 million face value of the 5.00% Convertible Senior Notes on the open market for $21.3 million, resulting in a gain on the early extinguishment of debt of $3.4 million after writing off deferred loan costs of approximately $1 million.  On February 1, 2010, Toreador consummated an exchange transaction (the “Convertible Notes Exchange”). In the Convertible Notes Exchange, in exchange for (a) $22,231,000 principal amount of our outstanding 5.00% Convertible Senior Notes and (b) $9.4 million cash, we issued $31,631,000 aggregate principal amount of our 8.00%/7.00% Convertible Senior Notes, or the New Convertible Senior Notes, and paid accrued and unpaid interest on the Old Notes. We intend to continue to buy back a portion of the currently outstanding Notes in the open market or in privately negotiated transactions, subject to market conditions, applicable legal requirements and other factors.

 

As the debt instruments exchanged in the Convertible Notes Exchange have substantially different terms, the Company recognized the exchange of the 5.00% Convertible Senior Notes as extinguishment of debt. As a result, for the six months ended June 30, 2010, the Company recognized a loss of $4.3 million including write off of loan original fee of $822,000 for the debt extinguishment. The New Convertible Senior Notes are recorded at a fair value of $35,065,000 on the date of exchange. The accretion expense on the Convertible Notes Exchange, which was determined using fair market value of the New Convertible Senior Notes, will be amortized to income over their term. Amortization of $91,322 was recorded for the period ended June 30, 2010.

 

8.00%/7.00% CONVERTIBLE SENIOR NOTES DUE OCTOBER 1, 2025

 

On February 1, 2010, Toreador consummated the Convertible Notes Exchange. In the Convertible Notes Exchange, in exchange for (a) the Old Notes and (b) $9.4 million cash, we issued $31,631,000 aggregate principal amount of (the New Convertible Senior Notes) and paid accrued and unpaid interest on the Old Notes. We incurred approximately $1.9 million of costs associated with the issuance of the New Convertible Senior Notes; these costs have been recorded in other assets on the balance sheets and are being amortized to interest expense using the

 

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straight-line interest method (which approximates effective interest method) over the term of the New Convertible Senior Notes.

 

The New Convertible Senior Notes are senior unsecured obligations of the Company, ranking equal in right of payment with the Companys 5.00% Convertible Senior and future unsubordinated indebtedness. The New Convertible Senior Notes will mature on October 1, 2025 and pay annual cash interest at 8.00% from February 1, 2010 until January 31, 2011 and at 7.00% per annum thereafter. Interest on the New Convertible Senior Notes will be payable on February 1 and August 1 of each year, beginning on August 1, 2010.

 

The New Convertible Senior Notes are convertible prior to February 1, 2011 only if an event of default occurs and is continuing under the terms of the indenture, upon a change of control (as defined in the indenture) and to the extent the Company elects to redeem the New Convertible Senior Notes in a Provisional Redemption (as defined below). The New Convertible Senior Notes are convertible at any time on or after February 1, 2011 and before the close of business on October 1, 2025.

 

The New Convertible Senior Notes are convertible into shares of our common stock at an initial conversion rate of 72.9927 shares of common stock per $1,000 principal amount of New Convertible Senior Notes (which is equivalent to an initial conversion price of $13.70 per share), subject to adjustment upon certain events. Under the terms of the indenture governing the New Convertible Senior Notes, if on or before October 1, 2010, we sold shares of our common stock in an equity offering or an equity-linked offering (other than for compensation), for cash consideration per share such that 120% of the issuance price was less than the conversion price of the New Convertible Senior Notes then in effect, the conversion price was to be reduced to an amount equal to 120% of such offering price. As a result of our February 2010 public offering, the conversion rate of the New Convertible Senior Notes adjusted to 98.0392 shares of common stock per $1,000 principal amount of New Convertible Senior Notes (which is equivalent to a conversion price of approximately $10.20 per share).  Pursuant to the indenture, the conversion price of the New Convertible Senior Notes will not be further adjusted under such provision because the proceeds from the public offering were in excess of $20 million.

 

The New Convertible Senior Notes may be redeemed in whole or in part at the Company’s option prior to October 1, 2013, in cash at a redemption price equal to one hundred percent (100%) of the principal amount of the New Convertible Senior Notes redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date plus a make-whole payment, if the closing sale price of the Company’s common stock has exceeded 200% of the conversion price then in effect for at least twenty (20) trading days in any consecutive thirty (30)-trading day period ending on the trading day prior to the date of mailing of the relevant notice of redemption (a “Provisional Redemption”).  The New Convertible Senior Notes may be redeemed in whole or in part at the Company’s option on or after October 1, 2013 for cash at a redemption price equal to 100% of the principal amount of the New Convertible Senior Notes redeemed, plus any accrued and unpaid interest to, but excluding, the redemption date.  In addition, upon the occurrence of certain fundamental changes, or on each of October 1, 2013, October 1, 2015 and October 1, 2020, a holder may require the Company to repurchase all or a portion of the New Convertible Senior Notes in cash for 100% of the principal amount of the New Convertible Senior Notes to be purchased, plus any accrued and unpaid interest to, but excluding, the purchase date.

 

Pursuant to the indenture, the Company and its subsidiaries may not incur debt other than Permitted Indebtedness. “Permitted Indebtedness” includes (i) the New Convertible Senior Notes; (ii) the 5.00% Convertible Senior Notes or any indebtedness of the Company that serves to refund or refinance the 5.00% Convertible Senior Notes (“Refinancing Debt”), so long as the principal amount of the Refinancing Debt does not exceed the outstanding principal amount of the 5.00% Convertible Senior Notes; (iii) indebtedness incurred by the Company or its subsidiaries not to exceed the sum of (i) the product of (x) $7.00 and (y) the number of barrels of proved plus probable reserves and (ii) cash equivalents less the aggregate principal amount of the New Convertible Senior Notes outstanding less the aggregate principal amount of the 5.00% Convertible Senior Notes less any Refinancing Debt; (iv) indebtedness that is nonrecourse to the Company or any of its subsidiaries used to finance projects or acquisitions, joint ventures or partnerships, including acquired indebtedness (“Nonrecourse Debt”); and (v) certain other customary categories of permitted debt. In addition, the Company may not permit its total consolidated net debt as of any date to exceed the product of (x) $7.00 and (y) the number of barrels of proved plus probable reserves other than for Nonrecourse Debt. The proved plus probable reserves underlying any Nonrecourse Debt for which debt has been incurred as permitted debt pursuant to clause (iv) above will be excluded from the proved plus probable reserves calculation for the purposes of the above debt covenants.

 

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Dividends

 

Dividends on our common stock may be declared and paid out of funds legally available when and as determined by our Board of Directors. Our policy is to hold and invest corporate funds on a conservative basis, and, thus, we do not anticipate paying cash dividends on our common stock in the foreseeable future.

 

Contractual Obligations

 

The following table sets forth our contractual obligations in thousands at June 30, 2010 for the periods shown:

 

 

 

Total

 

Less Than
One Year

 

One to
Three Years

 

Four to
Five Years

 

More Than
Five Years

 

Long-term debt

 

$

67,358

 

$

32,385

 

$

34,973

 

$

 

$

 

Asset retirement obligation

 

5,915

 

1,852

 

295

 

397

 

3,371

 

Lease commitments

 

497

 

110

 

387

 

 

 

Total contractual obligations

 

$

73,770

 

$

34,347

 

$

35,655

 

$

397

 

$

3,371

 

 

Contractual obligations for long-term debt above does not include amounts for interest payments.

 

CRITICAL ACCOUNTING POLICIES

 

The discussion and analysis of our financial condition and results of operations is based upon the consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Our significant accounting policies are described in Note 2 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2009. We have identified below policies that are of particular importance to the portrayal of our financial position and results of operations and which require the application of significant judgment by management. We analyze our estimates on a periodic basis and base our estimates on experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates using different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements:

 

Successful Efforts Method of Accounting

 

We account for our oil and natural gas exploration and development activities utilizing the successful efforts method of accounting. Under this method, costs of productive exploratory wells, development dry holes and productive wells and undeveloped leases are capitalized. Oil and natural gas lease acquisition costs are also capitalized. Exploration costs, including personnel costs, certain geological and geophysical expenses and delay rentals for oil and natural gas leases, are charged to expense as incurred. Exploratory drilling costs are initially capitalized, but such costs are charged to expense if and when the well is determined not to have found reserves in commercial quantities. In most cases, a gain or loss is recognized for sales of producing properties.

 

The application of the successful efforts method of accounting requires management’s judgment to determine the proper designation of wells as either developmental or exploratory, which will ultimately determine the proper accounting treatment of the costs incurred. The results from a drilling operation can take considerable time to analyze, and the determination that commercial reserves have been discovered requires both judgment and application of industry experience. Wells may be completed that are assumed to be productive and actually deliver oil and natural gas in quantities insufficient to be economic, which may result in the abandonment of the wells at a later date. On occasion, wells are drilled which have targeted geologic structures that are both developmental and exploratory in nature, and in such instances an allocation of costs is required to properly account for the results. Delineation seismic costs incurred to select development locations within a productive oil and natural gas field are typically treated as development costs and capitalized, but often these seismic programs extend beyond the proved reserve areas and therefore management must estimate the portion of seismic costs to expense as exploratory. The evaluation of oil and natural gas leasehold acquisition costs requires management’s judgment to estimate the fair

 

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value of exploratory costs related to drilling activity in a given area. Drilling activities in an area by other companies may also effectively condemn leasehold positions.

 

The successful efforts method of accounting can have a significant impact on the operational results reported when we enter a new exploratory area in hopes of finding oil and natural gas reserves. The initial exploratory wells may be unsuccessful and the associated costs will be expensed as dry hole costs. Seismic costs can be substantial which will result in additional exploration expenses when incurred.