Kosmos Energy Ltd. - Quarter Report: 2014 September (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended September 30, 2014

 

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

 

For the transition period from               to         

 

Commission file number:  001-35167

 

 

Kosmos Energy Ltd.

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code: +1 441 295 5950

 

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes 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 x  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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class		Outstanding at October 28, 2014
Common Shares, $0.01 par value		386,872,550

 

 

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TABLE OF CONTENTS

 

Unless otherwise stated in this report, references to “Kosmos,” “we,” “us” or “the company” refer to Kosmos Energy Ltd. and its subsidiaries. We have provided definitions for some of the industry terms used in this report in the “Glossary and Selected Abbreviations” beginning on page 3.

 

	Page
PART I. FINANCIAL INFORMATION
Glossary and Select Abbreviations	3
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013	6
Consolidated Statements of Operations for the three and nine months ended September 30, 2014 and 2013	7
Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2014 and 2013	8
Consolidated Statements of Shareholders’ Equity for the nine months ended September 30, 2014	9
Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013	10
Notes to Consolidated Financial Statements	11
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3. Quantitative and Qualitative Disclosures about Market Risk	34
Item 4. Controls and Procedures	35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	36
Item 1A. Risk Factors	36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3. Defaults Upon Senior Securities	37
Item 4. Mine Safety Disclosures	37
Item 5. Other Information	37
Item 6. Exhibits	39
Signatures	40
Index to Exhibits	41

 

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KOSMOS ENERGY LTD.

GLOSSARY AND SELECTED ABBREVIATIONS

 

The following are abbreviations and definitions of certain terms that may be used in this report. Unless listed below, all defined terms under Rule 4-10(a) of Regulation S-X shall have their statutorily prescribed meanings.

 

“2D seismic data”		Two-dimensional seismic data, serving as interpretive data that allows a view of a vertical cross-section beneath a prospective area.
“3D seismic data”		Three-dimensional seismic data, serving as geophysical data that depicts the subsurface strata in three dimensions. 3D seismic data typically provides a more detailed and accurate interpretation of the subsurface strata than 2D seismic data.
“API”		A specific gravity scale, expressed in degrees, that denotes the relative density of various petroleum liquids. The scale increases inversely with density. Thus lighter petroleum liquids will have a higher API than heavier ones.
“ASC”		Financial Accounting Standards Board Accounting Standards Codification.
“ASU”		Financial Accounting Standards Board Accounting Standards Update.
“Barrel” or “Bbl”		A standard measure of volume for petroleum corresponding to approximately 42 gallons at 60 degrees Fahrenheit.
“BBbl”		Billion barrels of oil.
“BBoe”		Billion barrels of oil equivalent.
“Bcf”		Billion cubic feet.
“Boe”		Barrels of oil equivalent. Volumes of natural gas converted to barrels of oil using a conversion factor of 6,000 cubic feet of natural gas to one barrel of oil.
“Boepd”		Barrels of oil equivalent per day.
“Bopd”		Barrels of oil per day.
“Bwpd”		Barrels of water per day.
“Debt cover ratio”		The “debt cover ratio” is broadly defined, for each applicable calculation date, as the ratio of (x) total long-term debt less cash and cash equivalents and restricted cash, to (y) the aggregate EBITDAX (see below) of the Company for the previous twelve months.
“Developed acreage”		The number of acres that are allocated or assignable to productive wells or wells capable of production.
“Development”		The phase in which an oil or natural gas field is brought into production by drilling development wells and installing appropriate production systems.
“Dry hole”		A well that has not encountered a hydrocarbon bearing reservoir expected to produce in commercial quantities.
“EBITDAX”		Net income (loss) plus (i) exploration expense, (ii) depletion, depreciation and amortization expense, (iii) equity-based compensation expense, (iv) unrealized (gain) loss on commodity derivatives, (v) (gain) loss on sale of oil and gas properties, (vi) interest (income) expense, (vii) income taxes, (viii) loss on extinguishment of debt, (ix) doubtful accounts expense and (x) similar other material items which management believes affect the comparability of operating results.
“E&P”		Exploration and production.
“FASB”		Financial Accounting Standards Board.

 

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“Farm-in”		An agreement whereby an oil company acquires a portion of the participating interest in a block from the owner of such interest, usually in return for cash and for taking on a portion of the drilling costs of one or more specific wells or other performance by the assignee as a condition of the assignment.
“Farm-out”		An agreement whereby the owner of the participating interest agrees to assign a portion of its participating interest in a block to another party for cash or for the assignee taking on a portion of the drilling costs of one or more specific wells and/or other work as a condition of the assignment.
“Field life cover ratio”		The “field life cover ratio” is broadly defined, for each applicable forecast period, as the ratio of (x) net present value of net cash flow through the depletion of the Jubilee Field plus the net present value of certain capital expenditures incurred in relation to the Jubilee Field and certain other fields in Ghana, to (y) the aggregate loan amounts outstanding under the Facility.
“FPSO”		Floating production, storage and offloading vessel.
“Interest cover ratio”		The “interest cover ratio” is broadly defined, for each applicable calculation date, as the ratio of (x) the aggregate EBITDAX (see above) of the Company for the previous twelve months, to (y) interest expense less interest income for the Company for the previous twelve months.
“Loan life cover ratio”		The “loan life cover ratio” is broadly defined, for each applicable forecast period, as the ratio of (x) net present value of net cash flow through the final maturity date of the Facility plus the net present value of capital expenditures incurred in relation to the Jubilee Field and certain other fields in Ghana, to (y) the aggregate loan amounts outstanding under the Facility.
“Make-whole redemption price”		The “make-whole redemption price” is equal to the outstanding principal amount of such notes plus the greater of 1) 1% of the then outstanding principal amount of such notes and 2) the present value of the notes at 103.938% and required interest payments thereon through August 1, 2017 at such redemption date.
“MBbl”		Thousand barrels of oil.
“Mcf”		Thousand cubic feet of natural gas.
“Mcfpd”		Thousand cubic feet per day of natural gas.
“MMBbl”		Million barrels of oil.
“MMBoe”		Million barrels of oil equivalent.
“MMcf”		Million cubic feet of natural gas.
“Natural gas liquid” or “NGL”		Components of natural gas that are separated from the gas state in the form of liquids. These include propane, butane, and ethane, among others.
“Petroleum contract”		A contract in which the owner of hydrocarbons gives an E&P company temporary and limited rights, including an exclusive option to explore for, develop, and produce hydrocarbons from the lease area.
“Petroleum system”		A petroleum system consists of organic material that has been buried at a sufficient depth to allow adequate temperature and pressure to expel hydrocarbons and cause the movement of oil and natural gas from the area in which it was formed to a reservoir rock where it can accumulate.
“Plan of development” or “PoD”		A written document outlining the steps to be undertaken to develop a field.
“Productive well”		An exploratory or development well found to be capable of producing either oil or natural gas in sufficient quantities to justify completion as an oil or natural gas well.

 

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“Prospect(s)”		A potential trap that may contain hydrocarbons and is supported by the necessary amount and quality of geologic and geophysical data to indicate a probability of oil and/or natural gas accumulation ready to be drilled. The five required elements (generation, migration, reservoir, seal and trap) must be present for a prospect to work and if any of them fail neither oil nor natural gas will be present, at least not in commercial volumes.
“Proved reserves”		Estimated quantities of crude oil, natural gas and natural gas liquids that geological and engineering data demonstrate with reasonable certainty to be economically recoverable in future years from known reservoirs under existing economic and operating conditions, as well as additional reserves expected to be obtained through confirmed improved recovery techniques, as defined in SEC Regulation S-X 4-10(a)(2).
“Proved developed reserves”		Proved developed reserves are those proved reserves that can be expected to be recovered through existing wells and facilities and by existing operating methods.
“Proved undeveloped reserves”		Proved undeveloped reserves are those proved reserves that are expected to be recovered from future wells and facilities, including future improved recovery projects which are anticipated with a high degree of certainty in reservoirs which have previously shown favorable response to improved recovery projects.
“Reconnaissance contract”		A contract in which the owner of hydrocarbons gives an E&P company rights to perform evaluation of existing data or potentially acquire additional data but does not convey an exclusive option to explore for, develop, and/or produce hydrocarbons from the lease area.
“Shelf margin”		The path created by the change in direction of the shoreline in reaction to the filling of a sedimentary basin.
“Structural trap”		A structural trap is a topographic feature in the earth’s subsurface that forms a high point in the rock strata. This facilitates the accumulation of oil and gas in the strata.
“Structural-stratigraphic trap”		A structural-stratigraphic trap is a combination trap with structural and stratigraphic features.
“Stratigraphy”		The study of the composition, relative ages and distribution of layers of sedimentary rock.
“Stratigraphic trap”		A stratigraphic trap is formed from a change in the character of the rock rather than faulting or folding of the rock and oil is held in place by changes in the porosity and permeability of overlying rocks.
“Submarine fan”		A fan-shaped deposit of sediments occurring in a deep water setting where sediments have been transported via mass flow, gravity induced, processes from the shallow to deep water. These systems commonly develop at the bottom of sedimentary basins or at the end of large rivers.
“Three-way fault trap”		A structural trap where at least one of the components of closure is formed by offset of rock layers across a fault.
“Trap”		A configuration of rocks suitable for containing hydrocarbons and sealed by a relatively impermeable formation through which hydrocarbons will not migrate.
“Undeveloped acreage”		Lease acreage on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of natural gas and oil regardless of whether such acreage contains discovered resources.

 

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KOSMOS ENERGY LTD.

 

CONSOLIDATED BALANCE SHEETS

 

(In thousands, except share data)

 

		September 30,			December 31,
		2014			2013
		(Unaudited)
Assets
Current assets:
Cash and cash equivalents		$	600,626		$	598,108
Restricted cash		34,621			21,475
Receivables:
Joint interest billings		54,027			19,930
Oil sales		41,764			281
Other		20,344			1,115
Inventories		57,571			47,424
Prepaid expenses and other		20,086			27,010
Current deferred tax assets		10,474			19,618
Derivatives		6,848			—
Total current assets		846,361			734,961
Property and equipment:
Oil and gas properties, net		1,641,393			1,508,062
Other property, net		12,208			14,900
Property and equipment, net		1,653,601			1,522,962
Other assets:
Restricted cash		16,125			31,500
Long-term receivables – joint interest billings		10,124			—
Deferred financing costs, net of accumulated amortization of $30,778 and $24,976 at September 30, 2014 and December 31, 2013, respectively		51,337			40,111
Long-term deferred tax assets		21,767			16,292
Derivatives		3,892			—
Total assets		$	2,603,207		$	2,345,826
Liabilities and shareholders’ equity
Current liabilities:
Accounts payable		$	89,838		$	94,172
Accrued liabilities		197,132			115,212
Derivatives		1,994			9,940
Total current liabilities		288,964			219,324
Long-term liabilities:
Long-term debt		794,106			900,000
Derivatives		429			3,811
Asset retirement obligations		42,861			39,596
Deferred tax liability		271,376			170,226
Other long-term liabilities		14,539			20,534
Total long-term liabilities		1,123,311			1,134,167
Shareholders’ equity:
Preference shares, $0.01 par value; 200,000,000 authorized shares; zero issued at September 30, 2014 and December 31, 2013		—			—
Common shares, $0.01 par value; 2,000,000,000 authorized shares; 392,388,533 and 391,974,287 issued at September 30, 2014 and December 31, 2013, respectively		3,924			3,920
Additional paid-in capital		1,840,615			1,781,535
Accumulated deficit		(623,621		)	(774,220		)
Accumulated other comprehensive income		1,057			2,158
Treasury stock, at cost, 5,543,118 and 4,400,135 shares at September 30, 2014 and December 31, 2013, respectively		(31,043		)	(21,058		)
Total shareholders’ equity		1,190,932			992,335
Total liabilities and shareholders’ equity		$	2,603,207		$	2,345,826

 

See accompanying notes.

 

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KOSMOS ENERGY LTD.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

(In thousands, except per share data)

 

(Unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2014			2013			2014			2013
Revenues and other income:
Oil and gas revenue		$	137,485		$	215,169		$	678,635		$	636,648
Gain on sale of assets		—			—			23,769			—
Interest income		69			77			323			191
Other income		882			133			2,190			708
Total revenues and other income		138,436			215,379			704,917			637,547
Costs and expenses:
Oil and gas production		15,097			32,576			54,366			79,651
Exploration expenses		21,334			75,607			57,652			194,384
General and administrative		35,148			38,077			95,041			118,787
Depletion and depreciation		36,959			58,367			152,883			175,578
Amortization—deferred financing costs		2,593			2,786			7,938			8,269
Interest expense		9,838			8,781			20,984			27,789
Derivatives, net		(40,407		)	7,585			(20,869		)	386
Restructuring charges		(46		)	—			11,758			—
Loss on extinguishment of debt		—			—			2,898			—
Other expenses, net		329			1,864			1,632			3,345
Total costs and expenses		80,845			225,643			384,283			608,189
Income (loss) before income taxes		57,591			(10,264		)	320,634			29,358
Income tax expense		38,468			34,224			170,035			124,568
Net income (loss)		$	19,123		$	(44,488	)	$	150,599		$	(95,210	)
Net income (loss) per share:
Basic		$	0.05		$	(0.12	)	$	0.39		$	(0.25	)
Diluted		$	0.05		$	(0.12	)	$	0.39		$	(0.25	)
Weighted average number of shares used to compute net income (loss) per share:
Basic		379,969			377,654			378,881			376,509
Diluted		382,190			377,654			382,287			376,509

 

See accompanying notes.

 

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KOSMOS ENERGY LTD.

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

 

(In thousands)

 

(Unaudited)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2014			2013			2014			2013
Net income (loss)		$	19,123		$	(44,488	)	$	150,599		$	(95,210	)
Other comprehensive income:
Reclassification adjustments for gains on cash flow hedges included in net income (loss)		(290		)	(405		)	(1,101		)	(1,122		)
Other comprehensive income		(290		)	(405		)	(1,101		)	(1,122		)
Comprehensive income (loss)		$	18,833		$	(44,893	)	$	149,498		$	(96,332	)

 

See accompanying notes.

 

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KOSMOS ENERGY LTD.

 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

(In thousands)

 

(Unaudited)

 

		Common Shares					Additional Paid-in			Accumulated			Accumulated Other Comprehensive			Treasury
		Shares		Amount			Capital			Deficit			Income			Stock			Total
Balance as of December 31, 2013		391,974		$	3,920		$	1,781,535		$	(774,220	)	$	2,158		$	(21,058	)	$	992,335
Equity-based compensation		—		—			60,166			—			—			—			60,166
Derivatives, net		—		—			—			—			(1,101		)	—			(1,101		)
Restricted stock awards and units		415		4			(4		)	—			—			—			—
Restricted stock forfeitures		—		—			2			—			—			(2		)	—
Purchase of treasury stock		—		—			(1,084		)	—			—			(9,983		)	(11,067		)
Net income		—		—			—			150,599			—			—			150,599
Balance as of September 30, 2014		392,389		$	3,924		$	1,840,615		$	(623,621	)	$	1,057		$	(31,043	)	$	1,190,932

 

See accompanying notes.

 

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KOSMOS ENERGY LTD.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(In thousands)

 

(Unaudited)

 

		Nine Months Ended September 30,
		2014			2013
Operating activities
Net income (loss)		$	150,599		$	(95,210	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depletion, depreciation and amortization		160,821			183,847
Deferred income taxes		103,372			62,757
Unsuccessful well costs		3,091			98,912
Change in fair value of derivatives		(13,508		)	4,752
Cash settlements on derivatives		(9,661		)	(18,658		)
Equity-based compensation		59,941			50,792
Gain on sale of assets		(23,769		)	—
Loss on extinguishment of debt		2,898			—
Other		(4,368		)	4,468
Changes in assets and liabilities:
Increase in receivables		(104,708		)	(56,725		)
Increase in inventories		(10,197		)	(2,419		)
Decrease (increase) in prepaid expenses and other		6,924			(1,126		)
Decrease in accounts payable		(4,334		)	(30,037		)
Increase in accrued liabilities		55,133			79,996
Net cash provided by operating activities		372,234			281,349
Investing activities
Oil and gas assets		(290,218		)	(244,452		)
Other property		(1,403		)	(3,712		)
Proceeds on sale of assets		58,315			—
Restricted cash		2,229			7,214
Net cash used in investing activities		(231,077		)	(240,950		)
Financing activities
Payments on long-term debt		(400,000		)	(100,000		)
Net proceeds from issuance of senior secured notes		294,000			—
Purchase of treasury stock		(11,067		)	(13,069		)
Deferred financing costs		(21,572		)	(2,227		)
Net cash used in financing activities		(138,639		)	(115,296		)
Net increase (decrease) in cash and cash equivalents		2,518			(74,897		)
Cash and cash equivalents at beginning of period		598,108			515,164
Cash and cash equivalents at end of period		$	600,626		$	440,267
Supplemental cash flow information
Cash paid for:
Interest		$	20,192		$	27,046
Income taxes		$	101,068		$	49,716

 

See accompanying notes.

 

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KOSMOS ENERGY LTD.

 

Notes to Consolidated Financial Statements

(Unaudited)

 

1. Organization

 

Kosmos Energy Ltd. was incorporated pursuant to the laws of Bermuda in January 2011 to become a holding company for Kosmos Energy Holdings. Kosmos Energy Holdings is a privately held Cayman Islands company that was formed in March 2004. As a holding company, Kosmos Energy Ltd.’s management operations are conducted through a wholly owned subsidiary, Kosmos Energy, LLC. The terms “Kosmos,” the “Company,” “we,” “us,” “our,” “ours,” and similar terms refer to Kosmos Energy Ltd. and its wholly owned subsidiaries, unless the context indicates otherwise.

 

We are a leading independent oil and gas exploration and production company focused on frontier and emerging areas along the Atlantic Margin. Our assets include existing production and other major development projects offshore Ghana, as well as exploration licenses with significant hydrocarbon potential offshore Ireland, Mauritania, Morocco (including Western Sahara), Senegal and Suriname. Kosmos is listed on the New York Stock Exchange and is traded under the ticker symbol KOS.

 

We have one reportable segment, which is the exploration and production of oil and natural gas. Substantially all of our long-lived assets and product sales are currently related to production located offshore Ghana.

 

2. Accounting Policies

 

General

 

The interim-period financial information presented in the consolidated financial statements included in this report is unaudited and, in the opinion of management, includes all adjustments of a normal recurring nature necessary to present fairly the consolidated financial position as of September 30, 2014, the changes in the consolidated statements of shareholders’ equity for the nine months ended September 30, 2014, the consolidated results of operations for the three and nine months ended September 30, 2014 and 2013, and consolidated cash flows for the nine months ended September 30, 2014 and 2013. The results of the interim periods shown in this report are not necessarily indicative of the final results to be expected for the full year. The consolidated financial statements were prepared in accordance with the requirements of the Securities and Exchange Commission (“SEC”) for interim reporting. As permitted under those rules, certain notes or other financial information that are normally required by Generally Accepted Accounting Principles in the United States of America (“GAAP”) have been condensed or omitted from these interim consolidated financial statements. These consolidated financial statements and the accompanying notes should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2013, included in our annual report on Form 10-K.

 

Reclassifications

 

Certain prior period amounts have been reclassified to conform with the current year presentation. Such reclassifications had no impact on our reported net income (loss), current assets, total assets, current liabilities, total liabilities or shareholders’ equity.

 

Restricted Cash

 

In accordance with our commercial debt facility (the “Facility”), we are required to maintain a restricted cash balance that is sufficient to meet the payment of interest and fees for the next six-month period on the 7.875% Senior Secured Notes due 2021 (“Senior Notes”) plus the Corporate Revolver or the Facility, whichever is greater. As of September 30, 2014 and December 31, 2013, we had $15.5 million and $18.6 million, respectively, in current restricted cash to meet this requirement. In addition, in accordance with certain of our petroleum contracts, we have posted letters of credit related to performance guarantees for our minimum work obligations. These letters of credit are cash collateralized in accounts held by us and as such are classified as restricted cash. Upon completion of the minimum work obligations and/or entering into the next phase of the petroleum contract, the requirement to post the existing letters of credit will be satisfied and the cash collateral will be released. However, additional letters of credit may be required should we choose to move into the next phase of certain of our petroleum contracts. As of September 30, 2014 and December 31, 2013, we had $19.1 million and $2.9 million, respectively, of current restricted cash and $16.1 million and $31.5 million, respectively, of long-term restricted cash used to cash collateralize performance guarantees related to our petroleum contracts.

 

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Inventories

 

Inventories consisted of $55.0 million and $45.8 million of materials and supplies and $2.6 million and $1.6 million of hydrocarbons as of September 30, 2014 and December 31, 2013, respectively. The Company’s materials and supplies inventory primarily consists of casing and wellheads and is stated at the lower of cost, using the weighted average cost method, or market.

 

Hydrocarbon inventory is carried at the lower of cost, using the weighted average cost method, or market. Hydrocarbon inventory costs include expenditures and other charges incurred in bringing the inventory to its existing condition. Selling expenses and general and administrative expenses are reported as period costs and excluded from inventory costs.

 

Restructuring Charges

 

The Company accounts for restructuring charges in accordance with ASC 420-Exit or Disposal Cost Obligations. Under these standards, the costs associated with restructuring charges are recorded during the period in which the liability is incurred. During the nine months ended September 30, 2014, we recognized $11.8 million in restructuring charges for employee severance and related benefit costs incurred as part of a corporate reorganization, which includes $5.0 million of accelerated non-cash expense related to awards previously granted under our Long-Term Incentive Plan (the “LTIP”).

 

Recent Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606),” which supersedes the revenue recognition requirements in Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition,” and most industry-specific guidance. ASU 2014-09 is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. ASU 2014-09 applies to all contracts with customers except those that are within the scope of other topics in the FASB ASC. The new guidance is effective for annual reporting periods beginning after December 15, 2016 for public companies. Early adoption is not permitted. Entities have the option of using either a full retrospective or modified approach to adopt ASU 2014-09. The Company is currently evaluating the new guidance and has not determined the impact this standard may have on its financial statements or decided upon the method of adoption.

 

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” ASU 2014-08 prospectively changes the criteria for reporting discontinued operations while enhancing disclosures around disposals of assets whether or not the disposal meets the definition of a discontinued operation. ASU 2014-08 is effective for annual and interim periods beginning after December 31, 2014 with early adoption permitted but only for disposals that have not been reported in financial statements previously issued. The adoption of this new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

 

3. Property and Equipment

 

Property and equipment is stated at cost and consisted of the following:

 

		September 30,			December 31,
		2014			2013
		(In thousands)
Oil and gas properties:
Proved properties		$	865,500		$	801,348
Unproved properties		716,933			524,257
Support equipment and facilities		732,567			710,289
Total oil and gas properties		2,315,000			2,035,894
Less: accumulated depletion		(673,607		)	(527,832		)
Oil and gas properties, net		1,641,393			1,508,062
Other property		32,745			31,658
Less: accumulated depreciation		(20,537		)	(16,758		)
Other property, net		12,208			14,900
Property and equipment, net		$	1,653,601		$	1,522,962

 

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We recorded depletion expense of $34.6 million and $56.1 million for the three months ended September 30, 2014 and 2013, respectively and $145.8 million and $169.2 million for the nine months ended September 30, 2014 and 2013, respectively.

 

In the first quarter of 2014, the Moroccan government issued a joint ministerial order approving a partial sale of our participating interests to BP Exploration (Morocco) Limited, a wholly owned subsidiary of BP plc (“BP”), covering our three blocks in the Agadir Basin, offshore Morocco. Upon receipt of this order, we closed the partial sale with BP. Under the terms of the agreements, BP acquired a non-operating interest in each of the Essaouira Offshore, Foum Assaka Offshore and Tarhazoute Offshore blocks. The sales price of the farm-outs was $56.9 million. All proceeds were received as of June 30, 2014. After giving effect to these farm-outs, our participating interests are 30.0%, 29.925% and 30.0% in the Essaouira Offshore, Foum Assaka Offshore and Tarhazoute Offshore blocks, respectively, and we remain the operator. The proceeds on the sale of the interests exceeded our book basis in the assets, resulting in a $23.8 million gain on the transaction.

 

In the first quarter of 2014, the Moroccan government issued a joint ministerial order approving a partial sale of our participating interest to Capricorn Exploration and Development Company Limited, a wholly owned subsidiary of Cairn Energy PLC (“Cairn”), covering the Cap Boujdour Offshore block, offshore Western Sahara. Upon receipt of this order, we closed the partial sale with Cairn. During the second quarter of 2014, Cairn paid $1.5 million for their share of costs incurred from the effective date of the farm-out agreement through the closing date, which was recorded as a reduction in our basis. After giving effect to the farm-out, our participating interest in the Cap Boujdour Offshore block is 55.0% and we remain the operator.

 

In August 2014, we entered into a farm-in agreement with Timis Corporation Limited, whereby we acquired a 60% participating interest and operatorship, covering the Cayar Offshore Profond and Saint Louis Offshore Profond blocks offshore Senegal. As part of the agreement, we will carry the full costs of a planned 3D seismic program. Additionally, we will carry the full costs of two contingent exploration wells, subject to a maximum gross cost per well of $120.0 million, should Kosmos elect to drill such wells. We also retain the option to increase our equity to 65% in exchange for carrying the full cost of a third contingent exploration or appraisal well, subject to a maximum gross cost of $120.0 million.

 

4. Suspended Well Costs

 

The following table reflects the Company’s capitalized exploratory well costs on completed wells as of and during the nine months ended September 30, 2014. The table excludes $3.1 million in costs that were capitalized and subsequently expensed during the same period.

 

		Nine Months Ended September 30, 2014
		(In thousands)
Beginning balance		$	376,166
Additions to capitalized exploratory well costs pending the determination of proved reserves		53,367
Reclassification due to determination of proved reserves		—
Capitalized exploratory well costs charged to expense		—
Ending balance		$	429,533

 

The following table provides an aging of capitalized exploratory well costs based on the date drilling was completed and the number of projects for which exploratory well costs have been capitalized for more than one year since the completion of drilling:

 

		September 30, 2014			December 31, 2013
		(In thousands, except well counts)
Exploratory well costs capitalized for a period of one year or less		$	52,502		$	11,426
Exploratory well costs capitalized for a period of one to two years		137,367			229,140
Exploratory well costs capitalized for a period of three to five years		239,664			135,600
Ending balance		$	429,533		$	376,166
Number of projects that have exploratory well costs that have been capitalized for a period greater than one year		8			8

 

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As of September 30, 2014, the projects with exploratory well costs capitalized for more than one year since the completion of drilling are related to the Mahogany, Teak-1, Teak-2 and Akasa discoveries in the West Cape Three Points (“WCTP”) Block and the Tweneboa, Enyenra, Ntomme and Wawa discoveries in the Deepwater Tano (“DT”) Block, which are all in Ghana.

 

Effective January 14, 2014, Ghana’s Ministry of Energy and Ghana National Petroleum Corporation (“GNPC”) entered into a Memorandum of Understanding with Kosmos Energy, on behalf of the WCTP Petroleum Agreement (“PA”) Block partners, wherein all parties have settled all matters pertaining to the Notices of Dispute for the Mahogany East PoD, and the Ministry of Energy has approved the Appraisal Programs for the Mahogany, Teak, and Akasa discoveries.

 

Mahogany— Three appraisal wells have been drilled. Additionally, we deepened a development well in the Jubilee Field to further appraise the Mahogany discovery. Following additional appraisal and evaluation, a decision regarding commerciality of the Mahogany discovery is expected to be made by the WCTP Block partners in early 2015. Within six months of such a declaration, a PoD would be prepared and submitted to Ghana’s Ministry of Energy, as required under the WCTP PA.

 

Teak-1 Discovery—Two appraisal wells have been drilled. Following additional appraisal and evaluation, a decision regarding commerciality of the Teak-1 discovery is expected to be made by the WCTP Block partners in early 2015. Within six months of such a declaration, a PoD would be prepared and submitted to Ghana’s Ministry of Energy, as required under the WCTP PA.

 

Teak-2 Discovery—We have performed a gauge installation on the well and are reprocessing seismic data. Following additional appraisal and evaluation, a decision regarding commerciality of the Teak-2 discovery is expected to be made by the WCTP Block partners in early 2015. Within six months of such a declaration, a PoD would be prepared and submitted to Ghana’s Ministry of Energy, as required under the WCTP PA.

 

Akasa Discovery—We performed a drill stem test and gauge installation on the discovery well and drilled one appraisal well. Following additional appraisal and evaluation, a decision regarding commerciality of the Akasa discovery is expected to be made by the WCTP Block partners in early 2015. Within six months of such a declaration, a PoD would be prepared and submitted to Ghana’s Ministry of Energy, as required under the WCTP PA.

 

Tweneboa, Enyenra and Ntomme (“TEN”) Discoveries—In May 2013, the government of Ghana approved the PoD over the TEN discoveries. Development of TEN has commenced and is expected to include the drilling and completion of up to 24 development wells, half of the wells are designed as producers, with the remaining wells designed for water or gas injection. The TEN project is expected to deliver first oil in the second half of 2016. The costs associated with the TEN development will remain as unproved property pending the determination of whether the discoveries are associated with proved reserves.

 

Wawa Discovery—We are currently reprocessing seismic data and have acquired a high resolution seismic survey over the discovery area. Following additional evaluation and potential appraisal activities, a decision regarding commerciality of the Wawa discovery is expected to be made by the DT Block partners in 2016. Within six months of such declaration, a PoD would be prepared and submitted to Ghana’s Ministry of Energy, as required under the DT PA.

 

5. Accrued Liabilities

 

Accrued liabilities consisted of the following:

 

		September 30,			December 31,
		2014			2013
		(In thousands)
Accrued liabilities:
Accrued exploration, development and production		$	150,149		$	73,976
Accrued general and administrative expenses		20,082			4,255
Accrued taxes other than income		18,472			15,188
Accrued interest		4,505			—
Income taxes		2,282			20,379
Accrued other		1,642			1,414
		$	197,132		$	115,212

 

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6. Debt

 

Debt consists of the following:

 

		September 30,			December 31,
		2014			2013
		(In thousands)
Outstanding debt principal balances:
Facility		$	500,000		$	900,000
Senior Notes		300,000			—
Total		800,000			900,000
Unamortized issuance discounts		(5,894		)	—
Long-term debt		$	794,106		$	900,000

 

Facility

 

In March 2014, the Company amended and restated the Facility with a total commitment of $1.5 billion from a number of financial institutions. The Facility supports our oil and gas exploration, appraisal and development programs and corporate activities.

 

As part of the debt refinancing in March 2014, the repayment of borrowings under the existing facility attributable to financial institutions that did not participate in the amended Facility was accounted for as an extinguishment of debt, and existing unamortized debt issuance costs attributable to those participants were expensed. As a result, we recorded a $2.9 million loss on the extinguishment of debt. As of September 30, 2014, we have $46.4 million of net deferred financing costs related to the Facility, which will be amortized over the remaining term of the Facility, including certain costs related to the amendment.

 

As of September 30, 2014, borrowings under the Facility totaled $500.0 million and the undrawn availability under the Facility was $1.0 billion.

 

Interest is the aggregate of the applicable margin (3.25% to 4.50%, depending on the length of time that has passed from the date the Facility was entered into); LIBOR; and mandatory cost (if any, as defined in the Facility). Interest is payable on the last day of each interest period (and, if the interest period is longer than six months, on the dates falling at six-month intervals after the first day of the interest period). We pay commitment fees on the undrawn and unavailable portion of the total commitments, if any. Commitment fees are equal to 40% per annum of the then-applicable respective margin when a commitment is available for utilization and, equal to 20% per annum of the then-applicable respective margin when a commitment is not available for utilization. We recognize interest expense in accordance with ASC 835—Interest, which requires interest expense to be recognized using the effective interest method. As part of the March 2014 amendment, the Facility’s estimated effective interest rate was changed and, accordingly, we adjusted our estimate of deferred interest previously recorded during prior years by $4.5 million, which was recorded as a reduction to interest expense.

 

The Facility provides a revolving-credit and letter of credit facility. The availability period for the revolving-credit facility, as amended in March 2014 expires on March 31, 2018, however the Facility has a revolving-credit sublimit, which will be the lesser of $500.0 million and the total available facility at that time, that will be available for drawing until the date falling one month prior to the final maturity date. The letter of credit sublimit expires on the final maturity date. The available facility amount is subject to borrowing base constraints and, beginning on March 31, 2018, outstanding borrowings will be constrained by an amortization schedule. The Facility has a final maturity date of March 31, 2021. As of September 30, 2014, we had no letters of credit issued under the Facility.

 

Kosmos has the right to cancel all the undrawn commitments under the Facility. The amount of funds available to be borrowed under the Facility, also known as the borrowing base amount, is determined each year on March 31 and September 30 as part of a forecast that is prepared by and agreed to by us and the Technical and Modeling Bank and the Facility Agent. The formula to calculate the borrowing base amount is based on the sum of the net present values of net cash flows and relevant capital expenditures reduced by certain percentages as well as value attributable to certain assets’ reserves and/or resources.

 

If an event of default exists under the Facility, the lenders can accelerate the maturity and exercise other rights and remedies, including the enforcement of security granted pursuant to the Facility over certain assets held by our subsidiaries. The Facility contains customary cross default provisions.

 

We were in compliance with the financial covenants contained in the Facility as of the September 30, 2014 forecast (the most recent assessment date).

 

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Corporate Revolver

 

In November 2012, we secured a Corporate Revolver from a number of financial institutions. In April 2013, the availability under the Corporate Revolver was increased from $260.0 million to $300.0 million due to additional commitments received from existing and new financial institutions. As of September 30, 2014, there were no borrowings outstanding under the Corporate Revolver and the undrawn availability under the Corporate Revolver was $300.0 million. The Corporate Revolver contains customary cross default provisions.

 

Revolving Letter of Credit Facility

 

In July 2013, we entered into a revolving letter of credit facility agreement (“LC Facility”). The size of the LC Facility is $100.0 million, with additional commitments up to $50.0 million being available if the existing lender increases its commitment or if commitments from new financial institutions are added. As of September 30, 2014, we had $35.3 million of restricted cash collateralizing seven outstanding letters of credit under the LC Facility. The LC Facility contains customary cross default provisions.

 

7.875% Senior Secured Notes due 2021

 

During August 2014, the Company issued $300.0 million of Senior Notes and received net proceeds of approximately $292.5 million after deducting discounts, commissions and deferred financing costs. The Company used the net proceeds to repay a portion of the outstanding indebtedness under the Facility and for general corporate purposes.

 

The Senior Notes mature on August 1, 2021. Interest is payable semi-annually in arrears each February 1 and August 1 commencing on February 1, 2015. The Senior Notes are secured (subject to certain exceptions and permitted liens) by a first ranking fixed equitable charge on all shares held by us in our direct subsidiary, Kosmos Energy Holdings. The Senior Notes are currently guaranteed on a subordinated, unsecured basis by our existing restricted subsidiaries that guarantee the Facility and the Corporate Revolver, and, in certain circumstances, the Senior Notes will become guaranteed by certain of our other existing or future restricted subsidiaries (the “Guarantees”).

 

Redemption and Repurchase.  At any time prior to August 1, 2017 and subject to certain conditions, the Company may, on any one or more occasions, redeem up to 35% of the aggregate principal amount of Senior Notes issued under the indenture dated August 1, 2014 related to the Senior Notes (the “Indenture”) at a redemption price of 107.875%, plus accrued and unpaid interest, with the cash proceeds of certain eligible equity offerings. Additionally, at any time prior to August 1, 2017, the Company may, on any one or more occasions, redeem all or a part of the Senior Notes at a redemption price equal to 100%, plus any accrued and unpaid interest, and plus a make-whole premium. On or after August 1, 2017, the Company may redeem all or a part of the Senior Notes at the redemption prices (expressed as percentages of principal amount) set forth below plus accrued and unpaid interest:

 

Year		Percentage
On or after August 1, 2017, but before August 1, 2018		103.938	%
On or after August 1, 2018, but before August 1, 2019		101.969	%
On or after August 1, 2019 and thereafter		100.000	%

 

We may also redeem the Senior Notes in whole, but not in part, at any time if changes in tax laws impose certain withholding taxes on amounts payable on the Senior Notes at a price equal to the principal amount of the Senior Notes plus accrued interest and additional amounts, if any, as may be necessary so that the net amount received by each holder after any withholding or deduction on payments of the Senior Notes will not be less than the amount such holder would have received if such taxes had not been withheld or deducted.

 

Upon the occurrence of a change of control triggering event as defined under the Indenture, the Company will be required to make an offer to repurchase the Senior Notes at a repurchase price equal to 101% of the principal amount, plus accrued and unpaid interest to, but excluding, the date of repurchase.

 

If we sell assets, under certain circumstances outlined in the Indenture, we will be required to use the net proceeds to make an offer to purchase the Senior Notes at an offer price in cash in an amount equal to 100% of the principal amount of the Senior Notes, plus accrued and unpaid interest to, but excluding, the repurchase date.

 

Covenants.  The Indenture restricts our ability and the ability of our restricted subsidiaries to, among other things:  incur or guarantee additional indebtedness, create liens, pay dividends or make distributions in respect of capital stock, purchase or redeem capital stock,  make investments or certain other restricted payments, sell assets, enter into agreements that restrict the ability of our subsidiaries to make dividends or other payments to us, enter into transactions with affiliates, or effect certain consolidations, mergers or amalgamations. These covenants are subject to a number of important qualifications and exceptions. Certain of these covenants will be terminated if the Senior Notes are assigned an investment grade rating by both Standard & Poor’s Rating Services and Fitch Ratings Inc. and no default or event of default has occurred and is continuing.

 

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Collateral.  The Senior Notes are secured (subject to certain exceptions and permitted liens) by a first ranking fixed equitable charge on all currently outstanding shares, additional shares, dividends or other distributions paid in respect of such shares or any other property derived from such shares, in each case held by us in relation to the Company’s direct subsidiary, Kosmos Energy Holdings, pursuant to the terms of the Charge over Shares of Kosmos Energy Holdings dated November 23, 2012, as amended and restated on March 14, 2014, between the Company and BNP Paribas as Security and Intercreditor Agent. The Senior Notes share pari passu in the benefit of such equitable charge based on the respective amounts of the obligations under the Indenture and the amount of obligations under the Corporate Revolver. The Guarantees are not secured.

 

At September 30, 2014, the estimated repayments of debt during the five fiscal year periods and thereafter are as follows:

 

		Payments Due by Year
		2014(2)			2015			2016			2017			2018			Thereafter
		(In thousands)
Principal debt repayments(1)		$	—		$	—		$	—		$	—		$	—		$	800,000

 

(1)                                Includes the scheduled principal maturities for the Senior Notes and the Facility. The scheduled maturities of debt related to the Facility are based on the level of borrowings and the estimated future available borrowing base as of September 30, 2014. Any increases or decreases in the level of borrowings or decreases in the available borrowing base would impact the scheduled maturities of debt during the next five years and thereafter.

 

(2)                                Represents payments for the period October 1, 2014 through December 31, 2014.

 

7. Derivative Financial Instruments

 

We use financial derivative contracts to manage exposures to commodity price and interest rate fluctuations. We do not hold or issue derivative financial instruments for trading purposes. We manage market and counterparty credit risk in accordance with our policies and guidelines. In accordance with these policies and guidelines, our management determines the appropriate timing and extent of derivative transactions.

 

Oil Derivative Contracts

 

The following table sets forth the volumes in barrels underlying the Company’s outstanding oil derivative contracts and the weighted average Dated Brent prices per Bbl for those contracts as of September 30, 2014.

 

						Weighted Average Dated Brent Price per Bbl
Term		Type of Contract		MBbl		Net Deferred Premium Payable			Swap			Floor			Ceiling			Call
2014:
October — December		Three-way collars		1,507		$	0.01		$	—		$	88.44		$	113.75		$	134.58
2015:
January — December		Three-way collars		4,230		$	0.46		$	—		$	87.43		$	110.00		$	133.82
January — December		Swaps with calls		2,000		—			99.00			—			—			115.00
2016:
January — December		Purchased puts		2,000		$	3.41		$	—		$	85.00		$	—		$	—

 

Provisional Oil Sales

 

At September 30, 2014, we had sales volumes of 447.9 MBbls provisionally priced at an average of $92.95 per Bbl, after differentials, which are subject to final pricing during the next month.

 

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