Gastar Exploration Inc.
GASTAR EXPLORATION LTD (Form: 10-Q, Received: 08/05/2013 17:22:15)
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, 2013
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM                    TO                    
Commission File Number: 001-32714
Commission File Number: 001-35211
____________________________________________________
GASTAR EXPLORATION LTD.
GASTAR EXPLORATION USA, INC.
(Exact name of registrant as specified in its charter)
____________________________________________________
Alberta, Canada
98-0570897
Delaware
38-3531640
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
1331 Lamar Street, Suite 650
 
Houston, Texas
77010
(Address of principal executive offices)
(Zip Code)
(713) 739-1800
(Registrant’s telephone number, including area code)
____________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   
Gastar Exploration Ltd.
Yes
ý
No
o
Gastar Exploration USA, Inc.
Yes
ý
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).    
Gastar Exploration Ltd.
Yes
ý
No
o
Gastar Exploration USA, Inc.
Yes
ý
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.


Gastar Exploration Ltd.
Large accelerated filer
o
Accelerated filer
ý
Non-accelerated filer
o   (Do not check if a smaller reporting company)
Smaller reporting company
o

Gastar Exploration USA, Inc.
Large accelerated filer
o
Accelerated filer
o
Non-accelerated filer
ý   (Do not check if a smaller reporting company)
Smaller reporting company
o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    
Gastar Exploration Ltd.
Yes
o
No
ý
Gastar Exploration USA, Inc.
Yes
o
No
ý

The total number of outstanding common shares, no par value per share, as of August 2, 2013 was
Gastar Exploration Ltd.
61,592,860

shares of common stock
Gastar Exploration USA, Inc.
750

shares of common stock


Table of Contents

GASTAR EXPLORATION LTD. AND
GASTAR EXPLORATION USA, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2013
TABLE OF CONTENTS
 
 
 
Page
 
Item 1.
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.

Unless otherwise indicated or required by the context, (i) “Gastar,” the “Company,” “we,” “us,” “our” and similar terms refer collectively to Gastar Exploration Ltd. and its subsidiaries, including Gastar Exploration USA, Inc., and predecessors, (ii) “Gastar USA” refers to Gastar Exploration USA, Inc., our first-tier subsidiary and primary operating company, (iii) “Parent” refers solely to Gastar Exploration Ltd., (iv) all dollar amounts appearing in this report on Form 10-Q are stated in U.S. dollars unless otherwise noted and (v) all financial data included in this report on Form 10-Q have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”).
General information about us can be found on our website at www.gastar.com . The information available on or through our website, or about us on any other website, is neither incorporated into, nor part of, this report. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other filings that we make with the U.S. Securities and Exchange Commission (“SEC”), as well as any amendments and exhibits to those reports, will be available free of charge through our website as soon as reasonably practicable after we file or furnish them to the SEC. Information is also available on the SEC website at www.sec.gov for our U.S. filings.



2

Table of Contents

Glossary of Terms

AMI
Area of Mutual Interest, an agreed designated geographic area where joint venturers or other industry partners have a right of participation in acquisitions and operations
 
 
Bbl
Barrel of oil, condensate or NGLs
 
 
Bbl/d
Barrels of oil, condensate or NGLs per day
 
 
BOE/d
Barrels of oil equivalent per day
 
 
Btu
British thermal unit, typically used in measuring natural gas energy content
 
 
CRP
Central receipt point
 
 
FASB
Financial Accounting Standards Board
 
 
MBbl
One thousand barrels of oil, condensate or NGLs
 
 
MBbl/d
One thousand barrels of oil, condensate or NGLs per day
 
 
Mcf
One thousand cubic feet of natural gas
 
 
Mcf/d
One thousand cubic feet of natural gas per day
 
 
Mcfe
One thousand cubic feet of natural gas equivalent
 
 
MMBtu/d
One million British thermal units per day
 
 
MMcf
One million cubic feet of natural gas
 
 
MMcf/d
One million cubic feet of natural gas per day
 
 
MMcfe
One million cubic feet of natural gas equivalent
 
 
MMcfe/d
One million cubic feet of natural gas equivalent per day
 
 
NGLs
Natural gas liquids
 
 
NYMEX
New York Mercantile Exchange
 
 
psi
Pounds per square inch


3

Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements
GASTAR EXPLORATION LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 
June 30,
2013
 
December 31,
2012
 
(Unaudited)
 
 
 
(in thousands, except share data)
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
10,799

 
$
8,901

Accounts receivable, net of allowance for doubtful accounts of $540 and $546, respectively
10,344

 
9,540

Commodity derivative contracts
2,835

 
7,799

Prepaid expenses
838

 
1,097

Total current assets
24,816

 
27,337

PROPERTY, PLANT AND EQUIPMENT:
 
 
 
Natural gas and oil properties, full cost method of accounting:
 
 
 
Unproved properties, excluded from amortization
152,665

 
67,892

Proved properties
762,747

 
671,193

Total natural gas and oil properties
915,412

 
739,085

Furniture and equipment
2,076

 
1,925

Total property, plant and equipment
917,488

 
741,010

Accumulated depreciation, depletion and amortization
(497,720
)
 
(484,759
)
Total property, plant and equipment, net
419,768

 
256,251

OTHER ASSETS:
 
 
 
Commodity derivative contracts
1,753

 
1,369

Deferred charges, net
2,170

 
836

Advances to operators and other assets
1,701

 
4,275

Total other assets
5,624

 
6,480

TOTAL ASSETS
$
450,208

 
$
290,068

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
25,413

 
$
23,863

Revenue payable
13,742

 
8,801

Accrued interest
2,173

 
151

Accrued drilling and operating costs
3,637

 
3,907

Advances from non-operators
30,414

 
17,540

Commodity derivative contracts
253

 
1,399

Asset retirement obligation
358

 
358

Other accrued liabilities
5,211

 
1,493

Total current liabilities
81,201

 
57,512

LONG-TERM LIABILITIES:
 
 
 
Long-term debt
194,609

 
98,000

Commodity derivative contracts

 
1,304

Asset retirement obligation
8,235

 
6,605

Other long-term liabilities
274

 
111

Total long-term liabilities
203,118

 
106,020

Commitments and contingencies (Note 13)

 

SHAREHOLDERS' EQUITY:
 
 
 
Common stock, no par value; unlimited shares authorized; 61,593,024 and 66,432,609 shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively
306,593

 
316,346

Additional paid-in capital
30,059

 
28,336

Accumulated deficit
(247,537
)
 
(294,787
)
Total shareholders' equity
89,115

 
49,895

Non-controlling interest:
 
 
 
Preferred stock of subsidiary, aggregate liquidation preference $98,954 and $98,781 at June 30, 2013 and December 31, 2012, respectively
76,774

 
76,641

Total equity
165,889

 
126,536

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$
450,208

 
$
290,068


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


4

Table of Contents

GASTAR EXPLORATION LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands, except share and per share data)
REVENUES:
 
 
 
 
 
 
 
Natural gas
$
12,044

 
$
6,682

 
$
23,277

 
$
13,593

Condensate and oil
8,017

 
2,408

 
14,143

 
4,291

NGLs
3,380

 
2,027

 
6,922

 
3,911

Total natural gas, condensate, oil and NGLs revenues
23,441

 
11,117

 
44,342

 
21,795

Unrealized hedge gain (loss)
7,485

 
2,804

 
(2,152
)
 
1,280

Total revenues
30,926

 
13,921

 
42,190

 
23,075

EXPENSES:
 
 
 
 
 
 
 
Production taxes
1,150

 
481

 
1,793

 
934

Lease operating expenses
2,169

 
1,558

 
4,006

 
3,974

Transportation, treating and gathering
1,124

 
1,231

 
2,288

 
2,410

Depreciation, depletion and amortization
7,596

 
6,956

 
12,961

 
12,609

Impairment of natural gas and oil properties

 
72,733

 

 
72,733

Accretion of asset retirement obligation
114

 
89

 
216

 
183

General and administrative expense
4,964

 
3,151

 
7,966

 
6,312

Litigation settlement expense

 

 
1,000

 
1,250

Total expenses
17,117

 
86,199

 
30,230

 
100,405

INCOME (LOSS) FROM OPERATIONS
13,809

 
(72,278
)
 
11,960

 
(77,330
)
OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
Gain on acquisition of assets at fair value
43,712

 

 
43,712

 

Interest expense
(3,545
)
 
(29
)
 
(4,154
)
 
(56
)
Investment income and other
5

 
2

 
8

 
4

Foreign transaction loss
(11
)
 
(3
)
 
(12
)
 

INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
53,970

 
(72,308
)
 
51,514

 
(77,382
)
Provision for income taxes

 

 

 

NET INCOME (LOSS)
53,970

 
(72,308
)
 
51,514

 
(77,382
)
Dividend on preferred stock attributable to non-controlling interest
(2,134
)
 
(1,727
)
 
(4,264
)
 
(2,963
)
NET INCOME (LOSS) ATTRIBUTABLE TO GASTAR EXPLORATION LTD.
$
51,836

 
$
(74,035
)
 
$
47,250

 
$
(80,345
)
NET INCOME (LOSS) PER COMMON SHARE ATTRIBUTABLE TO GASTAR EXPLORATION LTD. COMMON SHAREHOLDERS:
 
 
 
 
 
 
 
Basic
$
0.83

 
$
(1.17
)
 
$
0.75

 
$
(1.27
)
Diluted
$
0.81

 
$
(1.17
)
 
$
0.74

 
$
(1.27
)
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
 
 
 
 
 
 
 
Basic
62,398,472

 
63,541,739

 
63,089,987

 
63,439,412

Diluted
63,813,423

 
63,541,739

 
63,699,525

 
63,439,412


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

5


GASTAR EXPLORATION LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 
For the Six Months Ended June 30,
 
2013
 
2012
 
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income (loss)
$
51,514

 
$
(77,382
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation, depletion and amortization
12,961

 
12,609

Impairment of natural gas and oil properties

 
72,733

Stock-based compensation
1,966

 
1,846

Unrealized hedge (gain) loss
2,152

 
(1,280
)
Realized loss (gain) on derivative contracts
7

 
(440
)
Amortization of deferred financing costs
1,450

 
98

Accretion of asset retirement obligation
216

 
183

Gain on acquisition of assets at fair value
(43,712
)
 

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
394

 
(2,996
)
Prepaid expenses
259

 
222

Accounts payable and accrued liabilities
9,825

 
(932
)
Net cash provided by operating activities
37,032

 
4,661

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Development and purchase of natural gas and oil properties
(55,955
)
 
(62,856
)
Acquisition of natural gas and oil properties
(69,775
)
 

Advances to operators
(5,154
)
 
(1,911
)
Deposit for sale of natural gas and oil properties
2,300

 

Advances from non-operators
12,874

 
5,847

Purchase of furniture and equipment
(151
)
 
(225
)
Net cash used in investing activities
(115,861
)
 
(59,145
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from revolving credit facility
19,000

 
43,000

Repayment of revolving credit facility
(117,000
)
 
(26,000
)
Proceeds from issuance of senior secured notes, net of discount
194,500

 

Repurchase of outstanding common shares
(9,753
)
 

Proceeds from issuance of preferred stock, net of issuance costs
133

 
38,449

Dividend on preferred stock attributable to non-controlling interest
(3,554
)
 
(2,963
)
Deferred financing charges
(2,355
)
 
(332
)
Other
(244
)
 
(278
)
Net cash provided by financing activities
80,727

 
51,876

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
1,898

 
(2,608
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
8,901

 
10,647

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
10,799

 
$
8,039


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

6


GASTAR EXPLORATION USA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
June 30,
2013
 
December 31,
2012
 
(Unaudited)
 
 
 
(in thousands, except share data)
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
10,760

 
$
8,892

Accounts receivable, net of allowance for doubtful accounts of $540 and $546, respectively
10,344

 
9,539

Commodity derivative contracts
2,835

 
7,799

Prepaid expenses
746

 
919

Total current assets
24,685

 
27,149

PROPERTY, PLANT AND EQUIPMENT:
 
 
 
Natural gas and oil properties, full cost method of accounting:
 
 
 
Unproved properties, excluded from amortization
152,665

 
67,892

Proved properties
762,739

 
671,185

Total natural gas and oil properties
915,404

 
739,077

Furniture and equipment
2,076

 
1,925

Total property, plant and equipment
917,480

 
741,002

Accumulated depreciation, depletion and amortization
(497,713
)
 
(484,752
)
Total property, plant and equipment, net
419,767

 
256,250

OTHER ASSETS:
 
 
 
Commodity derivative contracts
1,753

 
1,369

Deferred charges, net
2,170

 
836

Advances to operators and other assets
1,701

 
4,275

Total other assets
5,624

 
6,480

TOTAL ASSETS
$
450,076

 
$
289,879

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
25,413

 
$
23,863

Revenue payable
13,742

 
8,801

Accrued interest
2,173

 
151

Accrued drilling and operating costs
3,637

 
3,907

Advances from non-operators
30,414

 
17,540

Commodity derivative contracts
253

 
1,399

Asset retirement obligation
358

 
358

Other accrued liabilities
5,088

 
1,480

Total current liabilities
81,078

 
57,499

LONG-TERM LIABILITIES:
 
 
 
Long-term debt
194,609

 
98,000

Commodity derivative contracts

 
1,304

Asset retirement obligation
8,228

 
6,598

Due to parent
34,473

 
30,903

Other long-term liabilities
274

 
111

Total long-term liabilities
237,584

 
136,916

Commitments and contingencies (Note 13)


 


STOCKHOLDERS' EQUITY:
 
 
 
Preferred stock, $0.01 par value; 10,000,000 shares authorized; 3,958,160 and 3,951,254 shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively, with liquidation preference of $25.00 per share
40

 
40

Common stock, no par value; 1,000 shares authorized; 750 shares issued and outstanding
225,431

 
237,431

Additional paid-in capital
76,734

 
76,601

Accumulated deficit
(170,791
)
 
(218,608
)
Total stockholders' equity
131,414

 
95,464

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$
450,076

 
$
289,879

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

7


GASTAR EXPLORATION USA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands, except share and per share data)
REVENUES:
 
 
 
 
 
 
 
Natural gas
$
12,044

 
$
6,682

 
$
23,277

 
$
13,593

Condensate and oil
8,017

 
2,408

 
14,143

 
4,291

NGLs
3,380

 
2,027

 
6,922

 
3,911

Total natural gas, condensate, oil and NGLs revenues
23,441

 
11,117

 
44,342

 
21,795

Unrealized hedge gain (loss)
7,485

 
2,804

 
(2,152
)
 
1,280

Total revenues
30,926

 
13,921

 
42,190

 
23,075

EXPENSES:
 
 
 
 
 
 
 
Production taxes
1,150

 
481

 
1,793

 
934

Lease operating expenses
2,169

 
1,558

 
4,006

 
3,974

Transportation, treating and gathering
1,124

 
1,231

 
2,288

 
2,410

Depreciation, depletion and amortization
7,596

 
6,956

 
12,961

 
12,609

Impairment of natural gas and oil properties

 
72,733

 

 
72,733

Accretion of asset retirement obligation
114

 
89

 
216

 
183

General and administrative expense
4,616

 
2,853

 
7,397

 
5,624

Litigation settlement expense

 

 
1,000

 
1,250

Total expenses
16,769

 
85,901

 
29,661

 
99,717

INCOME (LOSS) FROM OPERATIONS
14,157

 
(71,980
)
 
12,529

 
(76,642
)
OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
Gain on acquisition of assets at fair value
43,712

 

 
43,712

 

Interest expense
(3,545
)
 
(29
)
 
(4,154
)
 
(57
)
Investment income and other
(3
)
 
(1
)
 
2

 
1

Foreign transaction (loss) gain
(9
)
 
(1
)
 
(8
)
 
1

INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
54,312

 
(72,011
)
 
52,081

 
(76,697
)
Provision for income taxes

 

 

 

NET INCOME (LOSS)
54,312

 
(72,011
)
 
52,081

 
(76,697
)
Dividend on preferred stock
(2,134
)
 
(1,727
)
 
(4,264
)
 
(2,963
)
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDER
$
52,178

 
$
(73,738
)
 
$
47,817

 
$
(79,660
)

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

8


GASTAR EXPLORATION USA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 
For the Six Months Ended June 30,
 
2013
 
2012
 
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income (loss)
$
52,081

 
$
(76,697
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation, depletion and amortization
12,961

 
12,609

Impairment of natural gas and oil properties

 
72,733

Stock-based compensation
1,966

 
1,846

Unrealized hedge loss (gain)
2,152

 
(1,280
)
Realized loss (gain) on derivative contracts
7

 
(440
)
Amortization of deferred financing costs
1,450

 
98

Accretion of asset retirement obligation
216

 
183

Gain on acquisition of assets at fair value
(43,712
)
 

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
393

 
(2,998
)
Prepaid expenses
173

 
147

Accounts payable and accrued liabilities
9,721

 
(1,078
)
Net cash provided by operating activities
37,408

 
5,123

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Development and purchase of natural gas and oil properties
(55,955
)
 
(62,856
)
Acquisition of natural gas and oil properties
(69,775
)
 

Advances to operators
(5,154
)
 
(1,911
)
Deposit for sale of natural gas and oil properties
2,300

 

Advances from non-operators
12,874

 
5,847

Purchase of furniture and equipment
(151
)
 
(225
)
Net cash used in investing activities
(115,861
)
 
(59,145
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from revolving credit facility
19,000

 
43,000

Repayment of revolving credit facility
(117,000
)
 
(26,000
)
Proceeds from issuance of senior secured notes, net of discounts
194,500

 

Proceeds from issuance of preferred stock, net of issuance costs
133

 
38,449

Dividend on preferred stock
(3,554
)
 
(2,963
)
Deferred financing charges
(2,355
)
 
(332
)
Distribution to Parent, net
(10,401
)
 
(766
)
Other
(2
)
 

Net cash provided by financing activities
80,321

 
51,388

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
1,868

 
(2,634
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
8,892

 
10,595

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
10,760

 
$
7,961


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

9


GASTAR EXPLORATION LTD. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.
Description of Business
Gastar Exploration Ltd. is an independent energy company engaged in the exploration, development and production of natural gas, condensate, oil and NGLs in the United States (“U.S.”). Gastar Exploration Ltd.’s principal business activities include the identification, acquisition, and subsequent exploration and development of natural gas and oil properties with an emphasis on unconventional reserves, such as shale resource plays. Gastar Exploration Ltd. is currently pursuing the development of liquids-rich natural gas in the Marcellus Shale in West Virginia and is in the early stages of exploring and developing the Hunton Limestone horizontal oil play in Oklahoma. Gastar Exploration Ltd. also holds prospective Marcellus Shale acreage in Pennsylvania and producing natural gas acreage in the deep Bossier play in East Texas. The Company entered into a definitive agreement to sell substantially all of its East Texas assets on April 19, 2013, with closing to be completed on August 16, 2013.
Gastar Exploration Ltd. is a holding company and substantially all of its operations are conducted through, and substantially all of its assets are held by, its primary operating subsidiary, Gastar Exploration USA, Inc. and its wholly-owned subsidiaries. Unless otherwise stated or the context requires otherwise, all references in these notes to “Gastar USA” refer collectively to Gastar Exploration USA, Inc. and its wholly-owned subsidiaries, all references to “Parent” refer solely to Gastar Exploration Ltd., and all references to “Gastar,” the “Company” and similar terms refer collectively to Gastar Exploration Ltd. and its subsidiaries, including Gastar Exploration USA, Inc.

2.
Summary of Significant Accounting Policies
The accounting policies followed by the Company are set forth in the notes to the Company’s audited consolidated financial statements included in its Annual Report on Form 10-K for the year ended December 31, 2012 (as amended, the “ 2012 Form 10-K”) filed with the SEC. Please refer to the notes to the financial statements included in the 2012 Form 10-K for additional details of the Company’s financial condition, results of operations and cash flows. No material item included in those notes has changed except as a result of normal transactions in the interim or as disclosed within this report.
These financial statements are a combined presentation of the condensed consolidated financial statements of the Company and Gastar USA. Separate information is provided for the Company and Gastar USA as required. Except as otherwise noted, there are no material differences between the unaudited condensed consolidated information for the Company presented herein and the unaudited condensed consolidated information of Gastar USA.
The unaudited interim condensed consolidated financial statements of the Company and Gastar USA included herein are stated in U.S. dollars and were prepared from the records of the Company and Gastar USA by management in accordance with U.S. GAAP applicable to interim financial statements and reflect all normal and recurring adjustments, which are, in the opinion of management, necessary to provide a fair presentation of the results of operations and financial position for the interim periods. Such financial statements conform to the presentation reflected in the 2012 Form 10-K. The current interim period reported herein should be read in conjunction with the financial statements and accompanying notes, including Item 8. “Financial Statements and Supplementary Data, Note 2 – Summary of Significant Accounting Policies,” included in the 2012 Form 10-K.
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates with regard to these financial statements include the estimate of proved natural gas and oil reserve quantities and the related present value of estimated future net cash flows.
The unaudited condensed consolidated financial statements of the Company include the accounts of Parent and the consolidated accounts of all of its subsidiaries, including Gastar USA. All significant intercompany accounts and transactions have been eliminated in consolidation.
The unaudited condensed consolidated financial statements of Gastar USA include the accounts of Gastar USA and the consolidated accounts of all of its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
Certain reclassifications of prior year balances have been made to conform to the current year presentation; these reclassifications have no impact on net income (loss).
The results of operations for the three and six months ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013 . In preparing these financial statements, the Company has evaluated

10


events and transactions for potential recognition or disclosure through the date the financial statements were issued and has disclosed certain subsequent events in these condensed consolidated financial statements, as appropriate.
Recent Accounting Developments
Management does not believe that there are any recently issued and effective, or not yet effective, pronouncements as of June 30, 2013 that would have, or are expected to have, any significant effect on the Company's consolidated financial position, cash flows or results of operations.

3.
Property, Plant and Equipment
The amount capitalized as natural gas and oil properties was incurred for the purchase and development of various properties in the U.S., specifically the states of Texas, Pennsylvania, West Virginia and Oklahoma and the acquisition of properties in Oklahoma.
The following table summarizes the components of unproved properties excluded from amortization for the periods indicated:
 
 
June 30, 2013
 
December 31, 2012
 
(in thousands)
Unproved properties, excluded from amortization:
 
 
 
Drilling in progress costs
$
2,311

 
$
1,902

Acreage acquisition costs (1)
146,141

 
62,395

Capitalized interest
4,213

 
3,595

Total unproved properties excluded from amortization
$
152,665

 
$
67,892

 _________________________________
(1)
Includes gain on acquisition of assets at fair value.

For the three and six months ended June 30, 2013 , management's evaluation of unproved properties resulted in an impairment. Due to continued lower natural gas prices for dry gas, the Company reclassified $7.9 million of unproved properties to proved properties at June 30, 2013 related to acreage in Marcellus East. For the three and six months ended June 30, 2012 , management's evaluation of unproved properties did not result in an impairment.

The full cost method of accounting for natural gas and oil properties requires a quarterly calculation of a limitation on capitalized costs, often referred to as a full cost ceiling calculation. The ceiling is the present value of estimated future cash flow from proved natural gas, condensate, oil and NGLs reserves reduced by future operating expenses, development expenditures, abandonment costs (net of salvage) to the extent not included in natural gas and oil properties pursuant to authoritative guidance and estimated future income taxes thereon. To the extent that our capitalized costs (net of accumulated depletion and deferred taxes) exceed the ceiling, the excess must be written off to expense. Once incurred, this impairment of natural gas and oil properties is not reversible at a later date even if natural gas and oil prices increase. The ceiling calculation dictates that the trailing 12-month unweighted arithmetic average of the first-day-of-the-month prices and costs in effect are held constant indefinitely. The 12-month unweighted arithmetic average of the first-day-of-the-month prices are adjusted for basis and quality differentials in determining the present value of the reserves. The table below sets forth relevant assumptions utilized in the quarterly ceiling test computations for the respective periods noted:

 
2013
 
Total Impairment
 
June 30
 
March 31
Henry Hub natural gas price (per MMBtu)
 
 
$
3.44

 
$
2.95

West Texas Intermediate oil price (per Bbl)
 
 
$
88.13

 
$
89.17

Impairment recorded (pre-tax) (in thousands)
$

 
$

 
$



11


 
2012
 
Total Impairment
 
June 30
 
March 31
Henry Hub natural gas price (per MMBtu)
 
 
$
3.15

 
$
3.73

West Texas Intermediate oil price (per Bbl)
 
 
$
92.17

 
$
94.65

Impairment recorded (pre-tax) (in thousands)
$
72,733

 
$
72,733

 
$


Future declines in the 12-month average of natural gas, condensate, oil and NGLs prices could result in the recognition of future ceiling impairments.
Chesapeake Acquisition
On March 28, 2013 , Gastar USA entered into a Purchase and Sale Agreement by and among Chesapeake Exploration, L.L.C., Arcadia Resources, L.P., Jamestown Resources, L.L.C., Larchmont Resources, L.L.C. (together, the “Chesapeake Parties”) and Gastar USA (the “Chesapeake Purchase Agreement”). Pursuant to the Chesapeake Purchase Agreement, Gastar USA was to acquire approximately 157,000 net acres of Oklahoma oil and gas leasehold interests from the Chesapeake Parties, including production from interests in 206 producing wells located in Oklahoma (the “Chesapeake Assets”). The Chesapeake Purchase Agreement contains customary representations and warranties and covenants, including provisions for indemnification, subject to the limitations described in the Chesapeake Purchase Agreement. On June 7, 2013 , the parties to the Chesapeake Purchase Agreement entered into an Amendment to Purchase and Sale Agreement, dated June 7, 2013 , in order to revise the description of the properties to be acquired and to evidence the withdrawal of Arcadia Resources, L.P. and Jamestown Resources, L.L.C. from the Chesapeake Purchase Agreement. Pursuant to the Chesapeake Purchase Agreement, as amended, on June 7, 2013 , Gastar USA completed the acquisition of the Chesapeake Assets for an adjusted purchase price of $69.8 million , subject to adjustment for an acquisition effective date of October 1, 2012 .
Upon completion of the initial purchase price allocation, as of June 7, 2013 , the Company reviewed and verified its assessment, including the identification and valuation of assets acquired. The Company accounted for the acquisition as a business combination and therefore, recorded the assets acquired at their estimated acquisition date fair values. The Company included $1.4 million of transaction and integration costs associated with the acquisition and expensed these costs as incurred as general and administrative expenses. The Company utilized relevant market assumptions to determine fair value and allocate the purchase price, such as future commodity prices, projections of estimated natural gas and oil reserves, expectations for future development and operating costs, projections of future rates of production, expected recovery rates and market multiples for similar transactions. Many of the assumptions used are unobservable and as such, represent Level 3 inputs under the fair value hierarchy as described in Note 5, “Fair Value Measurements.” The Company's preliminary assessment of the fair value of the Chesapeake Assets resulted in a fair market valuation of $113.5 million . As a result of incorporating the valuation information into the purchase price allocation, a bargain purchase gain of $43.7 million was recognized in the accompanying condensed consolidated statements of operations. The bargain purchase gain was primarily attributable to the non-strategic nature of the divestiture to the seller, coupled with favorable economic trends in the industry and the geographic region in which the Chesapeake Assets are located. The Company believes the estimates used in the fair market valuation and purchase price allocation are reasonable and that the significant effects of the acquisition are properly reflected. However, the estimates are subject to change as additional information becomes available and is assessed by the Company. Changes to the purchase price allocation and any corresponding change to the bargain purchase gain will be adjusted retrospectively to the period of the acquisition.
The following table summarizes the estimated fair value of the assets acquired in connection with the Chesapeake Acquisition (in thousands):

12


 
 
 
Consideration:
 
 
Cash consideration
 
$
69,775

 
 
 
Estimated Fair Value of Assets Acquired:
 
 
Unproved properties
 
$
86,172

Proved properties
 
27,315

Total assets acquired
 
$
113,487

 
 
 
Bargain purchase gain
 
$
43,712

Hunton Joint Venture
Effective July 1, 2013 , Gastar USA's working interest partner in its original AMI in Oklahoma exercised its rights to acquire approximately 12,800 net acres and certain proved properties that Gastar USA acquired pursuant to the Chesapeake Purchase Agreement for a total payment of $12.1 million .
Hunton Divestiture
On July 2, 2013 , Gastar USA entered into a purchase and sale agreement with an unrelated third party, dated July 2, 2013 , pursuant to which the unrelated third party will acquire approximately 76,000 net acres of oil and gas leasehold interests in Kingfisher and Canadian Counties, Oklahoma from Gastar USA for a cash purchase price of approximately $62.0 million , subject to customary adjustments and Gastar USA will acquire approximately 1,850 net acres of Oklahoma oil and gas leasehold interests from the unrelated third party through a downward adjustment to the cash purchase price. The unrelated third party paid a deposit of approximately $6.3 million which was placed into escrow and will be applied to the purchase price upon closing on or before August 6, 2013 . The closing of the proposed transaction is subject to satisfaction of customary closing conditions and delivery of the total purchase price (subject to adjustment for an acquisition effective date of May 1, 2013 and downward adjustment for the acreage to be acquired by Gastar USA).
Hilltop Area, East Texas Sale
On April 19, 2013 , Gastar Exploration Texas, LP (“Gastar Texas”) and Gastar USA entered into a Purchase and Sale Agreement by and among Gastar Texas, Gastar USA and Cubic Energy, Inc. (“Cubic Energy”) (the “East Texas Sale Agreement”). Pursuant to the East Texas Sale Agreement, Cubic Energy will acquire from Gastar Texas approximately 32,400 gross ( 16,600 net) acres of leasehold interests in the Hilltop area of East Texas in Leon and Robertson Counties, Texas, including production from interests in producing wells, for a cash purchase price of approximately $46.0 million , subject to adjustment for accounting effective date of January 1, 2013 and other customary adjustments. The East Texas Sale Agreement contains customary representations and warranties and covenants, including provisions for indemnification, subject to the limitations described in the East Texas Sale Agreement. On June 11, 2013 , the parties to the East Texas Sale Agreement entered into the First Amendment of Purchase and Sale Agreement (the “First East Texas Sale Amendment”) in order to extend the closing date and termination date and to adjust the purchase price to reflect the exclusion of certain assets. On June 27, 2013 , the parties further amended the East Texas Sale Agreement by entering into the Second Amendment of Purchase and Sale Agreement, dated June 27, 2013 , but effective June 5, 2013 , to further extend the closing date. On July 11, 2013 , the parties further amended the East Texas Sale Agreement by entering into the Third Amendment of Purchase and Sale Agreement (the “Third East Texas Sale Amendment”), dated July 11, 2013 , in order to extend the closing and termination date to July 31, 2013 . Pursuant to the Third East Texas Sale Amendment, in the event the closing of the transaction has not occurred on or before July 31, 2013 , the East Texas Sale Agreement will terminate automatically and the $2.3 million deposit previously paid by Cubic Energy will automatically become the property of Gastar Texas. Additionally, although certain assets will be excluded from the sale, the Third East Texas Sale Amendment eliminated the purchase price adjustment provided for in the First East Texas Sale Amendment for excluded assets. On July 31, 2013 , the parties further amended the East Texas Sale Agreement by entering into the Fourth Amendment of Purchase and Sale Agreement (the “Fourth East Texas Sale Amendment”) to further extend the closing and termination date to August 16, 2013 , with Cubic Energy having an option to extend the closing date to August 30, 2013 (the “Option”). Pursuant to the Fourth East Texas Sale Amendment, Cubic Energy made an additional $1.15 million deposit on July 31, 2013 and will make another $1.15 million deposit on August 16, 2013 if they elect to exercise the Option. The deposits will automatically become the property of Gastar Texas if the East Texas Sale Agreement terminates. The closing of the sale is subject to satisfaction of customary closing conditions.

13


Atinum Joint Venture
In September 2010, Gastar USA entered into a joint venture (the “Atinum Joint Venture”) pursuant to which Gastar USA assigned to an affiliate of Atinum Partners Co., Ltd. (“Atinum”), for $70.0 million in total consideration, an initial 21.43% interest in all of its existing Marcellus Shale assets in West Virginia and Pennsylvania at that date, which consisted of certain undeveloped acreage and a 50% working interest in 16 producing shallow conventional wells and one non-producing vertical Marcellus Shale well (the “Atinum Joint Venture Assets”). In early 2012 , Gastar USA made additional assignments to Atinum as a result of which Atinum owns a 50% interest in the Atinum Joint Venture Assets. Subsequent to December 31, 2011 , Atinum funds only its 50% share of costs. Effective June 30, 2011 , an AMI was established for additional acreage acquisitions in Ohio, New York, Pennsylvania and West Virginia, excluding the counties of Pendleton, Pocahontas, Preston, Randolph and Tucker, West Virginia. Within this AMI, Gastar USA acts as operator and is obligated to offer any future lease acquisitions within the AMI to Atinum on a 50/50 basis, and Atinum will pay Gastar USA on an annual basis an amount equal to 10% of lease bonuses and third party leasing costs up to $20.0 million and 5% of such costs on activities above $20.0 million .
The Atinum Joint Venture's initial three -year development program called for the partners to drill a minimum of 12 horizontal wells in 2011 and 24 operated horizontal wells in each of 2012 and 2013 , respectively, for a total of 60 wells to be drilled. At December 31, 2012 , 38 gross operated wells were on production under the Atinum Joint Venture. Due to natural gas price declines, Atinum and Gastar USA agreed to reduce the 2013 minimum wells to be drilled requirement to 19 wells which will result in 57 gross wells on production at December 31, 2013 , compared to the 60 gross wells originally agreed upon.
  
4.
Long-Term Debt
Second Amended and Restated Revolving Credit Facility
On June 7, 2013 , Gastar USA entered into the Second Amended and Restated Credit Agreement, dated as of June 7, 2013 , among Gastar USA, Wells Fargo Bank, National Association, as Administrative Agent, Collateral Agent, Swing Line Lender and Issuing Lender and the lenders named therein (the “New Revolving Credit Facility”). The New Revolving Credit Facility provides an initial borrowing base of $50.0 million , with borrowings bearing interest, at Gastar USA's election, at the reference rate or the Eurodollar rate plus an applicable margin. The reference rate is the greater of (i) the rate of interest publicly announced by the administrative agent or (ii) the federal funds rate plus 50 basis points. The applicable interest rate margin varies from 1.0% to 2.0% in the case of borrowings based on the reference rate and from 2.0% to 3.0% in the case of borrowings based on the Eurodollar rate, depending on the utilization percentage in relation to the borrowing base. An annual commitment fee of 0.5% is payable quarterly on the unutilized balance of the borrowing base. The New Revolving Credit Facility has a scheduled maturity of November 14, 2017 .
The New Revolving Credit Facility is guaranteed by all of Gastar USA's current domestic subsidiaries and all future domestic subsidiaries formed during the term of the New Revolving Credit Facility. Borrowings and related guarantees are secured by a first priority lien on all domestic natural gas and oil properties currently owned by or later acquired Gastar USA and its subsidiaries, excluding de minimus value properties as determined by the lender. The New Revolving Credit Facility is secured by a first priority pledge of the stock of each domestic subsidiary, a first priority interest on all accounts receivable, notes receivable, inventory, contract rights, general intangibles and material property of the issuer and 65% of the stock of each foreign subsidiary of Gastar USA.
The New Revolving Credit Facility contains various covenants, including among others:
Restrictions on liens, incurrence of other indebtedness without lenders' consent and common stock dividends and other restricted payments;
Maintenance of a minimum consolidated current ratio as of the end of each quarter of not less than 1.0 to 1.0 , as adjusted;
Maintenance of a maximum ratio of indebtedness to EBITDA, as of the fiscal quarter ending June 30, 2013 , of not greater than 4.5 to 1.0 , as of the fiscal quarter ending September 30, 2013 , of not greater than 4.25 to 1.0 , and for each quarter thereafter, of not greater than 4.0 to 1.0 ; and
Maintenance of an interest coverage ratio on a rolling four quarters basis, as adjusted, of EBITDA to interest expense, as of the end of each quarter, to be less than 2.5 to 1.0 .
All outstanding amounts owed become due and payable upon the occurrence of certain usual and customary events of default, including among others:
Failure to make payments;
Non-performance of covenants and obligations continuing beyond any applicable grace period; and

14


The occurrence of a change in control of Gastar USA, as defined in the New Revolving Credit Facility.
On July 31, 2013, Gastar USA, together with the parties thereto, entered into the Waiver, Agreement and Amendment No. 1 to Second Amended and Restated Credit Agreement (the “First Amendment”). The First Amendment amended the New Revolving Credit Facility to clarify the current ratio covenant calculation.
Borrowing base redeterminations are scheduled semi-annually in May and November of each calendar year. Gastar USA and its lenders may request one additional unscheduled redetermination during any six-month period between scheduled redeterminations. At June 30, 2013 , the New Revolving Credit Facility had a borrowing base of $50.0 million , with $0 borrowings outstanding and availability of $50.0 million . The next regularly scheduled redetermination is set for November 2013. Future increases in the borrowing base in excess of the $50.0 million are limited to 17.5% of the increase in adjusted consolidated net tangible assets as defined in the Notes agreement (as discussed below).
At June 30, 2013 , Gastar USA was not in compliance with the current ratio covenant under the New Revolving Credit Facility. Gastar USA has been granted a waiver in regards to the current ratio covenant at June 30, 2013 . At June 30, 2013 , Gastar USA was in compliance with all other covenants under the New Revolving Credit Facility.
Amended and Restated Revolving Credit Facility
For the period October 28, 2009 through June 6, 2013 , Gastar USA, together with the other parties thereto, was subject to an amended and restated credit facility (the “Old Amended Revolving Credit Facility”). The Old Amended Revolving Credit Facility provided for various borrowing base amounts based on an initial borrowing base of $47.5 million and a final borrowing base of $160.0 million effective March 31, 2013 . Borrowings bore interest, at Gastar USA’s election, at the prime rate or LIBO rate plus an applicable margin. The applicable interest rate margin varied from 1.0% to 2.0% in the case of borrowings based on the prime rate and from 2.5% to 3.5% in the case of borrowings based on LIBO rate, depending on the utilization percentage in relation to the borrowing base. An annual commitment fee of 0.5% was payable quarterly based on the unutilized balance of the borrowing base. The Old Amended Revolving Credit Facility had a final scheduled maturity date of September 30, 2015 .
The Old Amended Revolving Credit Facility was guaranteed by Parent (as defined in the Old Amended Revolving Credit Facility) and all of Gastar USA’s current domestic subsidiaries and all future domestic subsidiaries formed during the term of the Old Amended Revolving Credit Facility. Borrowings and related guarantees were secured by a first priority lien on all domestic natural gas and oil properties currently owned by or later acquired by Gastar USA and its subsidiaries, excluding de minimus value properties as determined by the lender. The facility was secured by a first priority pledge of the stock of each domestic subsidiary, a first priority interest on all accounts receivable, notes receivable, inventory, contract rights, general intangibles and material property of the issuer and 65% of the stock of each foreign subsidiary of Gastar USA.
The Old Amended Revolving Credit Facility contained various covenants, including among others:
Restrictions on liens, incurrence of other indebtedness without lenders' consent and other restricted payments including a restriction on the amount of cash dividends to be paid in aggregate on the Gastar USA Series A Preferred Stock each calendar year, subject to certain available commitment thresholds;
Limitation of hedging volumes with a final limitation of 100% of the proved developed reserves as reflected in Gastar USA's reserve report using hedging other than floors and protective spreads;
Maintenance of a minimum consolidated current ratio as of the end of each quarter of not less than 1.0 to 1.0 , as adjusted, except for quarters ending on March 31, 2013 through December 31, 2013 whereby the ratio was reduced to 0.6 to 1.0 and making certain changes in the calculation of current liabilities for such periods to exclude advances from non-operators;
Maintenance of a maximum ratio of indebtedness to EBITDA on a rolling four quarter basis, as adjusted, of not greater than 4.0 to 1.0 ; and
Maintenance of an interest coverage ratio on a rolling four quarters basis, as adjusted, of EBITDA to interest expense, as of the end of each quarter, to be less than 2.5 to 1.0 .
All outstanding amounts owed became due and payable upon the occurrence of certain usual and customary events of default, including among others:
Failure to make payments;
Non-performance of covenants and obligations continuing beyond any applicable grace period; and
The occurrence of a “Change in Control” (as defined in the Old Amended Revolving Credit Facility) of the Parent.
The Old Amended Revolving Credit Facility was amended and restated on June 7, 2013 .

15


Senior Secured Notes
On May 15, 2013 , Gastar USA issued $200.0 million aggregate principal amount of its 8 5/8 % Senior Secured Notes due 2018 (the “Notes”) under an indenture (the “Indenture”) by and among Gastar USA, the Guarantors named therein (the “Guarantors”), Wells Fargo Bank, National Association, as Trustee (in such capacity, the “Trustee”) and Collateral Agent (in such capacity, the “Collateral Agent”). The Notes bear interest at a rate of 8.625% per year, payable semiannually in arrears on May 15 and November 15 of each year, beginning on November 15, 2013 . The Notes will mature on May 15, 2018 .
In the event of a change of control, as defined in the Indenture, each holder of the Notes will have the right to require Gastar USA to repurchase all or any part of their notes at an offer price in cash equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid interest, if any, to the date of purchase.
The Notes are fully and unconditionally guaranteed, jointly and severally, on a senior secured basis by each of Gastar USA's material subsidiaries and certain future domestic subsidiaries (the “Guarantees”). The Notes and Guarantees will rank senior in right of payment to all of Gastar USA's and the Guarantors' future subordinated indebtedness and equal in right of payment to all of Gastar USA's and the Guarantors' existing and future senior indebtedness. The Notes and Guarantees also will be effectively senior to Gastar USA's unsecured indebtedness and effectively subordinated to Gastar USA's and Guarantors' under the New Revolving Credit Facility, any other indebtedness secured by a first-priority lien on the same collateral and any other indebtedness secured by assets other than the collateral, in each case to the extent of the value of the assets securing such obligation.
The Indenture contains covenants that, among other things, limit Gastar USA's ability and the ability of its subsidiaries to:
Transfer or sell assets or use asset sale proceeds;
Pay dividends or make distributions, redeem subordinated debt or make other restricted payments;
Make certain investments; incur or guarantee additional debt or issue preferred equity securities;
Create or incur certain liens on Gastar USA's assets;
Incur dividend or other payment restrictions affecting future restricted subsidiaries;
Merge, consolidated or transfer all or substantially all of Gastar USA's assets;
Enter into certain transactions with affiliates; and
Enter into certain sale and leaseback transactions.
These and other covenants that are contained in the Indenture are subject to important limitations and qualifications that are described in the Indenture.
On May 15, 2013 , in connection with the issuance and sale of the Notes, Gastar USA and each of the Guarantors entered into a Registration Rights Agreement (the “Registration Rights Agreement”) with Imperial Capital, LLC, as representative of the initial purchasers. Under the Registration Rights Agreement, Gastar USA has agreed, subject to certain exceptions, to (i) file a registration statement with the SEC with respect to an exchange of the Notes for new notes having terms substantially identical in all material respects to the Notes (except that the exchange notes will not contain terms relating to transfer restrictions), (ii) use its reasonable best efforts to cause the exchange offer registration statement to be declared effective under the Securities Act of 1933, as amended, within 360 days after the issue date of the Notes, (iii) as soon as practicable after the effectiveness of the exchange offer registration statement, offer the exchange notes in exchange for the Notes, and (iv) keep the registered exchange offer open for not less than 30 days (or longer if required by applicable law) after the date of the registered exchange offer is mailed to the holders of the Notes. Gastar USA and the Guarantors also agreed to file a shelf registration statement for the resale of the Notes if an exchange offer cannot be effected within the time period specified above and in other circumstances.
At June 30, 2013 , the Notes reflected a balance of $194.6 million , net of unamortized discounts of $5.4 million , on the condensed consolidated balance sheets.

5.
Fair Value Measurements
The Company’s financial assets and liabilities are measured at fair value on a recurring basis. The Company discloses its recognized non-financial assets and liabilities, such as asset retirement obligations, unproved properties and other property and equipment, at fair value on a non-recurring basis. For non-financial assets and liabilities, the Company is required to disclose information that enables users of its financial statements to assess the inputs used to develop these measurements. The Company assesses its unproved properties for impairment whenever events or circumstances indicate the carrying value of those properties may not be recoverable. The fair value of the unproved properties is measured using an income approach based upon internal estimates of future production levels, current and future prices, drilling and operating costs, discount rates,

16


current drilling plans and favorable and unfavorable drilling activity on the properties being evaluated and/or adjacent properties or estimated market data based on area transactions, which are Level 3 inputs. For the three and six months ended June 30, 2013 , management's evaluation of unproved properties resulted in an impairment. Due to continued lower natural gas prices for dry gas, the Company reclassified $7.9 million of unproved properties to proved properties at June 30, 2013 related to acreage in Marcellus East. For the three and six months ended June 30, 2012 , management's evaluation of unproved properties did not result in an impairment. As no other fair value measurements are required to be recognized on a non-recurring basis at June 30, 2013 , no additional disclosures are provided at June 30, 2013 .
As defined in the guidance, fair value is the amount 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 (an exit price). To estimate fair value, the Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable. The guidance establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted market prices in active markets for identical assets or liabilities (“Level 1”) and the lowest priority to unobservable inputs (“Level 3”). The three levels of the fair value hierarchy are as follows:
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. The Company’s cash equivalents consist of short-term, highly liquid investments, which have maturities of 90 days or less, including sweep investments and money market funds.
Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument.
Level 3 inputs are 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. These inputs may be used with internally developed methodologies or third party broker quotes that result in management’s best estimate of fair value. The Company’s valuation models consider various inputs including (a) quoted forward prices for commodities, (b) time value, (c) volatility factors and (d) current market and contractual prices for the underlying instruments. Significant increases or decreases in any of these inputs in isolation would result in a significantly higher or lower fair value measurement. Level 3 instruments are commodity costless collars, index swaps, basis and fixed price swaps and put and call options to hedge natural gas, oil and NGLs price risk. At each balance sheet date, the Company performs an analysis of all applicable instruments and includes in Level 3 all of those whose fair value is based on significant unobservable inputs. The fair values derived from counterparties and third-party brokers are verified by the Company using publicly available values for relevant NYMEX futures contracts and exchange traded contracts for each derivative settlement location. Although such counterparty and third-party broker quotes are used to assess the fair value of its commodity derivative instruments, the Company does not have access to the specific assumptions used in its counterparties valuation models. Consequently, additional disclosures regarding significant Level 3 unobservable inputs were not provided and the Company does not currently have sufficient corroborating market evidence to support classifying these contracts as Level 2 instruments.
As required, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. The determination of the fair values below incorporates various factors, including the impact of the counterparty’s non-performance risk with respect to the Company’s financial assets and the Company’s non-performance risk with respect to the Company’s financial liabilities. The Company has not elected to offset the fair value amounts recognized for multiple derivative instruments executed with the same counterparty, but reports them gross on its consolidated balance sheets.
Transfers between levels are recognized at the end of the reporting period. There were no transfers between levels during the 2013 and 2012 periods.

17


The following tables set forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of June 30, 2013 and December 31, 2012 :
 
Fair value as of June 30, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
10,799

 
$

 
$

 
$
10,799

Commodity derivative contracts

 

 
4,588

 
4,588

Liabilities:
 
 
 
 
 
 
 
Commodity derivative contracts

 

 
(253
)
 
(253
)
Total
$
10,799

 
$

 
$
4,335

 
$
15,134

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fair value as of December 31, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
8,901

 
$

 
$

 
$
8,901

Commodity derivative contracts

 

 
9,168

 
9,168

Liabilities:
 
 
 
 
 
 
 
Commodity derivative contracts

 

 
(2,703
)
 
(2,703
)
Total
$
8,901

 
$

 
$
6,465

 
$
15,366


The table below presents a reconciliation of the assets and liabilities classified as Level 3 in the fair value hierarchy for the three and six months ended June 30, 2013 and 2012 . Level 3 instruments presented in the table consist of net derivatives that, in management’s opinion, reflect the assumptions a marketplace participant would have used at June 30, 2013 and 2012 .
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Balance at beginning of period
$
(3,145
)
 
$
13,456

 
$
6,465

 
$
15,873

Total gains (realized or unrealized):
 
 
 
 
 
 
 
included in earnings
7,036

 
5,768

 
3,034

 
6,641

included in other comprehensive income

 

 

 

Purchases

 

 

 

Issuances

 

 

 

Settlements (1)
444

 
(3,764
)
 
(5,164
)
 
(7,054
)
Transfers in and (out) of Level 3

 

 

 

Balance at end of period
$
4,335

 
$
15,460

 
$
4,335

 
$
15,460

The amount of total gains (losses) for the period included in earnings attributable to the change in unrealized gains or (losses) relating to assets still held at June 30, 2013 and 2012
$
7,485

 
$
2,804

 
$
(2,152
)
 
$
1,280

 _________________________________
(1)
Included in total revenues on the statement of operations.
At June 30, 2013 , the estimated fair value of accounts receivable, prepaid expenses, accounts and revenue payables and accrued liabilities approximates their carrying value due to their short-term nature. The estimated fair value of the Company’s long-term debt at June 30, 2013 was $191.3 million based on quoted market prices of the senior secured notes (Level 1).
The Company has consistently applied the valuation techniques discussed above in all periods presented.

18


The fair value guidance, as amended, establishes that every derivative instrument is to be recorded on the balance sheet as either an asset or liability measured at fair value. See Note 6, “Derivative Instruments and Hedging Activity.”

6.
Derivative Instruments and Hedging Activity
The Company maintains a commodity price risk management strategy that uses derivative instruments to minimize significant, unanticipated earnings fluctuations that may arise from volatility in commodity prices. The Company uses costless collars, index, basis and fixed price swaps and put and call options to hedge natural gas, condensate, oil and NGLs price risk.
All derivative contracts are carried at their fair value on the balance sheet and all unrealized gains and losses are recorded in the statement of operations in unrealized hedge gain (loss), while realized gains and losses related to contract settlements are recognized in natural gas, condensate, oil and NGLs revenues. For the three months ended June 30, 2013 and 2012 , the Company reported unrealized gains of $7.5 million and $2.8 million , respectively, in the condensed consolidated statement of operations related to the change in the fair value of its commodity derivative instruments. For the six months ended June 30, 2013 and 2012 , the Company reported an unrealized loss of $2.2 million and an unrealized gain of $1.3 million , respectively, in the condensed consolidated statement of operations related to the change in the fair value of its commodity derivative instruments.
As of June 30, 2013 , the following natural gas derivative transactions were outstanding with the associated notional volumes and weighted average underlying hedge prices:
 
Settlement Period
 
Derivative Instrument
 
Average
Daily
Volume
 
Total of
Notional
Volume
 
Base
Fixed
Price
 
Floor
(Long)
 
Short
Put
 
Call
(Long)
 
Ceiling
(Short)
 
 
 
 
(in MMBtu's)
 
 
 
 
 
 
 
 
 
 
2013
 
Fixed price swap
 
2,000

 
368,000

 
$
3.85

 
$

 
$

 
$

 
$

2013
 
Fixed price swap
 
2,000

 
368,000

 
4.00

 

 

 

 

2013
 
Fixed price swap
 
3,000

 
552,000

 
4.06

 

 

 

 

2013
 
Fixed price swap
 
2,500

 
460,000

 
4.05

 

 

 

 

2013
 
Fixed price swap
 
13,082

 
2,407,000

 
3.87

 

 

 

 

2013 (1)
 
Fixed price swap
 
2,500

 
307,500

 
4.05

 

 

 

 

2013 (2)
 
Protective spread
 
2,500

 
152,500

 
4.05

 

 
3.79

 

 

2013 (3)
 
Protective spread
 
4,025

 
124,760

 
3.70

 

 
3.00

 

 

2013 (1)
 
Costless collar
 
2,500

 
307,500

 

 
5.00

 

 

 
6.45

2013 (2)
 
Costless three-way collar
 
2,500

 
152,500

 

 
5.00

 
4.00

 

 
6.45

2013
 
Call spread
 
2,500

 
460,000

 

 

 

 
4.75

 
5.25

2013
 
Basis - HSC (4)
 
4,000

 
736,000

 
(0.11
)
 

 

 

 

2014
 
Short calls
 
2,500

 
912,500

 

 

 

 

 
4.59

2014
 
Costless three-way collar
 
10,500

 
3,832,500

 

 
3.88

 
3.00

 

 
4.53

2014
 
Fixed price swap
 
11,136

 
4,064,500

 
4.06

 

 

 

 

 _______________________________
(1)
For the period July to October 2013
(2)
For the period November to December 2013
(3)
For the month of July 2013
(4)
East Houston-Katy - Houston Ship Channel


19


As of June 30, 2013 , the following crude derivative transactions were outstanding with the associated notional volumes and weighted average underlying hedge prices:
Settlement Period
 
Derivative Instrument
 
Average
Daily
Volume (1)
 
Total of
Notional
Volume
 
Base
Fixed
Price
 
Floor
(Long)
 
Short
Put
 
Ceiling
(Short)
 
 
 
 
(in Bbls)
 
 
 
 
 
 
 
 
2013
 
Fixed price swap
 
92

 
16,900

 
$
92.80

 
$

 
$

 
$

2013
 
Fixed price swap
 
150

 
27,600

 
92.80

 

 

 

2013
 
Fixed price swap
 
400

 
73,600

 
94.86

 

 

 

2013
 
Protective spread
 
400

 
73,600

 
92.80

 

 
70.00

 

2014
 
Producer three-way collar
 
200

 
73,000

 

 
90.00

 
70.00

 
106.20

2014
 
Fixed price swap
 
270

 
98,500

 
90.77

 

 

 

2014
 
Fixed price swap
 
500

 
182,500

 
91.10

 

 

 

2015
 
Producer three-way collar
 
345

 
126,100

 

 
85.00

 
65.00

 
97.80

2015
 
Producer three-way collar
 
400

 
146,000

 

 
85.00

 
70.00

 
96.50

2016
 
Producer three-way collar
 
275

 
100,600

 

 
85.00

 
65.00

 
95.10

2016
 
Producer three-way collar
 
330

 
120,780

 

 
80.00

 
65.00

 
97.35

2017
 
Producer three-way collar
 
242

 
88,150

 

 
80.00

 
60.00

 
98.70

2017
 
Producer three-way collar
 
280

 
102,200

 

 
80.00

 
65.00

 
97.25

 _______________________________
(1)
Crude volumes hedged include oil, condensate and certain components of our NGLs production.

As of June 30, 2013 , the following NGLs derivative transactions were outstanding with the associated notional volumes and weighted average underlying hedge prices:
Settlement Period
 
Derivative Instrument
 
Average
Daily
Volume
 
Total of
Notional
Volume
 
Base
Fixed
Price
 
 
 
 
(in Bbls)
 
 
2013
 
Fixed price swap
 
150

 
27,600

 
$
41.06

2013
 
Fixed price swap
 
350

 
64,400

 
41.32

As of June 30, 2013 , all of the Company’s economic derivative hedge positions were with multinational energy companies or large financial institutions, which are not known to the Company to be in default on their derivative positions. The Company is exposed to credit risk to the extent of non-performance by the counterparties in the derivative contracts discussed above; however, the Company does not anticipate non-performance by such counterparties. None of the Company’s derivative instruments contains credit-risk related contingent features.


20


Additional Disclosures about Derivative Instruments and Hedging Activities
The tables below provide information on the location and amounts of derivative fair values in the condensed consolidated statement of financial position and derivative gains and losses in the condensed consolidated statement of operations for derivative instruments that are not designated as hedging instruments:
 
 
Fair Values of Derivative Instruments
Derivative Assets (Liabilities)
 
 
 
Fair Value
 
Balance Sheet Location
 
June 30, 2013
 
December 31, 2012
 
 
 
(in thousands)
Derivatives not designated as hedging instruments
 
 
 
 
 
Commodity derivative contracts
Current assets
 
$
2,835

 
$
7,799

Commodity derivative contracts
Other assets
 
1,753

 
1,369

Commodity derivative contracts
Current liabilities
 
(253
)
 
(1,399
)
Commodity derivative contracts
Long-term liabilities
 

 
(1,304
)
Total derivatives not designated as hedging instruments
 
 
$
4,335

 
$
6,465

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Amount of Gain (Loss) Recognized in Income on Derivatives
 
 
 
Amount of Gain (Loss)
Recognized in Income on
Derivatives For the Three
Months Ended
 
Location of Gain (Loss) Recognized in Income on Derivatives
 
June 30, 2013
 
June 30, 2012
 
 
 
(in thousands)
Derivatives not designated as hedging instruments
 
 
 
 
 
Commodity derivative contracts
Natural gas, condensate, oil and NGLs revenues
 
$
(449
)
 
$
3,003

Commodity derivative contracts
Unrealized hedge gain
 
7,485

 
2,804

Commodity derivative contracts
Interest expense
 

 
(39
)
Total
 
 
$
7,036

 
$
5,768

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Amount of Gain (Loss) Recognized in Income on Derivatives
 
 
 
Amount of Gain (Loss)
Recognized in Income on
Derivatives For the Six
Months Ended
 
Location of Gain (Loss) Recognized in Income on Derivatives
 
June 30, 2013
 
June 30, 2012
 
 
 
(in thousands)
Derivatives not designated as hedging instruments
 
 
 
 
 
Commodity derivative contracts
Natural gas, condensate, oil and NGLs revenues
 
$
5,186

 
$
5,443

Commodity derivative contracts
Unrealized hedge (loss) gain
 
(2,152
)
 
1,280

Commodity derivative contracts
Interest expense
 

 
(82
)
Total
 
 
$
3,034

 
$
6,641

 
 
 
 
 
 





21



7.
Capital Stock

Other Share Issuances
The following table provides information regarding the issuances and forfeitures of Parent’s common shares pursuant to Parent’s 2006 Long-Term Stock Incentive Plan (the “2006 Plan”) for the periods indicated:
 
 
For the Three Months Ended June 30, 2013
 
For the Six Months Ended June 30, 2013
Other share issuances:
 
 
 
Restricted common shares granted

 
2,177,903

Restricted common shares vested
1,500

 
630,529

Common shares surrendered upon vesting (1)
490

 
189,393

Common shares forfeited
20,000

 
86,327

 __________________
(1)
Represents common shares forfeited in connection with the payment of estimated withholding taxes on restricted common shares that vested during the period.

On June 7, 2012 , Parent's shareholders voted to approve the Second Amendment to the 2006 Plan. This amendment, effective June 3, 2012 , increased the total number of shares available for issuance under the plan from 6,000,000 shares to 11,000,000 shares. There were 2,540,247 shares available for issuance under the 2006 Plan at June 30, 2013 .
Shares Reserved
At June 30, 2013 , Parent had 919,100 common shares reserved for the exercise of stock options.
Shares Owned by Chesapeake Energy Corporation
On March 28, 2013 , the Company entered into a Settlement Agreement, dated March 28, 2013 , between Chesapeake Exploration, L.L.C. and Chesapeake Energy Corporation (collectively, “Chesapeake”) and the Company, Gastar Exploration Texas, LP and Gastar Exploration Texas, LLC (the “Settlement Agreement”). Pursuant to the Settlement Agreement, the Company settled and resolved all claims of Chesapeake and its subsidiaries against the Company and its subsidiaries made in a previously disclosed lawsuit filed in the U.S. District Court for the Southern District of Texas. In order to effect a mutual full and unconditional release and settlement of all claims made in the lawsuit filed by Chesapeake, the Company paid Chesapeake approximately $10.8 million in cash, approximately $9.8 million of which was paid for the repurchase of 6,781,768 outstanding common shares of Parent held by Chesapeake Energy Corporation upon the closing of the stock repurchase and settlement on June 7, 2013 . See Note 13, “Commitments and Contingencies.”
Gastar USA Common Stock
Prior to its conversion, as described below, Gastar USA’s articles of incorporation allowed Gastar USA to issue 1,000 shares of common stock, without par value. There were 750 shares issued and outstanding at June 30, 2013 and December 31, 2012 , all of which were held by Parent.
On May 24, 2011 , Gastar USA converted from a Michigan corporation to a Delaware corporation (the “Conversion”). Following the Conversion, Gastar USA’s new Delaware certificate of incorporation allows Gastar USA to issue 1,000 shares of common stock, without par value. In connection with the Conversion, the Parent’s 750 shares of common stock in the Michigan corporation were converted to 750 shares of common stock in the new Gastar USA Delaware corporation.
Gastar USA Preferred Stock
Prior to the Conversion, Gastar USA’s articles of incorporation did not authorize issuance of preferred stock.
Following the Conversion, Gastar USA’s new Delaware certificate of incorporation allows Gastar USA to issue 10,000,000 shares of preferred stock, with $0.01 par value. The preferred stock may be issued from time to time in one or more series. Gastar USA’s Board of Directors (the “Gastar USA Board”) is authorized to fix the number of shares of any series of preferred stock and to determine the designation of any such series. The Gastar USA Board is also authorized to determine or alter the rights, preferences, privileges and restrictions granted to or imposed upon any wholly unissued series of preferred stock and, within the limits and restrictions stated in any resolution or resolutions of the Gastar USA Board originally fixing the number of

22


shares constituting any series, to increase or decrease (but not below the number of shares of any such series outstanding) the number of shares of any series subsequent to the issues shares of that series).
For the three and six months ended June 30, 2013 , Gastar USA sold 6,906 shares of Series A Preferred Stock under its at the market preferred share purchase agreement (the “ATM Agreement”) for net proceeds of $136,000 . At June 30, 2013 , there were 3,958,160 total shares of Series A Preferred Stock issued and outstanding. Subsequent to June 30, 2013 , Gastar USA did not sell any additional shares of Series A Preferred Stock under the ATM Agreement.
The Series A Preferred Stock is subordinated to all of Gastar USA’s existing and future debt and all future capital stock designated as senior to the Series A Preferred Stock. Parent has entered into a guarantee agreement, whereby it will fully and unconditionally guarantee the payment of dividends that have been declared by the board of directors of Gastar USA, amounts payable upon redemption or liquidation, dissolution or winding up, and any other amounts due with respect to the Series A Preferred Stock, to the extent described in the guarantee agreement. Parent’s obligations with respect to the guarantee will be effectively subordinated to all of its existing and future debt.
The Series A Preferred Stock cannot be converted into common stock of Gastar USA or the Company, but may be redeemed by Gastar USA, at Gastar USA’s option, on or after June 23, 2014 for $25.00 per share plus any accrued and unpaid dividends or in certain circumstances prior to such date as a result of a change in control. Following a change in control, Gastar USA will have the option to redeem the Series A Preferred Stock, in whole but not in part, within 90 days after the date on which the change in control occurs, for cash at the following prices per share, plus accrued and unpaid dividends (whether or not declared), up to the redemption date:
 
Redemption Date
Redemption
Price
On or after June 23, 2013 and prior to June 23, 2014
$
25.25

On or after June 23, 2014
$
25.00


Gastar USA pays cumulative dividends on the Series A Preferred Stock at a fixed rate of 8.625%  per annum of the $25.00 per share liquidation preference. For the three and six months ended June 30, 2013 , Gastar USA recognized dividend expense of $2.1 million and $4.3 million , respectively.