Gastar Exploration Inc.
GASTAR EXPLORATION LTD (Form: 10-Q, Received: 11/05/2013 06:02:18)
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 September 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 November 1, 2013 was
Gastar Exploration Ltd.
61,134,950

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 NINE MONTHS ENDED SEPTEMBER 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
 
September 30,
2013
 
December 31,
2012
 
(Unaudited)
 
 
 
(in thousands, except share data)
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
21,375

 
$
8,901

Accounts receivable, net of allowance for doubtful accounts of $514 and $546, respectively
10,697

 
9,540

Commodity derivative contracts
2,259

 
7,799

Prepaid expenses
616

 
1,097

Total current assets
34,947

 
27,337

PROPERTY, PLANT AND EQUIPMENT:
 
 
 
Natural gas and oil properties, full cost method of accounting:
 
 
 
Unproved properties, excluded from amortization
102,338

 
67,892

Proved properties
769,054

 
671,193

Total natural gas and oil properties
871,392

 
739,085

Furniture and equipment
2,409

 
1,925

Total property, plant and equipment
873,801

 
741,010

Accumulated depreciation, depletion and amortization
(506,187
)
 
(484,759
)
Total property, plant and equipment, net
367,614

 
256,251

OTHER ASSETS:
 
 
 
Commodity derivative contracts
7,399

 
1,369

Deferred charges, net
2,133

 
836

Advances to operators and other assets
12,311

 
4,275

Total other assets
21,843

 
6,480

TOTAL ASSETS
$
424,404

 
$
290,068

LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
5,611

 
$
23,863

Revenue payable
12,063

 
8,801

Accrued interest
6,469

 
151

Accrued drilling and operating costs
2,727

 
3,907

Advances from non-operators
12,951

 
17,540

Commodity derivative contracts
794

 
1,399

Commodity derivative premium payable
1,819

 

Asset retirement obligation
750

 
358

Other accrued liabilities
8,319

 
1,493

Total current liabilities
51,503

 
57,512

LONG-TERM LIABILITIES:
 
 
 
Long-term debt
194,830

 
98,000

Commodity derivative contracts

 
1,304

Commodity derivative premium payable
7,651

 

Asset retirement obligation
8,006

 
6,605

Other long-term liabilities

 
111

Total long-term liabilities
210,487

 
106,020

Commitments and contingencies (Note 13)

 

SHAREHOLDERS' EQUITY:
 
 
 
Common stock, no par value; unlimited shares authorized; 61,134,950 and 66,432,609 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively
306,593

 
316,346

Additional paid-in capital
30,526

 
28,336

Accumulated deficit
(251,479
)
 
(294,787
)
Total shareholders' equity
85,640

 
49,895

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

 
76,641

Total equity
162,414

 
126,536

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$
424,404

 
$
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 September 30,
 
For the Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands, except share and per share data)
REVENUES:
 
 
 
 
 
 
 
Natural gas
$
11,396

 
$
8,906

 
$
34,673

 
$
22,499

Condensate and oil
8,680

 
3,457

 
22,823

 
7,748

NGLs
3,768

 
2,483

 
10,690

 
6,394

Total natural gas, condensate, oil and NGLs revenues
23,844

 
14,846

 
68,186

 
36,641

Unrealized hedge loss
(5,004
)
 
(5,403
)
 
(7,156
)
 
(4,123
)
Total revenues
18,840

 
9,443

 
61,030

 
32,518

EXPENSES:
 
 
 
 
 
 
 
Production taxes
1,319

 
560

 
3,112

 
1,494

Lease operating expenses
2,190

 
780

 
6,196

 
4,754

Transportation, treating and gathering
1,098

 
1,305

 
3,386

 
3,715

Depreciation, depletion and amortization
8,467

 
7,135

 
21,428

 
19,744

Impairment of natural gas and oil properties

 
78,054

 

 
150,787

Accretion of asset retirement obligation
142

 
101

 
358

 
284

General and administrative expense
3,998

 
2,951

 
11,964

 
9,263

Litigation settlement expense

 

 
1,000

 
1,250

Total expenses
17,214

 
90,886

 
47,444

 
191,291

INCOME (LOSS) FROM OPERATIONS
1,626

 
(81,443
)
 
13,586

 
(158,773
)
OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
Gain on acquisition of assets at fair value

 

 
43,712

 

Interest expense
(3,439
)
 
(30
)
 
(7,593
)
 
(86
)
Investment income and other
8

 
2

 
16

 
6

Foreign transaction loss
(3
)
 
(2
)
 
(15
)
 
(2
)
INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
(1,808
)
 
(81,473
)
 
49,706

 
(158,855
)
Provision for income taxes

 

 

 

NET INCOME (LOSS)
(1,808
)
 
(81,473
)
 
49,706

 
(158,855
)
Dividend on preferred stock attributable to non-controlling interest
(2,134
)
 
(1,984
)
 
(6,398
)
 
(4,947
)
NET INCOME (LOSS) ATTRIBUTABLE TO GASTAR EXPLORATION LTD.
$
(3,942
)
 
$
(83,457
)
 
$
43,308

 
$
(163,802
)
NET INCOME (LOSS) PER COMMON SHARE ATTRIBUTABLE TO GASTAR EXPLORATION LTD. COMMON SHAREHOLDERS:
 
 
 
 
 
 
 
Basic
$
(0.07
)
 
$
(1.31
)
 
$
0.71

 
$
(2.58
)
Diluted
$
(0.07
)
 
$
(1.31
)
 
$
0.68

 
$
(2.58
)
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
 
 
 
 
 
 
 
Basic
57,359,357

 
63,601,645

 
61,159,117

 
63,494,224

Diluted
57,359,357

 
63,601,645

 
63,971,038

 
63,494,224


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 Nine Months Ended September 30,
 
2013
 
2012
 
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income (loss)
$
49,706

 
$
(158,855
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation, depletion and amortization
21,428

 
19,744

Impairment of natural gas and oil properties

 
150,787

Stock-based compensation
2,540

 
2,575

Unrealized hedge loss
7,156

 
4,123

Realized loss (gain) on derivative contracts
18

 
(662
)
Amortization of deferred financing costs
1,790

 
157

Accretion of asset retirement obligation
358

 
284

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

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(1,259
)
 
2,429

Prepaid expenses
481

 
345

Accounts payable and accrued liabilities
733

 
129

Net cash provided by operating activities
39,239

 
21,056

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Development and purchase of natural gas and oil properties
(77,813
)
 
(100,606
)
Acquisition of natural gas and oil properties
(78,809
)
 

Proceeds from sale of natural gas and oil properties
70,708

 

Advances to operators
(13,104
)
 
(4,282
)
Use of advances from non-operators
(4,589
)
 
(1,085
)
Purchase of furniture and equipment
(484
)
 
(235
)
Net cash used in investing activities
(104,091
)
 
(106,208
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from revolving credit facility
19,000

 
70,000

Repayment of revolving credit facility
(117,000
)
 
(30,000
)
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

 
49,169

Dividend on preferred stock attributable to non-controlling interest
(6,398
)
 
(4,947
)
Deferred financing charges
(2,807
)
 
(332
)
Other
(349
)
 
(282
)
Net cash provided by financing activities
77,326

 
83,608

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
12,474

 
(1,544
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
8,901

 
10,647

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
21,375

 
$
9,103


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

6


GASTAR EXPLORATION USA, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
September 30,
2013
 
December 31,
2012
 
(Unaudited)
 
 
 
(in thousands, except share data)
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
21,362

 
$
8,892

Accounts receivable, net of allowance for doubtful accounts of $514 and $546, respectively
10,696

 
9,539

Commodity derivative contracts
2,259

 
7,799

Prepaid expenses
587

 
919

Total current assets
34,904

 
27,149

PROPERTY, PLANT AND EQUIPMENT:
 
 
 
Natural gas and oil properties, full cost method of accounting:
 
 
 
Unproved properties, excluded from amortization
102,338

 
67,892

Proved properties
769,046

 
671,185

Total natural gas and oil properties
871,384

 
739,077

Furniture and equipment
2,409

 
1,925

Total property, plant and equipment
873,793

 
741,002

Accumulated depreciation, depletion and amortization
(506,180
)
 
(484,752
)
Total property, plant and equipment, net
367,613

 
256,250

OTHER ASSETS:
 
 
 
Commodity derivative contracts
7,399

 
1,369

Deferred charges, net
2,133

 
836

Advances to operators and other assets
12,311

 
4,275

Total other assets
21,843

 
6,480

TOTAL ASSETS
$
424,360

 
$
289,879

LIABILITIES AND STOCKHOLDERS' EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
5,611

 
$
23,863

Revenue payable
12,063

 
8,801

Accrued interest
6,469

 
151

Accrued drilling and operating costs
2,727

 
3,907

Advances from non-operators
12,951

 
17,540

Commodity derivative contracts
794

 
1,399

Commodity derivative premium payable
1,819

 

Asset retirement obligation
750

 
358

Other accrued liabilities
7,974

 
1,480

Total current liabilities
51,158

 
57,499

LONG-TERM LIABILITIES:
 
 
 
Long-term debt
194,830

 
98,000

Commodity derivative contracts

 
1,304

Commodity derivative premium payable
7,651

 

Asset retirement obligation
7,999

 
6,598

Due to parent
34,805

 
30,903

Other long-term liabilities

 
111

Total long-term liabilities
245,285

 
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 September 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
(174,288
)
 
(218,608
)
Total stockholders' equity
127,917

 
95,464

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
$
424,360

 
$
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 September 30,
 
For the Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands, except share and per share data)
REVENUES:
 
 
 
 
 
 
 
Natural gas
$
11,396

 
$
8,906

 
$
34,673

 
$
22,499

Condensate and oil
8,680

 
3,457

 
22,823

 
7,748

NGLs
3,768

 
2,483

 
10,690

 
6,394

Total natural gas, condensate, oil and NGLs revenues
23,844

 
14,846

 
68,186

 
36,641

Unrealized hedge loss
(5,004
)
 
(5,403
)
 
(7,156
)
 
(4,123
)
Total revenues
18,840

 
9,443

 
61,030

 
32,518

EXPENSES:
 
 
 
 
 
 
 
Production taxes
1,319

 
560

 
3,112

 
1,494

Lease operating expenses
2,190

 
780

 
6,196

 
4,754

Transportation, treating and gathering
1,098

 
1,305

 
3,386

 
3,715

Depreciation, depletion and amortization
8,467

 
7,135

 
21,428

 
19,744

Impairment of natural gas and oil properties

 
78,054

 

 
150,787

Accretion of asset retirement obligation
142

 
101

 
358

 
284

General and administrative expense
3,538

 
2,481

 
10,935

 
8,105

Litigation settlement expense

 

 
1,000

 
1,250

Total expenses
16,754

 
90,416

 
46,415

 
190,133

INCOME (LOSS) FROM OPERATIONS
2,086

 
(80,973
)
 
14,615

 
(157,615
)
OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
Gain on acquisition of assets at fair value

 

 
43,712

 

Interest expense
(3,439
)
 
(30
)
 
(7,593
)
 
(87
)
Investment income and other
(7
)
 
(5
)
 
(5
)
 
(4
)
Foreign transaction (loss) gain
(3
)
 
1

 
(11
)
 
2

INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES
(1,363
)
 
(81,007
)
 
50,718

 
(157,704
)
Provision for income taxes

 

 

 

NET INCOME (LOSS)
(1,363
)
 
(81,007
)
 
50,718

 
(157,704
)
Dividend on preferred stock
(2,134
)
 
(1,984
)
 
(6,398
)
 
(4,947
)
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCKHOLDER
$
(3,497
)
 
$
(82,991
)
 
$
44,320

 
$
(162,651
)

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 Nine Months Ended September 30,
 
2013
 
2012
 
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income (loss)
$
50,718

 
$
(157,704
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation, depletion and amortization
21,428

 
19,744

Impairment of natural gas and oil properties

 
150,787

Stock-based compensation
2,540

 
2,575

Unrealized hedge loss
7,156

 
4,123

Realized loss (gain) on derivative contracts
18

 
(662
)
Amortization of deferred financing costs
1,790

 
157

Accretion of asset retirement obligation
358

 
284

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

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(1,259
)
 
2,427

Prepaid expenses
332

 
215

Accounts payable and accrued liabilities
421

 
(43
)
Net cash provided by operating activities
39,790

 
21,903

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Development and purchase of natural gas and oil properties
(77,813
)
 
(100,606
)
Acquisition of natural gas and oil properties
(78,809
)
 

Proceeds from sale of natural gas and oil properties
70,708

 

Advances to operators
(13,104
)
 
(4,282
)
Use of advances from non-operators
(4,589
)
 
(1,085
)
Purchase of furniture and equipment
(484
)
 
(235
)
Net cash used in investing activities
(104,091
)
 
(106,208
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from revolving credit facility
19,000

 
70,000

Repayment of revolving credit facility
(117,000
)
 
(30,000
)
Proceeds from issuance of senior secured notes, net of discounts
194,500

 

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

 
49,169

Dividend on preferred stock
(6,398
)
 
(4,947
)
Deferred financing charges
(2,807
)
 
(332
)
Distribution to Parent, net
(10,657
)
 
(1,196
)
Other

 
25

Net cash provided by financing activities
76,771

 
82,719

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
12,470

 
(1,586
)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
8,892

 
10,595

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
21,362

 
$
9,009


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. The Company sold substantially all of its East Texas assets on October 2, 2013.
On August 1, 2013, the shareholders of Gastar Exploration Ltd. voted to approve a special resolution approving a plan of arrangement (as amended, the “Arrangement”) pursuant to which Gastar Exploration Ltd. would be continued as if it had been incorporated under the laws of the State of Delaware (the “Delaware Migration”). On August 2, 2013, Gastar Exploration Ltd. obtained a Final Order from the Court of the Queen's Bench of Alberta, as amended on September 17, 2013 and October 28, 2013, approving the Arrangement. Gastar Exploration Ltd. expects to complete the Delaware Migration in the fourth quarter of 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.

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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 nine months ended September 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 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
The following recently issued accounting pronouncement may impact the Company in future periods:
Income Taxes. In July 2013, the FASB issued an amendment to previously issued guidance regarding the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. The amendment requires that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. This amendment does not require new recurring disclosures. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Earlier application is permitted. The Company is currently evaluating the provisions of this amendment.

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, as well as the acquisition of properties in Oklahoma. The Company sold substantially all of its East Texas assets on October 2, 2013 .
The following table summarizes the components of unproved properties excluded from amortization for the periods indicated:
 
 
September 30, 2013
 
December 31, 2012
 
(in thousands)
Unproved properties, excluded from amortization:
 
 
 
Drilling in progress costs
$
8,821

 
$
1,902

Acreage acquisition costs
88,033

 
62,395

Capitalized interest
5,484

 
3,595

Total unproved properties excluded from amortization
$
102,338

 
$
67,892


For the three and nine months ended September 30, 2013 , management's evaluation of unproved properties resulted in an impairment. Due to continued lower natural gas prices for dry gas and no current plans to drill or extend leases in Marcellus East, the Company reclassified $98,000 and $8.0 million of unproved properties to proved properties for the three and nine months ended September 30, 2013 , respectively, related to acreage in Marcellus East. For the nine months ended September 30, 2012 , management's evaluation of unproved properties resulted in an impairment and the Company reclassified $19.1 million of unproved properties to proved properties due to a decline in natural gas prices and the suspension of drilling activity in East Texas.

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

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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 pricing assumptions utilized in the quarterly ceiling test computations for the respective periods noted before adjustment for basis and quality differentials:

 
2013
 
Total Impairment
 
September 30
 
June 30
 
March 31
Henry Hub natural gas price (per MMBtu)
 
 
$
3.61

 
$
3.44

 
$
2.95

West Texas Intermediate oil price (per Bbl)
 
 
$
91.69

 
$
88.13

 
$
89.17

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

 
$

 
$

 
$


 
2012
 
Total Impairment
 
September 30
 
June 30
 
March 31
Henry Hub natural gas price (per MMBtu)
 
 
$
2.83

 
$
3.15

 
$
3.73

West Texas Intermediate oil price (per Bbl)
 
 
$
91.48

 
$
92.17

 
$
94.65

Impairment recorded (pre-tax) (in thousands)
$
150,787

 
$
78,054

 
$
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 contained 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 a final adjusted purchase price of $69.4 million , reflecting 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.

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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 , of which $133,000 was deemed to be a reimbursement of transaction and integration costs associated with the acquisition and was recorded as a reduction of the Company's general and administrative expense.
Hunton Divestiture
On July 2, 2013 , Gastar USA entered into a purchase and sale agreement with Newfield Exploration Mid-Continent Inc. (“Newfield”), dated July 2, 2013 , pursuant to which Newfield acquired approximately 76,000 net acres of oil and gas leasehold interests in Kingfisher and Canadian Counties, Oklahoma from Gastar USA and Gastar USA acquired approximately 2,260 net acres of Oklahoma oil and gas leasehold interests from Newfield. The transaction closed on August 6, 2013 for a net cash purchase price of approximately $54.0 million , adjusted for an acquisition effective date of May 1, 2013 . The Company did not record a gain or loss related to the divestiture as it was not significant to the full cost pool.
WEHLU Acquisition
On September 4, 2013 , Gastar USA entered into a Purchase and Sale Agreement, dated September 4, 2013 , by and among Lime Rock Resources II-A, L.P. and Lime Rock Resources II-C, L.P. (the “Lime Rock Parties”) and Gastar USA (the “WEHLU Purchase Agreement”). Pursuant to the WEHLU Purchase Agreement, Gastar USA will acquire a 98.3% working interest ( 80.5% net revenue interest) in 24,000 net acres of the West Edmond Hunton Lime Unit (“WEHLU”) located in Kingfisher, Logan and Oklahoma Counties, Oklahoma, for a cash purchase price of $187.5 million , subject to, among other customary adjustments, adjustment for an acquisition effective date of August 1, 2013 (the “WEHLU Acquisition”). The Company paid a deposit of $9.4 million , which is currently recorded as an other asset and will be applied to the purchase price at closing. The closing of the WEHLU Acquisition is subject to satisfaction of customary closing conditions and delivery of the total acquisition purchase price. Gastar USA anticipates the WEHLU Acquisition will close in late November 2013 .
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, as amended, on October 2, 2013 , Cubic Energy acquired from Gastar Texas approximately 31,800 gross ( 16,300 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 net proceeds of approximately $43.9 million , reflecting adjustment for accounting effective date of January 1, 2013 and other customary adjustments and of which $4.7 million was previously received as a deposit and was accounted for in other liabilities at September 30, 2013 . The Company will not record a gain or loss related to the divestiture as it was not significant to the full cost pool.
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. As of September 30, 2013 , all 57 gross wells were on production as agreed upon.
  

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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 by 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 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
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.

On October 18, 2013 , Gastar USA, together with the parties thereto, entered into the Agreement and Amendment No. 2 (“Amendment No. 2”) to Second Amended and Restated Credit Agreement, dated as of June 7, 2013 . Amendment No. 2 amended the New Revolving Credit Facility to, among other things, (i) increase the aggregate principal amount of 8 5/8% Senior Secured Notes due 2018 permitted to be issued from $200.0 million to $325.0 million , (ii) allow for the issuance by Gastar USA of Series B Preferred Stock and (iii) increase the aggregate amount of cash dividends permitted to be paid to preferred stockholders from $12.5 million to $20.0 million .
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 September 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 in “Senior Secured Notes”).
At September 30, 2013 , Gastar USA was in compliance with all financial covenants under the New Revolving Credit Facility.

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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 .
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

15


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 September 30, 2013 , the Notes reflected a balance of $194.8 million , net of unamortized discounts of $5.2 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, 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 nine months ended September 30, 2013 , management's evaluation of unproved properties resulted in an impairment. Due to continued lower natural gas prices for dry gas and no current plans to drill or extend leases in Marcellus East, the Company reclassified $8.0 million of unproved properties to proved properties as of September 30, 2013 related to acreage in Marcellus East. For the nine months ended September 30, 2012 , the Company reclassified $19.1 million of unproved properties to proved properties due to a decline in natural gas prices and the suspension of drilling activity in East Texas. As no other fair value measurements are required to be recognized on a non-recurring basis at September 30, 2013 , no additional disclosures are provided at September 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

16


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 September 30, 2013 and December 31, 2012 :
 
Fair value as of September 30, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(in thousands)
Assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
21,375

 
$

 
$

 
$
21,375

Commodity derivative contracts

 

 
9,658

 
9,658

Liabilities:
 
 
 
 
 
 
 
Commodity derivative contracts

 

 
(794
)
 
(794
)
Total
$
21,375

 
$

 
$
8,864

 
$
30,239

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 nine months ended September 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 September 30, 2013 and 2012 .
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
 
(in thousands)
Balance at beginning of period
$
4,335

 
$
15,460

 
$
6,465

 
$
15,873

Total gains (losses) (realized or unrealized):
 
 
 
 
 
 
 
included in earnings
(5,263
)
 
(2,045
)
 
(2,229
)
 
4,594

Purchases
9,470

 

 
9,470

 

Issuances

 

 

 

Settlements (1)
322

 
(4,314
)
 
(4,842
)
 
(11,366
)
Transfers in and (out) of Level 3

 

 

 

Balance at end of period
$
8,864

 
$
9,101

 
$
8,864

 
$
9,101

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 September 30, 2013 and 2012
$
(5,004
)
 
$
(5,403
)
 
$
(7,156
)
 
$
(4,123
)
 _________________________________
(1)
Included in total revenues on the statement of operations.
At September 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 September 30, 2013 was $199.3 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 September 30, 2013 and 2012 , the Company reported unrealized losses of $5.0 million and $5.4 million , respectively, in the condensed consolidated statement of operations related to the change in the fair value of its commodity derivative instruments. For the nine months ended September 30, 2013 and 2012 , the Company reported unrealized losses of $7.2 million and a $4.1 million , respectively, in the condensed consolidated statement of operations related to the change in the fair value of its commodity derivative instruments.
As of September 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 MMBtus)
 
 
 
 
 
 
 
 
 
 
2013
 
Fixed price swap
 
5,000

 
460,000

 
$
3.65

 
$

 
$

 
$

 
$

2013
 
Fixed price swap
 
1,500

 
138,000

 
$
3.85

 
$

 
$

 
$

 
$

2013
 
Fixed price swap
 
1,500

 
138,000

 
4.00

 

 

 

 

2013
 
Fixed price swap
 
3,000

 
276,000

 
4.06

 

 

 

 

2013
 
Fixed price swap
 
2,500

 
230,000

 
4.05

 

 

 

 

2013
 
Fixed price swap
 
12,663

 
1,165,000

 
3.87

 

 

 

 

2013 (1)
 
Fixed price swap
 
2,500

 
77,500

 
4.05

 

 

 

 

2013 (2)
 
Protective spread
 
2,500

 
152,500

 
4.05

 

 
3.79

 

 

2013 (1)
 
Costless collar
 
2,500

 
77,500

 

 
5.00

 

 

 
6.45

2013 (2)
 
Short calls
 
2,500

 
152,500

 

 

 

 

 
6.45

2013
 
Call spread
 
2,500

 
230,000

 

 

 

 
4.75

 
5.25

2013
 
Basis - HSC (4)
 
4,000

 
368,000

 
(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

 

 

 

 

2015
 
Fixed price swap
 
3,000

 
1,095,000

 
4.00

 

 

 

 

2015
 
Fixed price swap
 
2,500

 
912,500

 
4.06

 

 

 

 

2016
 
Fixed price swap
 
2,000

 
732,000

 
4.11

 

 

 

 

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


19


As of September 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
 
250

 
23,000

 
$
103.95

 
$

 
$

 
$

2013
 
Fixed price swap
 
850

 
78,200

 
99.77

 

 

 

2013
 
Fixed price swap
 
400

 
36,800

 
94.86

 

 

 

2013
 
Fixed price swap
 
611

 
56,200

 
92.80

 

 

 

2013 (2)
 
Put
 
1,000

 
31,000

 

 
103.00

 

 

2014 (3)
 
Fixed price swap
 
300

 
54,300

 
98.05

 

 

 

2014 (3)
 
Fixed price swap
 
550

 
99,550

 
95.15

 

 

 

2014 (3)
 
Put
 
900

 
162,900

 

 
98.00

 

 

2014 (4)
 
Fixed price swap
 
200

 
36,800

 
93.00

 

 

 

2014 (4)
 
Fixed price swap
 
350

 
64,400

 
91.55

 

 

 

2014 (4)
 
Put
 
750

 
138,000

 

 
93.00

 

 

2014
 
Costless collar
 
200

 
73,000

 

 
98.00

 

 
98.00

2014
 
Fixed price swap
 
500

 
182,500

 
91.10

 

 

 

2014
 
Fixed price swap
 
270

 
98,500

 
90.77

 

 

 

2014 (5)
 
Put spread
 
200

 
24,400

 

 
93.00

 
73.00

 

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

2015
 
Put spread
 
250

 
91,250

 

 
89.00

 
69.00

 

2015 (6)
 
Producer three-way collar
 
150

 
27,150

 

 
85.00

 
65.00

 
96.25

2015 (6)
 
Put spread
 
700

 
126,700

 

 
90.00

 
70.00

 

2015 (7)
 
Producer three-way collar
 
50

 
9,200

 

 
85.00

 
65.00

 
96.25

2015 (7)
 
Put spread
 
600

 
110,400

 

 
87.00

 
67.00

 

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

2016
 
Put spread
 
550

 
201,300

 

 
85.00

 
65.00

 

2016
 
Put spread
 
300

 
109,800

 

 
85.50

 
65.50

 

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

2017
 
Put spread
 
500

 
182,500

 

 
82.00

 
62.00

 

2018
 
Put spread
 
425

 
103,275

 

 
80.00

 
60.00

 

 _______________________________
(1)
Crude volumes hedged include oil, condensate and certain components of our NGLs production.
(2)
For the period December 2013.
(3)
For the period January to June 2014.