Gastar Exploration Inc.
GASTAR EXPLORATION LTD (Form: 10-Q, Received: 08/06/2009 16:48:51)
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, 2009

OR

 

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

FOR THE TRANSITION PERIOD FROM              TO             .

Commission File Number: 001-32714

 

 

GASTAR EXPLORATION LTD.

(Exact name of registrant as specified in its charter)

 

 

 

Alberta, Canada   98-0570897

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

1331 Lamar Street, Suite 1080

Houston, Texas 77010

  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.    Yes   x     No   ¨

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

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. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨   (Do not check if a smaller reporting company.)    Smaller reporting company   ¨

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

Total number of outstanding common shares, no par value per share, as of August 4, 2009 was 49,588,093.

 

 

 


Table of Contents

GASTAR EXPLORATION LTD.

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2009

TABLE OF CONTENTS

 

             Page
PART I – FINANCIAL INFORMATION
Item 1.   Financial Statements   
   

Condensed Consolidated Balance Sheets as of June 30, 2009 and December 31, 2008

   1
   

Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2009 and 2008

   2
   

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2009 and 2008

   3
   

Notes to the Condensed Consolidated Financial Statements

   4
   

Cautionary Note Regarding Forward-Looking Statements

   37
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations    38
Item 3.   Quantitative and Qualitative Disclosure About Market Risk    45
Item 4.   Controls and Procedures    45
PART II – OTHER INFORMATION
Item 1.   Legal Proceedings    46
Item 1A.   Risk Factors    46
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds    47
Item 3.   Defaults Upon Senior Securities    47
Item 4.   Submission of Matters to a Vote of Security Holders    48
Item 5.   Other Information    48
Item 6.   Exhibits    48
SIGNATURES    49

Unless otherwise indicated or required by the context, (i) “Gastar,” the “Company,” “we”, “us”, and “our” refer to Gastar Exploration Ltd. and its subsidiaries and predecessors, (ii) all dollar amounts appearing in this Quarterly Report on Form 10-Q as of and for the three and six months ended June 30, 2009 (“Form 10-Q”) are stated in United States dollars unless otherwise noted and (iii) all financial data included in this Form 10-Q have been prepared in accordance with generally accepted accounting principles in the United States of America (“US GAAP”).

General information about us can be found on our website at www.gastar.com . The information on our website is neither incorporated into, nor part of, this Form 10-Q. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, 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 United States Securities and Exchange Commission (“SEC”). Information is also available on the SEC website at www.sec.gov for our United States filings and on SEDAR at www.sedar.com for our Canadian filings.

As of the opening of trading on August 3, 2009, a previously announced common share consolidation on the basis of one (1) common share for five (5) common shares (the “1-for-5 Reverse Split”) became effective. All common share and per share amounts reported in the Form 10-Q have been reported on a post reverse split basis. See Note 17, “Subsequent Events” for additional information.

 

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GASTAR EXPLORATION LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

     June 30,
2009
    December 31,
2008
 
     (Unaudited)        
     (in thousands)  
ASSETS  

CURRENT ASSETS:

    

Cash and cash equivalents

   $ 12,499      $ 6,153   

Accounts receivable, net of allowance for doubtful accounts of $607 and $560, respectively

     2,943        5,296   

Commodity derivative contracts

     2,986        9,829   

Due from related parties

     1,197        2,382   

Prepaid expenses

     452        879   
                

Total current assets

     20,077        24,539   

PROPERTY, PLANT AND EQUIPMENT:

    

Natural gas and oil properties, full cost method of accounting:

    

Unproved properties, not being amortized

     159,182        141,860   

Proved properties

     327,162        309,103   
                

Total natural gas and oil properties

     486,344        450,963   

Furniture and equipment

     1,010        997   
                

Total property, plant and equipment

     487,354        451,960   

Accumulated depreciation, depletion and amortization

     (279,522     (199,433
                

Total property, plant and equipment, net

     207,832        252,527   

OTHER ASSETS:

    

Restricted cash

     533        70   

Commodity derivative contracts

     213        —     

Deferred charges, net

     6,937        6,849   

Drilling advances

     1,999        4,352   

Other

     100        100   
                

Total other assets

     9,782        11,371   
                

TOTAL ASSETS

   $ 237,691      $ 288,437   
                
LIABILITIES AND SHAREHOLDERS’ EQUITY   

CURRENT LIABILITIES:

    

Accounts payable

   $ 6,281      $ 14,256   

Revenue payable

     5,660        5,005   

Accrued interest

     2,034        1,505   

Accrued drilling and operating costs

     2,002        2,915   

Commodity derivative contracts

     1,299        1,121   

Other accrued liabilities

     1,732        3,131   

Due to related parties

     1,060        2,143   

Current portion of long-term debt

     168,825        151,684   
                

Total current liabilities

     188,893        181,760   

LONG-TERM LIABILITIES:

    

Long-term debt

     —          —     

Commodity derivative contracts

     273        —     

Asset retirement obligation

     5,481        5,095   
                

Total long-term liabilities

     5,754        5,095   

COMMITMENTS AND CONTINGENCIES (Note 14)

    

SHAREHOLDERS’ EQUITY:

    

Common stock, no par value, unlimited shares authorized, 49,539,093 and 41,926,494 shares issued and outstanding at June 30, 2009 and December 31, 2008, respectively

     263,799        249,980   

Additional paid-in capital

     24,806        22,883   

Accumulated other comprehensive gain – fair value of commodity hedging

     944        2,629   

Accumulated other comprehensive gain – foreign exchange

     4        19   

Accumulated deficit

     (246,509     (173,929
                

Total shareholders’ equity

     43,044        101,582   
                

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 237,691      $ 288,437   
                

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

 

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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,
 
     2009     2008     2009     2008  
     (in thousands, except share and per share data)  

REVENUES:

        

Natural gas and oil revenues

   $ 11,962      $ 15,884      $ 25,423      $ 32,730   

Unrealized natural gas hedge loss

     (4,426     (513     (4,622     (1,926
                                

Total revenues

     7,536        15,371        20,801        30,804   

EXPENSES:

        

Production taxes

     92        474        249        743   

Lease operating expenses

     1,449        2,408        3,326        3,950   

Transportation and treating

     325        498        818        957   

Depreciation, depletion and amortization

     3,361        5,890        11,360        12,299   

Impairment of natural gas and oil properties

     —          —          68,729        —     

Accretion of asset retirement obligation

     88        82        175        164   

General and administrative expense

     3,487        4,064        6,445        8,339   
                                

Total expenses

     8,802        13,416        91,102        26,452   
                                

INCOME (LOSS) FROM OPERATIONS

     (1,266     1,955        (70,301     4,352   

OTHER (EXPENSES) INCOME:

        

Interest expense

     (1,137     (1,889     (2,299     (3,985

Investment income and other

     10        481        23        1,304   

Foreign transaction loss

     —          (1     (3     (38
                                

INCOME (LOSS) BEFORE INCOME TAXES

     (2,393     546        (72,580     1,633   

Provision for income taxes

     —          —          —          —     
                                

NET INCOME (LOSS)

   $ (2,393   $ 546      $ (72,580   $ 1,633   
                                

NET INCOME (LOSS) PER SHARE:

        

Basic

   $ (0.05   $ 0.01      $ (1.68   $ 0.04   
                                

Diluted

   $ (0.05   $ 0.01      $ (1.68   $ 0.04   
                                

WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:

        

Basic

     44,854,954        41,419,714        43,163,088        41,419,714   
                                

Diluted

     44,854,954        41,495,033        43,163,088        41,495,033   
                                

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

 

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GASTAR EXPLORATION LTD. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     For the Six Months
Ended June 30,
 
     2009     2008  
     (in thousands)  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income (loss)

   $ (72,580   $ 1,633   

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

    

Depreciation, depletion and amortization

     11,360        12,299   

Impairment of natural gas and oil properties

     68,729        —     

Stock-based compensation

     2,134        1,711   

Net cash settlement of derivative contracts

     4,622        1,926   

Monetization of derivative contracts

     2,465        —     

Amortization of other comprehensive income – commodity hedging

     (1,685     —     

Amortization of deferred financing costs and debt discount

     1,408        948   

Accretion of asset retirement obligation

     175        164   

Changes in operating assets and liabilities:

    

Restricted cash for hedging program

     —          1,000   

Accounts receivable

     3,474        (4,719

Prepaid expenses

     368        225   

Accounts payable and accrued liabilities

     (5,068     9,071   
                

Net cash provided by operating activities

     15,402        24,258   
                

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Development and purchases of natural gas and oil properties

     (33,029     (66,190

Drilling advances

     (4,791     (1,551

Purchase of furniture and equipment

     (13     (131

Other

     —          (50
                

Net cash used in investing activities

     (37,833     (67,922
                

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Proceeds from the issuance of common shares

     13,819        —     

Repayment of revolving credit facility

     (4,975     —     

Repayment of subordinated unsecured notes

     (2,950     —     

Proceeds from term loan

     25,000        —     

(Increase) decrease in restricted cash

     (463     3   

Deferred financing charges

     (1,430     (177

Other

     (224     —     
                

Net cash provided by (used in) financing activities

     28,777        (174
                

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     6,346        (43,838

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

     6,153        85,854   
                

CASH AND CASH EQUIVALENTS, END OF PERIOD

   $ 12,499      $ 42,016   
                

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

 

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GASTAR EXPLORATION LTD. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Description of Business

Gastar Exploration Ltd. (the “Company”) is an independent energy and production company focused on finding and developing natural gas assets in North America and Australia. The Company’s emphasis is on combining deep natural gas exploration and development with lower risk coal bed methane (“CBM”) and shale resource development. The Company owns and operates exploration and development acreage in the deep Bossier gas play of East Texas and the Marcellus Shale play in West Virginia and Pennsylvania. The Company’s CBM activities are conducted within the Powder River Basin of Wyoming and Montana and concentrated on more than 6.0 million gross acres controlled by the Company in the Gunnedah Basin, located in New South Wales, Australia, with a joint venture partner. See Note 17 , “ Subsequent Events for more details regarding sale of Australian assets.

2. Summary of Significant Accounting Policies

The accounting policies followed by the Company and its subsidiaries are set forth in the notes to the Company’s audited condensed consolidated financial statements in its Annual Report on Form 10-K for the year ended December 31, 2008 (“2008 Form 10-K”) filed with the SEC. Additionally, please refer to the notes to those financial statements for additional details of the Company’s financial condition, results of operations and cash flows. All material items included in those notes have not changed except as a result of normal transactions in the interim or as disclosed within this report.

The unaudited interim condensed consolidated financial statements of the Company included herein are stated in United States (“U.S.”) dollars unless otherwise noted and were prepared from the records of the Company by management in accordance with accounting principles generally accepted in the United States of America (“US 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 Company’s 2008 Form 10-K. The current interim period reported herein should be read in conjunction with the financial statements and summary of significant accounting policies and notes included in the Company’s 2008 Form 10-K. The year end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

The preparation of financial statements in conformity with US 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.

Additionally, the consolidated financial statements included in this report have been prepared on the basis of accounting principles applicable to a going concern assuming that the Company will continue as a going concern, which contemplate the realization of assets and satisfaction of liabilities in the normal course of business.

The condensed consolidated financial statements include the accounts of the Company and the consolidated accounts of all its subsidiaries. The entities included in these consolidated accounts are all wholly owned. All significant intercompany accounts and transactions have been eliminated in consolidation.

The results of operations for the three months and six ended June 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

Recently Adopted Accounting Pronouncements

Determining Whether an Instrument is Indexed to an Entity’s Own Stock. Effective January 1, 2009, the Company adopted the provisions of Emerging Issues Task Force (“EITF”) EITF 07-05, “Determining Whether an

 

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GASTAR EXPLORATION LTD. AND SUBSIDIARIES

(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”, (“EITF 07-05”). EITF 07-05 applies to any freestanding financial instruments or embedded features that have the characteristics of a derivative, as defined by Statement of Financial Accounting Standards (“SFAS”) SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and to any freestanding financial instruments that are potentially settled in an entity’s own common stock. The effect of adoption of EITF 07-05 in January 1, 2009 was immaterial to the Company’s financial position, results of operations or cash flows.

Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement). In May 2008, the Financial Accounting Standards Board (“FASB”) issued FSP No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB 14-1”). FSP APB 14-1 applies to convertible debt instruments that, by their stated terms, may be settled in cash (or other assets) upon conversion, including partial cash settlement, unless the embedded conversion option is required to be separately accounted for as a derivative under SFAS 133. Convertible debt instruments within the scope of FSP APB 14-1 are not addressed by the existing APB 14. FSP APB 14-1 requires that the liability and equity components of convertible debt instruments within the scope of FSP APB 14-1 be separately accounted for in a manner that reflects the entity’s nonconvertible debt borrowing rate. This requires an allocation of the convertible debt proceeds between the liability component and the embedded conversion option (i.e., the equity component). The difference between the principal amount of the debt and the amount of the proceeds allocated to the liability component will be reported as a debt discount and subsequently amortized to earnings over the instrument’s expected life using the effective interest method. FSP APB 14-1 was effective for the Company’s fiscal year beginning January 1, 2009. The adoption of this standard did not have a material impact on the Company’s financial position, results of operations, or cash flows.

Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies. In April 2009, the FASB issued FASB Staff Position (FSP) FAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies” (FSP 141(R)-1), to amend and clarify the initial recognition and measurement, subsequent measurement and accounting, and related disclosures arising from contingencies in a business combination under SFAS 141(R). Under the new guidance, assets acquired and liabilities assumed in a business combination that arise from contingencies should be recognized at fair value on the acquisition date if fair value can be determined during the measurement period. If fair value can not be determined, companies should typically account for the acquired contingencies using existing guidance. The FSP is effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of this standard did not have a material impact on the Company’s financial position, results of operations, or cash flows.

Disclosures about Derivative Instruments and Hedging Activities. The Company has adopted SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”). SFAS No. 161 requires entities that utilize derivative instruments to provide qualitative disclosures about their objectives and strategies for using such instruments, as well as any details of credit-risk-related contingent features contained within derivatives. SFAS No. 161 also requires entities to disclose additional information about the amounts and location of derivatives located within the financial statements, how the provisions of SFAS No. 133 have been applied, and the impact that hedges have on an entity’s operating results, financial position or cash flows. See Note 7, “Commodity Hedging Contracts” for additional disclosures required by SFAS No. 161.

Subsequent Events. In May 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”). This statement incorporates guidance into accounting literature that was previously addressed only in auditing standards. The statement refers to subsequent events that provide additional evidence about conditions that existed at the balance-sheet date as “recognized subsequent events”. Subsequent events which provide evidence about conditions that arose after the balance-sheet date but prior to the issuance of the financial statements are referred to as ‘non-recognized subsequent events”. It also requires companies to disclose the date through which subsequent events have been evaluated and whether this date is the date the financial statements were issued or the date the financial statements were available to be issued. This statement is effective for interim and annual periods ending after June 15, 2009. The Company evaluated subsequent events up to immediately prior to the issuance of these financial statements. See Note 17 , “ Subsequent Events for more details.

 

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GASTAR EXPLORATION LTD. AND SUBSIDIARIES

(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

Interim Reporting of Fair Value of Financial Instruments. In April 2009, the FASB issued FSP FAS 107-1 and Accounting Principles Board (“APB”) Opinion No. 28-1 (“FSP FAS 107-1”), “Interim Disclosures about Fair Value of Financial Instruments.” FSP FAS 107-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments for interim reporting periods. The FSP FAS 107-1 also amends APB Opinion No. 28, “Interim Financial Reporting,” to require those disclosures about the fair value of financial instruments in summarized financial information at interim reporting periods. FSP FAS 107-1 is effective for reporting periods ending after June 15, 2009, and its adoption did not materially impact the Company’s results of operations and financial condition but did require additional disclosures regarding the fair value of financial instruments. See Note 5, “Fair Value of Financial Instruments” for more details .

Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly . In April 2009, the FASB issued FSP No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly”. The FSP provides additional guidance for estimating fair value when the market activity for an asset or liability has declined significantly. The FSP is effective for interim and annual periods ending after June 15, 2009, which is June 30, 2009 for the Company. The FSP did not have a material impact on the Company’s consolidated financial statements. See Note 8, “Fair Value Measurements” for more details .

Recognition and Presentation of Other-Than-Temporary Impairments . In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments”, which amends the other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. FSP No. FAS 115-2 and FAS 124-2 do not amend existing recognition and measurement guidance for equity securities, but do establish a new method of recognizing and reporting for debt securities. Disclosure requirements for impaired debt and equity securities have been expanded significantly and are now required quarterly, as well as annually. FSP No. FAS 115-2 and FAS 124-2 became effective for interim and annual reporting periods ending after June 15, 2009. Comparative disclosures are only required for periods ending after the initial adoption. FSP No. FAS 115-2 and FAS 124-2 did not have a material impact on the Company’s financial position, results of operations or cash flows.

Newly Issued But Not Yet Effective Accounting Standards

Amendments to FASB Interpretation No. 46(R) . In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R).” This Statement amends Interpretation 46(R) to require the Company to perform an analysis of our existing investments to determine whether our variable interest or interests give us a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as the enterprise that has both the power to direct the activities of significant impact on a variable interest entity and the obligation to absorb losses or receive benefits from the variable interest entity that could potentially be significant to the variable interest entity. It also amends Interpretation 46(R) to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. This Statement is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. We are currently assessing the impact of adoption.

The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles-a replacement of FASB Statement No. 162 . In June 2009, the FASB issued Statement No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles-a replacement of FASB Statement No. 162”. The FASB Accounting Standards Codification is intended to be the source of authoritative U.S. generally accepted accounting principles (“GAAP”) and reporting standards as issued by the FASB. Its primary purpose is to improve clarity and use of existing standards by grouping authoritative literature under common topics. This Statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The Codification does not change or alter existing GAAP and there is no expected impact on the Company’s financial position, results of operations, or cash flows.

 

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GASTAR EXPLORATION LTD. AND SUBSIDIARIES

(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

Modernization of Natural Gas and Oil Reporting. In January 2009, the SEC issued revisions to the natural gas and oil reporting disclosures, “Modernization of Oil and Gas Reporting; Final Rule” (“the Final Rule”). In addition to changing the definition and disclosure requirements for natural gas and oil reserves, the Final Rule changes the requirements for determining quantities of natural gas and oil reserves. The Final Rule also changes certain accounting requirements under the full cost method of accounting for natural gas and oil activities. The amendments are designed to modernize the requirements for the determination of natural gas and oil reserves, aligning them with current practices and updating them for changes in technology. The Final Rule is effective for annual reports on Form10-K for fiscal years ending on or after December 31, 2009. The Company has not yet determined the impact the implementation of the Final Rule will have, if any, on the Company’s financial position, results of operations, or cash flows.

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 states Montana, Pennsylvania, Texas, West Virginia and Wyoming in the United States and in New South Wales, Australia. The following schedule represents natural gas and oil property costs by country:

 

     United
States
    Australia     Total  
           (in thousands)        

From inception to June 30, 2009:

      

Natural gas and oil properties, full cost method of accounting:

      

Unproved properties

   $ 124,500      $ 34,682      $ 159,182   

Proved properties

     326,558        604        327,162   
                        

Total natural gas and oil properties

     451,058        35,286        486,344   

Furniture and equipment

     838        172        1,010   
                        

Total property and equipment

     451,896        35,458        487,354   

Impairment of proved natural gas and oil properties

     (187,152     (604     (187,756

Accumulated depreciation, depletion and amortization

     (91,751     (15     (91,766
                        

Total accumulated depreciation, depletion and amortization

     (278,903     (619     (279,522
                        

Total property and equipment, net

   $ 172,993      $ 34,839      $ 207,832   
                        

At June 30, 2009, unproved properties not being amortized consisted of U.S. acreage acquisition costs of $107.7 million, Australian unevaluated property costs of $30.3 million and capitalized interest of $21.2 million. The U.S. unproved properties are related to our East Texas and Marcellus shale play exploration activities. The East Texas exploration is ongoing and should be completed over the next six years. The Marcellus exploration is expected to commence in late 2009 with exploration activities over the next ten years.

For the six months ended June 30, 2009, the results of management’s ceiling test evaluation resulted in an impairment of the U.S. proved properties of $68.7 million. The U.S. proved property impairment was recorded at March 31, 2009 utilizing a weighted average natural gas price of $2.64 per Mcf. Management determined that an impairment was not required on the Australian properties for the six months ended June 30, 2009. There was no impairment of United States or Australian properties during the six months ended June 30, 2008.

 

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(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

4. Long-Term Debt

The following shows the Company’s long-term debt at maturity as of the dates indicated:

 

     June 30,
2009
   December 31,
2008
     (in thousands)

Revolving credit facility

   $ 13,900    $ 18,875

Term loan

     25,000      —  

12  3 / 4 % senior secured notes

     100,000      100,000

Convertible subordinated debentures

     30,000      30,000

Subordinated unsecured notes payable

     300      3,250
             

Total long-term debt at maturity

     169,200      152,125

Current portion of long-term debt

     168,825      151,684

Debt discount costs to be accreted

     375      441
             

Total net carrying value of long-term debt

   $ —      $ —  
             

The current portion of long-term debt as of June 30, 2009 is comprised of the following:

 

     Amount
     (in thousands)

Revolving credit facility

   $ 13,900

Convertible subordinated debentures

     30,000

Subordinated unsecured note payable

     300
      

Total current maturities

     44,200

Term loan

     25,000

12  3 / 4 % senior secured notes

     99,625
      

Total current portion of long-term debt

   $ 168,825
      

Revolving Credit Facility

On November 29, 2007, concurrent with the closing of the 12  3 / 4 % Senior Secured Notes (as defined below), Gastar Exploration USA, Inc. (“Gastar USA”), a wholly owned subsidiary of the Company, entered into a revolving credit facility (the “Revolving Credit Facility”) providing for a first priority lien borrowing base limit of $14.0 million at June 30, 2009. At June 30, 2009, the prime rate was 5.0%; the Eurodollar rates for one and three months were 0.309% and 0.595%, respectively; and the Company had no availability under the borrowing base. The borrowing base is to be re-determined at least semi-annually, using the lender’s usual and customary criteria for natural gas and oil reserve valuation. The Revolving Credit Facility and related guarantees under the Revolving Credit Facility are guaranteed by the Company as the Parent (the “Parent”) and all its current domestic subsidiaries and all future domestic subsidiaries formed during the term of the Revolving Credit Facility, and secured by a first priority lien on all domestic natural gas and oil properties currently owned by or later acquired by Gastar USA, excluding de minimus value properties as determined by the lender.

On February 16, 2009, in conjunction with the Company entering into a new $25.0 million term loan (the “Term Loan”), described below, Gastar USA, the Parent and certain subsidiaries of the Parent entered into the Waiver and Second Amendment to the Revolving Credit Agreement (the “Second Amendment”) to provide for the waiver of a breach of a covenant under the Revolving Credit Facility and the additional incurrence of first lien secured debt under the Term Loan. The Second Amendment provided for a waiver of any past or present breach of the current ratio covenant requiring the Company to maintain a ratio of current assets to current liabilities of 1.0 to 1.0. The Second Amendment also affected, among other matters, the following:

 

   

Allowed for the Term Loan to rank pari passu with the Revolving Credit Facility on liens;

 

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(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

   

Borrowings bear interest at a prime rate or LIBOR rate, plus in each case an applicable margin. The applicable interest rate margin varies from 0.25% to 1.0% in the case of borrowings based on the prime rate and from 2.5% to 3.25% in the case of borrowings based on the LIBOR rate, depending on the utilization level in relation to the borrowing base subject to a minimum borrowing interest rate of 5.0%;

 

   

Annual commitment fee, ranging from 0.50% to 0.75% depending on borrowing base utilization;

 

   

Borrowing base of $18.0 million and monthly amortization of $1.0 million per month commencing March 1, 2009;

 

   

Maintenance of a maximum total net debt to earnings before interest, taxes, depreciation and amortization (“EBITDA”), on a rolling four quarters basis as adjusted, of not more than 4.5 to 1.0 through December 31, 2009 and 4.0 to 1.0 for all quarters thereafter; and

 

   

Automatic extension of maturity date from the current maturity date of October 15, 2009 to December 1, 2010 if requested by the Company 30 days prior to maturity of the Revolving Credit Facility provided that the Convertible subordinated debentures repayment has occurred or the lender has been provided with assurance acceptable to the lender that such payment will occur.

On March 13, 2009, Gastar USA, the Parent, certain subsidiaries of the Parent and the Revolving Credit Facility lender, as Administrative Agent, entered into the Waiver and Third Amendment to the Credit Agreement (the “Third Amendment”) to provide for the waiver of a breach of the current ratio test under the Revolving Credit Facility. The waiver covered the current breach as well as any future breach of the current ratio covenant as determined as of the end of any quarter of the fiscal year ending December 31, 2009. The Third Amendment also provided for the waiver of a breach of a covenant under the Revolving Credit Facility resulting from the Company’s auditors issuance of a going concern statement in its report on our 2008 consolidated financial statements.

As of June 30, 2009, the Company was not in compliance with the total net indebtedness to EBITDA ratio, general and administrative expense ratio and the current ratio covenants under the Revolving Credit Facility. A waiver has been received for all defaults, including the current ratio covenant, which has been waived through December 31, 2009 as described above.

Term Loan

On February 17, 2009, Gastar USA drew $25.0 million under the Term Loan to fund current and future capital commitments and operating costs. The Term Loan bears interest at a fixed rate of 20% per annum and matures on February 15, 2012. The annual effective interest rate, after amortization of the fees paid to establish the Term Loan is 21.9% The Term Loan contains various customary covenants, including restrictions on liens, restrictions on incurring other indebtedness without the lender’s consent, restrictions on dividends and other restricted payments, and maintenance of various financial ratios consistent to the Revolving Credit Facility. Amounts outstanding under the Term Loan may be prepaid prior to maturity, with a prepayment premium of 10% if repaid prior to December 31, 2009, and a prepayment premium of 5% if repaid between January 1, 2010 and December 31, 2010. Upon a Change of Control (as defined in the Term Loan), all amounts outstanding under the Term Loan will be immediately due and payable.

Amounts outstanding under the Term Loan are secured by a first priority lien on Gastar USA’s and certain of the Parent’s subsidiaries’ primary natural gas and oil assets and certain other properties. The Term Loan and other existing and future indebtedness incurred under the Company’s existing Revolving Credit Facility are and remain senior to the liens securing the 12  3 / 4 % Senior Secured Notes.

On March 13, 2009, concurrent with the execution of the Third Amendment, the Parent and Gastar USA entered into the Waiver under Term Loan to provide for a waiver of a breach of a current ratio test under the Term Loan. The current ratio covenant under the Term Loan is similar to the covenant in the Revolving Credit Facility. The waiver covers the current breach and any future breach of the current ratio covenant as determined as of the end of any quarter of our fiscal year ending December 31, 2009.

As of June 30, 2009, the Company was not in compliance with the total net indebtedness to EBITDA ratio, general and administrative expense ratio and the current ratio covenants under the Term Loan. On July 13, 2009, the Company repaid the Term Loan in full. See Note 17, “Subsequent Events” for additional information.

 

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(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

12  3 / 4 % Senior Secured Notes

On November 29, 2007, Gastar USA sold $100.0 million aggregate principal amount of 12  3 / 4 % senior secured notes due December 1, 2012 (“12  3 / 4 % Senior Secured Notes”) at an issue price of 99.50%. The Notes are governed by an indenture, dated as of November 29, 2007 (the “Indenture”), by and among the Company, Gastar USA, Wells Fargo Bank, National Association, as Trustee and Collateral Agent and each of the other Guarantors party thereto The annual effective interest rate, after amortization of the debt discount and fees paid to establish the 12  3 / 4 % Senior Secured Notes, is 15.0%. The 12  3 / 4 % Senior Secured Notes are fully and unconditionally guaranteed jointly and severally by Gastar USA, the Parent, and all of the Parent’s existing and future material domestic subsidiaries (the “Guarantors”). The 12  3 / 4 % Senior Secured Notes and the guarantees are secured by a second lien on Gastar USA’s principal domestic natural gas and oil properties and other assets that secure the Revolving Credit Facility and Term Loan, subject to certain exceptions. The 12  3 / 4 % Senior Secured Notes mature on December 1, 2012.

On February 16, 2009, Gastar USA, the Parent and the Guarantors entered into a supplemental indenture amending and modifying the Indenture, with regards to, among other matters, the following:

 

   

Allowing incurrence of up to $55.0 million of first priority indebtedness including the Revolving Credit Facility and Term Loan;

 

   

Providing that in the event the Company or any of its subsidiaries sells assets in East Texas the net proceeds from such sale to be utilized to repay any debt outstanding under the Revolving Credit Facility and Term Loan and any remaining net proceeds to be used for the pro rata redemption of the 12  3 / 4 % Senior Secured Notes at stated premiums;

 

   

Allowing that net proceeds up to $60.0 million from non-East Texas asset sales before February 1, 2011 may be reinvested during the first 360 days from the closing date in existing properties with uninvested net proceeds in excess of $5.0 million after 360 days to be used for the repayment of amounts outstanding under the Revolving Credit Facility, the Term Loan, and for the pro rata redemption of the 12  3 / 4 % Senior Secured Notes at stated premiums; and

 

   

Continuing restrictions on Company dividends and other restricted payments.

As of June 30, 2009, the Company was in compliance with all debt covenants under the 12  3 / 4 % Senior Secured Notes.

On July 13, 2009, Gastar USA commenced an offer (the “Asset Sale Offer”) to repurchase any and all of the outstanding 12  3 / 4 % Senior Secured Notes from the holders at a price of 106.375% of par plus accrued and unpaid interest, upon the terms and subject to the conditions set forth in the Asset Sale Offer Statement. On August 6, 2009, the note holder’s tendered to the Company all of the outstanding $100.0 million principal amount of the 12  3 / 4 % Senior Secured Notes at 106.375% of the principal amounts plus accrued and unpaid interest. The Company expects to retire the 12  3 / 4 % Senior Secured Notes in full by tendering payment of $108.7 million on August 7, 2009. See Note 17, “Subsequent Events” for additional information.

Convertible Subordinated Debentures

In November 2004, the Company issued $30.0 million aggregate principal amount of Convertible senior unsecured subordinated debentures (the “Convertible Subordinated Debentures”). The Convertible Subordinated Debentures have a term of five years, are due November 20, 2009 and bear interest at 9.75% per annum, payable quarterly. After giving effect to the 1-for-5 Reverse Split (See Note 17, “Subsequent Events”), the Convertible Subordinated Debentures are convertible by the holders into 1,369,863 common shares at a conversion price of $21.90 per share and are redeemable, at the option of the Company, upon notice that the average price of the Company’s common shares for 20 consecutive trading days is at least 130% of the conversion price.

 

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(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

Subordinated Unsecured Notes Payable

The Company’s $3.25 million Subordinated Unsecured Notes Payable began maturing in April 2009. As of June 30, 2009, the Company had $300,000 of Subordinated Unsecured Notes Payable outstanding, which mature between July 2009 and September 2009, bear interest at 10% per annum and are callable by the Company at 101%.

5. Fair Value of Financial Instruments

The estimated fair values for financial instruments under FSP SFAS No. 107-1, Interim Disclosures about Fair Value of Financial Instruments, are determined at discrete points in time based on relevant market information. These estimates involve uncertainties and cannot be determined with precision. The estimated fair value of cash, marketable securities, accounts receivable and accounts payable approximates their carrying value due to their short-term nature. The estimated fair values of the Company’s Revolving Credit Facility and Term Loan approximate respective carrying values because the interest rates approximate current market rates. The following table presents the estimated fair values of the Company’s fixed interest rate debt instruments as of June 30, 2009 and December 31, 2008:

 

     As of June 30, 2009    As of December 31, 2008
     Carrying
Amount
   Estimated
Fair Value
   Carrying
Amount
   Estimated
Fair Value
     (in thousands)

12  3 / 4 % Senior secured notes

   $ 100,000    $ 83,560    $ 100,000    $ 79,867

Convertible subordinated debentures - 9.75%

     30,000      29,236      30,000      27,884

Subordinated unsecured notes payable - 10.0%

     300      298      3,250      3,144
                           

Total

   $ 130,300    $ 113,094    $ 133,250    $ 110,895
                           

The Company accounts for its derivative activities under the provisions of SFAS 133, Accounting for Derivative Instruments and Hedging Activities , as amended. This statement, as amended, establishes accounting and reporting that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at fair value. See Note 7, Commodity Hedging Contracts for more details.

6. Equity Compensation Plans

Share-Based Compensation Plans

At the annual meeting of shareholders held June 4, 2009 (the “Annual Meeting”), the Company’s shareholders approved amendments to the Gastar Exploration Ltd. 2006 Long-Term Stock Incentive Plan (the “2006 Plan”). The 2006 Plan was initially adopted by the Board of Directors and approved by the shareholders in 2006. Previously, the 2006 Plan authorized the Board of Directors to issue stock options, stock appreciation rights, bonus stock awards and any other type of award consistent with the 2006 Plan’s purpose to directors, officers and employees of the Company and its subsidiaries covering a maximum of 1.0 million shares of common stock of the Company. The Company also maintained the 2002 Stock Option Plan of Gastar Exploration Ltd. (the “2002 Stock Option Plan”) which provided for the grant of only stock options to directors, officers, employees and consultants of the Company and its subsidiaries to purchase a maximum of 5.0 million common shares. Pursuant to the amendments that were approved at the Annual Meeting and effective as of April 1, 2009, the 2002 Stock Option Plan was merged into the 2006 Plan so that all outstanding equity awards and all future equity awards to be made to employees, officers and directors will be under one plan – the 2006 Plan. The merging of the 2002 Stock Option Plan with and into the 2006 Plan, resulted in the cessation of the existence of the 2002 Stock Option Plan and the transfer of all common shares previously reserved and available for issuance under for the 2002 Stock Option Plan, including any common shares subject to outstanding stock option awards previously granted under the 2002 Stock Option Plan prior to the effective date of its merger into the 2006 Plan, to the common share reserve under the 2006 Plan.

The amendments to the 2006 Plan approved at the Annual Meeting: (a) provide that the Remuneration Committee, in its discretion, may provide in an award agreement that an individual who is granted an award under

 

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(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

the 2006 Plan (a “participant”) may elect to have common shares withheld from (or “netted against”) the total number of common shares otherwise issuable to such participant pursuant to his award in order to pay the exercise or purchase price of such award and/or to satisfy all employer tax withhold obligations with respect to the participant’s award under the 2006 Plan, (b) clarify that common shares issuable under the 2006 Plan and forfeited back to the 2006 Plan will be deemed not to have been issued under the 2006 Plan and will again be available for the grant of an award under the 2006 Plan, (c) provide that common shares withheld from (or “netted against”) an award granted under the 2006 Plan for payment of (1) the exercise or purchase price of an award and (2) all applicable employer tax withholding obligations associated with an award will be deemed not to have been issued under the 2006 Plan and will again be available for the grant of an award under the 2006 Plan, (d) provide that the maximum number of common shares that may be subject to stock options, bonus stock awards, and stock appreciation rights granted to any one individual during any calendar year may not exceed 200,000 common shares (subject to adjustment pursuant to Section 11(a) of the 2006 Plan), and (e) provide that the definition of “performance criteria” in the 2006 Plan include a criteria relating to the growth of proved natural gas and oil reserves of the Company.

At June 30, 2009, 1,505,471 common shares (after giving effect to the 1-for-5 Reverse Split) were available for future stock-based compensation grants under the 2006 Plan.

Determining Fair Value under SFAS No. 123R

In determining fair value for stock option grants pursuant to SFAS No. 123R, “Share Based Payments” (“SFAS No. 123R”) the Company utilized the following assumptions:

Valuation and Amortization Method. The Company estimates the fair value of share-based awards granted using the Black-Scholes-Merton valuation model. The fair value of all awards is expensed using the “graded-vesting method”.

Expected Life. The expected life of awards granted represents the period of time that stock options are expected to be outstanding. The Company determined the expected life to be 6.25 years, based on historical information, for all stock options issued with a four-year vesting period and ten-year grant expiration.

Expected Volatility. Using the Black-Scholes-Merton valuation model, the Company estimates the volatility of its common shares at the beginning of the quarter in which the stock option is granted. The volatility is based on historical movements of the Company’s common share price on the NYSE Amex over a period that approximates the expected life.

Risk-Free Interest Rate. The Company utilizes a risk-free interest rate equal to the rate of U.S. Treasury zero-coupon issues as of the date of grant with a term equivalent to the stock option’s expected life.

Expected Dividend Yield. The Company has not paid any cash dividends on its common shares and does not anticipate paying any cash dividends in the foreseeable future. Consequently, a dividend yield of zero is utilized in the Black-Scholes-Merton valuation model.

Expected Forfeitures. Forfeitures of unvested stock option and restricted common shares are calculated at the beginning of the year as a percentage of all stock option and restricted common share grants. For 2009, the Company is utilizing a 6.5% forfeiture rate in determining compensation expense.

 

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(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes-Merton valuation pricing model. The table below summarizes the number of stock options granted and the assumptions for the stock options granted for the period indicated:

 

     For the Six
Months Ended
June 30, 2009
 

Stock options granted during the reporting period

   217,300   

Expected life (in years)

   6.25   

Expected volatility

   59.3

Risk-free interest rate

   1.97

The weighted average grant date fair value of stock options granted and the intrinsic value of stock options exercised are shown below for the period indicated. Intrinsic value of stock options is calculated using the difference between the common share price on the date of exercise and the exercise price times the number of stock options exercised.

 

     For the Six
Months Ended
June 30, 2009
     (in thousands, except
per share data)

Weighted average grant date fair value of outstanding stock options

   $ 5.36

Intrinsic value of stock options exercised

   $ —  

Fair value of stock option shares vested during reporting period

   $ 667

Stock Option Activity

The following table summarizes certain information about stock options under the Company’s 2006 Plan as of and for the six months ended June 30, 2009.

 

     Number of
Shares Under
Stock Options
    Weighted
Average
Exercise
Price

Stock options outstanding as of December 31, 2008

   1,929,750      $ 13.80

Stock options granted

   217,300      $ 2.60

Stock options exercised

   —        $ —  

Stock options cancelled/expired

   (144,000   $ 15.70
        

Stock options outstanding as of June 30, 2009

   2,003,050      $ 13.00
        

Stock options exercisable as of June 30, 2009

   1,528,283      $ 14.38
        

The table below summarizes certain information about the stock options as of and during the six months ended June 30, 2009. Fair value calculations are as of the date of grant.

 

     Number of
Shares Under
Stock Options
   Weighted
Average
Fair Value

Unvested stock options at December 31, 2008

   359,833    $ 6.70

Unvested stock options at June 30, 2009

   474,767    $ 4.16

Stock options granted during the six months ended June 30, 2009

   217,300    $ 1.50

Stock options vested during the six months ended June 30, 2009

   85,200    $ 7.83

Stock options canceled during the six months ended June 30, 2009

   144,000    $ 5.34

As of June 30, 2009, there was no aggregate intrinsic value for outstanding stock options. The remaining weighted average contractual life of outstanding stock options was 4.5 years. As of June 30, 2009, the total fair value of exercisable stock options was $8.8 million.

 

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(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

The following table summarizes the range of exercise prices for stock options outstanding and exercisable as of June 30, 2009:

 

     Number of Shares
Under Stock Options
    
        Exercise
Prices (1)

Expiration Date

   Outstanding    Exercisable   

August 4, 2009

   710,750    710,750    $ 14.76

April 4, 2010

   4,200    4,200    $ 18.61

June 24, 2010

   65,000    65,000    $ 15.15

June 28, 2010

   10,000    10,000    $ 14.71

September 7, 2010

   30,000    22,500    $ 14.06

September 20, 2010

   8,000    6,000    $ 17.31

October 17, 2015

   15,000    11,250    $ 19.47

January 16, 2016

   54,000    40,500    $ 21.68

April 5, 2016

   167,600    125,700    $ 20.77

July 14, 2016

   581,000    487,333    $ 11.60

March 30, 2017

   40,000    20,000    $ 10.85

July 3, 2017

   60,000    15,000    $ 11.00

July 7, 2017

   40,000    10,000    $ 10.95

August 30, 2017

   200    50    $ 8.35

March 19, 2019

   217,300    —      $ 2.60
            
   2,003,050    1,528,283   
            

 

(1) Stock options granted with strike prices denominated in CDN$ have been converted to US$ by multiplying the CDN$ strike price by the exchange rate at June 30, 2009.

Restricted Share Activities

The following table summarizes the changes and grant date prices for restricted common share grants during the six months ended June 30, 2009:

 

     Number of
Shares Under
Stock Options
    Weighted
Average
Grant Date
Fair Value

Restricted common shares granted and subject to vesting as of December 31, 2008

   506,780      $ 10.10

Restricted common shares granted

   421,535      $ 2.60

Restricted common shares vested

   (226,449   $ 2.60

Restricted common shares forfeited/canceled

   (126,225   $ 4.41
        

Restricted common shares granted and subject to vesting as of June 30, 2009

   575,641      $ 8.79
        

The following table summarizes the range expiration dates and grant date prices for restricted common shares outstanding and unvested as of June 30, 2009:

 

Expiration Date

   Restricted
Common Shares
Outstanding
   Grant
Date
Fair Value

March 19, 2011

   5,000    $ 2.60

July 3, 2011

   194,450    $ 11.00

January 16, 2012

   2,000    $ 5.45

May 16, 2012

   268,541    $ 9.55

August 18, 2012

   9,000    $ 8.75

March 19, 2019

   96,650    $ 2.60
       

Total

   575,641   
       

 

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(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

As of June 30, 2009, the remaining weighted average contractual life of unvested restricted common shares was 2.7 years. The following table shows the total value and weighted average fair value per share of restricted common shares outstanding as of the date indicated:

 

     As of June 30, 2009
     (in thousands, except
per share data)

Total value of restricted common shares granted and subject to vesting (1)

   $ 1,151

Weighted average grant date fair value of restricted common share granted and subject to vesting

   $ 8.79

 

(1) Based on the closing price on June 30, 2009 of $2.00 per share. (adjusted for the 1-for-5 reverse split).

Stock-Based Compensation Expense

For the three months ended June 30, 2009 and 2008, the Company recorded stock-based compensation expense for stock options and restricted common shares granted using the fair-value method of $713,000 and $855,000, respectively. For the six months ended June 30, 2009 and 2008, the Company recorded stock-based compensation expense for stock options and restricted common shares granted using the fair-value method of $2.1 million and $1.7 million, respectively. Stock-based compensation expense for the six months ended June 30, 2009 includes $801,000 of compensation expense resulting from the payment of 2008 management bonuses in vested common shares in lieu of cash bonuses. All stock-based compensation costs were expensed and not tax effected, as the Company currently records no income tax expense. All common shares issued upon exercise or vesting are reserved and non-assessable.

As of June 30, 2009, the Company had approximately $3.3 million of total unrecognized compensation cost related to unvested stock options and restricted common shares, which is expected to be amortized over the following periods:

 

     Amount
     (in thousands)

From June 30, 2009

   $ 1,065

2010

     1,437

2011

     622

2012

     156

2013

     9
      

Total

   $ 3,289
      

7. Commodity Hedging Contracts

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 swaps, basis swaps and put options to hedge natural gas price risk.

Effective October 1, 2008, the Company elected to discontinue hedge accounting on all existing derivative contracts and elected not to designate any derivative contracts as cash flow hedges under SFAS No. 133. Any hedge effectiveness related to the Company’s previous cash flow hedging relationships will remain in Other Comprehensive Income until the underlying forecasted transactions affect earnings. As a result, for the three and six months ended June 30, 2009, gains of $0.8 million and $1.7 million, respectively, that were reclassified into earnings as a result of the discontinuance of cash flow hedge accounting treatment for the Company’s derivatives. 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 natural gas hedge loss, while realized gains and losses related to contract settlements are recognized in natural gas and oil revenues.

 

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The following derivative transactions were outstanding with associated notional volumes and hedge prices for the index specified as of June 30, 2009:

 

Date

  

Remaining
Period

   Derivative
Instrument (1)
   Notional
Daily Volume
Average
   Total Volume
Remaining
   Base Fixed
Price
   Puts    Call    Index    Production
Area Hedged
               (MMBtu)    (MMBtu)         (MMBtu)    (MMBtu)          
01/29/09    July-Dec 09    P    12,218    2,248,069       $ 5.00       Nymex-HH    TX/WY
05/12/09    July-Dec 09    CC    5,000    920,000       $ 4.50    $ 6.00    Nymex-HH    TX/WY
05/12/09    Nov-Dec 09    CC    5,000    305,000       $ 5.00    $ 7.00    Nymex-HH    TX/WY
10/15/08    July-Dec 09    B    5,000    920,000    -$ 0.3825          HSC (2)    TX
10/15/08    July-Dec 09    I    5,000    920,000             HSC (2)    TX
02/12/09    July-Dec 09    B    2,000    368,000    -$ 0.3750          HSC (2)    TX
03/16/09    July-Oct 09    B    2,000    246,000    -$ 0.2800          HSC (2)    TX
03/25/09    July-Oct 09    B    2,000    246,000    $ 0.2850          HSC (2)    TX
11/14/08    July-Dec 09    B    1,500    276,000    -$ 2.2200          CIG (3)    WY
11/21/08    July-Dec 09    B    1,000    184,000    -$ 2.0200          CIG (3)    WY
02/12/09    July-Dec 09    B    850    156,400    -$ 1.7500          CIG (3)    WY
05/05/09    Jan-Mar 10    CC    10,000    900,000       $ 5.00    $ 7.00    Nymex-HH    TX/WY
05/15/09    Apr-Oct 10    CC    2,500    535,000       $ 5.50    $ 8.50    Nymex-HH    TX/WY
06/17/09    Apr-Oct 10    CC    2,500    535,000       $ 5.50    $ 8.70    Nymex-HH    TX/WY
06/17/09    Nov-Dec 10    CC    2,500    152,500       $ 7.00    $ 9.15    Nymex-HH    TX/WY
05/15/09    Jan-Mar 10    B    7,500    675,000    -$ 0.2800          HSC (2)    TX
05/15/09    Jan-Oct 10    B    2,500    760,000    -$ 0.3900          HSC (2)    TX
04/07/09    Cal 10    B    1,000    365,000    -$ 1.3100          CIG (3)    WY
06/17/09    Jan-Mar 11    CC    2,500    225,000       $ 7.00    $ 9.15    Nymex-HH    TX/WY
04/07/09    Cal 11    B    1,000    365,000    -$ 1.2100          CIG (3)    WY

 

(1) CC = Costless collars.
(1) B = Basis Swaps.
(1) I = Index swaps;Gas Daily to IFERC Monthly Index.
(1) P = Put purchased.

As of June 30, 2009, all of the Company’s economic derivative hedge positions were with a multinational energy company or large financial institution, which are not known to the Company to be in default on their derivative positions. Credit support for the Company’s open derivatives at June 30, 2009 is provided under the Revolving Credit Facility through intercreditor agreements or under a $100,000 letter of credit. The Company is exposed to credit risk to the extent of nonperformance by the counterparties in the derivative contracts discussed above; however, the Company believes the credit risk is minimal and does not anticipate non-performance by such counterparties. None of the Company’s derivative instruments contains credit-risk related contingent features.

Based on the Company’s projections, approximately 84% of its remaining 2009 estimated future natural gas production was hedged as of June 30, 2009 at a weighted average NYMEX MMBtu put price of $4.87 and a call price of $6.25. The Company has approximately 2.1 Bcf of 2010 production hedged at a weighted average NYMEX MMBtu put price of $5.40 and a call price of $7.96.

 

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GASTAR EXPLORATION LTD. AND SUBSIDIARIES

(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

The Company adopted SFAS No. 161 at the beginning of the first quarter of 2009, and the expanded disclosures required by SFAS No. 161 are presented below. The table below provides data about the carrying values of derivatives that are not designated as hedge instruments under SFAS No. 133. Dollar amounts below are shown in thousands.

 

     Asset Derivatives  

Derivatives not designated as hedging instruments under SFAS No. 133

   June 30, 2009  
     Balance Sheet Location    Fair Value  

Current

   Commodity Derivative Contracts    $ 2,986   

Long-term

   Commodity Derivative Contracts    $ 213   

Total derivatives not designated as hedging instruments under SFAS 133

      $ 3,199   
     Liability Derivatives  

Derivatives not designated as hedging instruments under SFAS No. 133

   June 30, 2009  
     Balance Sheet Location    Fair Value  

Current

   Commodity Derivative Contracts    $ 1,299   

Long-term

   Commodity Derivative Contracts    $ 273   

Total derivatives not designated as hedging instruments under SFAS 133

      $ 1,572   
     Amount of Gain or (Loss) Recognized in Income on Derivatives  

Derivatives not designated as hedging instruments under SFAS No. 133

   Three Months Ended June 30, 2009  
     Location of Gain/(Loss) Recognized in
Income on Derivatives
   Amount of Gain or (Loss)
Recognized in Income on
Derivatives
 

Commodity Contracts

   Unrealized Natural Gas Hedges    $ (4,426
     Amount of Gain or (Loss) Recognized in Income on Derivatives  

Derivatives not designated as hedging instruments under SFAS No. 133

   Six Months Ended June 30, 2009  
     Location of Gain/(Loss) Recognized in
Income on Derivatives
   Amount of Gain or (Loss)
Recognized in Income on
Derivatives
 

Commodity Contracts

   Unrealized Natural Gas Hedges    $ (4,622

8. Fair Value Measurements

Fair Value Measurements. In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements; however, it does not require any new fair value measurements.

SFAS No. 157 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels 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.

 

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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. 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. Level 3 instruments are natural gas costless collars, index swaps, basis swaps and put options. Although the Company utilizes third party broker quotes to assess the reasonableness of prices and valuation techniques, the Company does not have sufficient corroborating market evidence to support classifying these instruments as Level 2.

A financial asset’s or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The determination of the fair values below incorporates various factors required under SFAS No. 157, 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. Under the guidance of FASB Staff Position No. FIN 39-1, “Amendment of FASB Interpretation No. 39”, we have not elected to offset the fair value amounts recognized for multiple derivative instruments executed with the same counterparty, but report them gross on the Condensed Consolidated Balance Sheets. The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of June 30, 2009:

 

     As of June 30, 2009
     Level 1    Level 2    Level 3    Total
     (in thousands)

Assets:

           

Cash equivalents

   $ 12,499    $ —      $ —      $ 12,499

Commodity derivatives

   $ —      $ —      $ 3,199    $ 3,199

Liabilities:

           

Commodity derivatives

   $ —      $ —      $ 1,572    $ 1,572

The following table sets forth a reconciliation of changes in the fair value of financial assets and liabilities classified as Level 3 in the fair value hierarchy for the six months ended June 30, 2009:

 

     Derivatives
For the Six
Months Ended
June 30, 2009
 
     (in thousands)  

Balance as of December 31, 2008

   $ 8,708   

Total gains or losses (realized or unrealized):

  

Included in earnings (1)

     847   

Included in other comprehensive (loss) income (2)

     —     

Purchases, issuances and settlements

     (7,928

Transfers in and out of Level 3

     —     
        

Balance as of June 30, 2009

   $ 1,627   
        

Changes in unrealized loss relating to derivatives still held as of June 30, 2009

   $ (1,926
        

 

(1) This amount is included in natural gas and oil revenues on the statement of operations.
(2) None of the changes in other comprehensive income for the period related to derivatives held as of December 31, 2008 or June 30, 2009. Effective October 1, 2008, the Company discontinued hedge accounting. Any hedge effectiveness related to the Company’s previous cash flow hedging relationships will remain in Other Comprehensive Income until the underlying forecasted transactions affect earnings.

 

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(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

9. Capital Stock

Common Shares

The Company’s articles of incorporation allow the Company to issue an unlimited number of common shares without par value. On July 23, 2009, the Company filed an article of amendment to its Articles of Incorporation with the Registrar of Corporations of Alberta, Canada for the purpose of affecting a reverse split of the Company’s common shares on a basis of one (1) new common share for each five (5) common share outstanding. The Company’s shareholders approved the reverse split at the 2008 Annual General and Special Meeting of Shareholders held on June 20, 2008 by a special resolution authorizing a reverse split of the Company’s common shares on the basis of (1) new common share for up to five (5) common shares outstanding or such fewer number of commons shares as the Board of Directors may, in its sole discretion, approve at a later date. The Board of Directors approved the 1-for-5 reverse split on June 29, 2009. As of the opening of trading on August 3, 2009, the Company’s common shares began trading on the NYSE Amex under the same symbol of “GST” on a post 1-for-5 Reverse Split basis. All common share and per share amounts reported in the Form 10-Q have been reported on a post reverse split basis.

Preferred Shares

On June 30, 2009, Company filed an article of amendment to its Articles of Incorporation to be effective as of June 30, 2009 with the Registrar of Corporations of Alberta, Canada for the purpose of creating and adding an unlimited number of preferred shares to the authorized capital of the Company. Pursuant to this amendment, the number of preferred shares which may be issued from time to time will be determined by the Board of Directors of the Company. The preferred shares will have the rights, privileges, restrictions and conditions set out in the share structure included in and forming part of the Company’s amended Articles of Incorporation. The Company’s shareholders approved the amendment by special resolution at the 2007 Annual General and Special Meeting of Shareholders held on June 1, 2007.

Other Share Issuances

On May 22, 2009, the Company sold 7,300,000 of its common shares in an underwritten public offering to investors in the United States pursuant to the Company’s Registration Statement on Form S-3, which was declared effective by the SEC on April 27, 2007.

During the six months ended June 30, 2009, pursuant to the Company’s 2006 Plan (see Note 6, “Equity Compensation Plans”), 421,535 restricted common shares were granted to employees, of which 226,449 vested immediately, 81,436 common shares were returned to the Company and cancelled in payment of withholding taxes, and 113,650 common shares are subject to vesting.

Shares Reserved

At June 30, 2009, the Company has reserved 5,377,149 common shares to be issued pursuant to the conversion of Convertible Subordinated Debentures (1,369,863 common shares), exercise of stock options (2,003,050 common shares) and the exercise of warrants (2,004,236 common shares).

 

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(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

10. Warrants

The following table summarizes warrant information to purchase common shares as of June 30, 2009:

 

     Number of
Warrants
   Fair
Value of
Warrant
(in thousands)
   Warrant
Price per

Share Range
    Weighted
Average
Remaining
Life in
Years
   Weighted
Average
Exercise
Price in
US$
 

Warrants issued in connection with subordinated unsecured notes payable

   4,236    $ 21      $14.10 - $14.20      0.1    $ 14.15   

Warrant issued in connection with litigation settlement

   2,000,000    $ 5,548      (1   2.4    $ (1

 

(1) The warrant is exercisable for $13.75 per share in the event that, on or before June 11, 2011, the Company sells all or substantially all of its present oil and gas interests located in Leon and Robertson Counties in East Texas for net proceeds exceeding $500.0 million. A sale or a series of sales, of all or substantially all of the Company’s present East Texas properties prior to June 11, 2011 for $500.0 million or less will terminate the warrant. If the Company does not sell all or substantially all of these properties by June 11, 2011, the warrant will be exercisable for a six-month period commencing on that date at $15.00 per share. The Company is not obligated to sell any of its East Texas properties.

11. Interest Expense

The following tables summarize the components of interest expense for the periods indicated:

 

     For the Three Months
Ended June 30,
    For the Six Months
Ended June 30,
 
     2009     2008     2009     2008  
     (in thousands)  

Interest expense:

        

Cash and accrued

   $ 5,447      $ 3,994      $ 10,273      $ 7,998   

Amortization of deferred financing costs and debt discount

     722        485        1,408        948   

Capitalized interest

     (5,032     (2,590     (9,382     (4,961
                                

Total interest expense

   $ 1,137      $ 1,889      $ 2,299      $ 3,985   
                                

12. Related Party Transactions

Chesapeake Energy Corporation

On November 4, 2005, the Company completed an integrated transaction with Chesapeake Energy Corporation (“Chesapeake”) whereby Chesapeake acquired 5,430,328 newly issued common shares equal to 19.9% of the Company’s then outstanding common shares and acquired a 33.3% working interest in the Company’s Bossier play in the Hilltop area of East Texas. As part of this transaction, Chesapeake paid an additional $7.8 million, before fees and expenses, to reimburse the Company for Chesapeake’s pro rata share of leasehold interests acquired and to pay a disproportionate amount of future drilling costs in exchange for an undivided 33.3% of the Company’s leasehold working interests in the deep Bossier Hilltop prospect, less and except 160 acres surrounding each existing well bore. Chesapeake agreed to pay 44.44% of the drilling costs through casing point in the first six wells drilled by the parties in the Hilltop prospect to a depth sufficient to test the deep Bossier formation (an approximate depth of 19,000 feet) in order to earn its 33.33% leasehold working interest. The leasehold reimbursement was recorded as a reduction to natural gas and oil property cost.

As a result of its purchase of common shares, Chesapeake has the right to negotiate exclusively with the Company for a period of 30 days on any proposed sale of assets in the Hilltop area of East Texas. Additionally, Chesapeake has the right, with certain exceptions, to maintain its percentage ownership of the Company, on a fully diluted basis, by participating in future stock issuances and has the right to have an observer present at meetings of the Board of Directors.

 

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On November 11, 2006 and May 23, 2007, Chesapeake acquired an additional 1,000,000 common shares and 351,439 common shares, respectively, in private placement transactions. As of June 30, 2009, Chesapeake owned 6,781,767 common shares, or 13.7% of the Company’s outstanding common shares. See Note 14, “Commitments and Contingencies”, for information regarding a lawsuit involving this transaction.

All related balances are the result of well operations activity governed by an existing standard form joint operating agreement. All balances are typically due and payable within 30 days.

13. Earnings or Loss per Share

In accordance with the provisions of SFAS No. 128, basic earnings or loss per share is computed on the basis of the weighted average number of common shares outstanding during the periods. Diluted earnings or loss per share is computed based upon the weighted average number of common shares plus the assumed issuance of common shares for all potentially dilutive securities. Diluted amounts are not included in the computation of diluted loss per share, as such would be anti-dilutive.

 

     For the Three Months
Ended June 30,
   For the Six Months
Ended June 30,
     2009     2008    2009     2008
     (in thousands, except share and per share data)

Basic and diluted loss and shares outstanding:

         

Net income (loss)

   $ (2,393   $ 546    $ (72,580   $ 1,633

Weighted average common shares outstanding

         

Basic

     44,854,954        41,419,714      43,163,088        41,419,714

Diluted

     44,854,954        41,495,033      43,163,088        41,495,033

Basic and diluted income (loss) per common share:

         

Basic

   $ (0.05   $ 0.01    $ (1.68     0.04

Diluted

   $ (0.05   $ 0.01    $ (1.68     0.04

Common shares excluded from denominator as anti-dilutive:

         

Stock options (1)

     2,003,050        1,854,431      2,003,050        1,854,431

Unvested restricted common shares (2)

     575,641        559,270      575,641        559,270

Warrants (3)

     2,004,236        2,046,506      2,004,236        2,046,506

Convertible subordinated debentures (1)

     1,369,863        1,369,863      1,369,863        1,369,863
                             

Total

     5,952,790        5,830,070      5,952,790        5,830,070
                             

 

(1) Common shares for the 2009 and 2008 periods have been excluded as the strike price of each was greater than the market price as of June 30, 2009 and 2008.
(2) Unvested common shares are included in the total outstanding number of common shares but are excluded from the calculation of weighted average common shares when calculating income per share.
(3) Underlying common shares are excluded, as events required for exercise are conditional or strike price was greater than the market price as of June 30, 2009 and 2008.

14. Commitments and Contingencies

Litigation

The Company is party to various litigation matters arising out of the normal course of business. The ultimate outcome of the matters discussed below cannot presently be determined, nor can the liability that could potentially result from an adverse outcome be reasonably estimated at this time. The Company does not expect that the outcome of these proceedings will have a material adverse effect on its financial position, results of operations or cash flow. The more significant litigation matters are summarized below.

Navasota Resources L.P. (“Navasota”) vs. First Source Texas, Inc., First Source Gas L.P. (now Gastar Exploration Texas LP) and Gastar Exploration Ltd. (Cause No. 0-05-451) District Court of Leon County, Texas 12th Judicial District . This lawsuit, dated October 31, 2005, contends that the Company breached Navasota’s

 

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(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

preferential right to purchase 33.33% of the Company’s interest in certain natural gas and oil leases located in Leon and Robertson Counties and sold to Chesapeake Energy Corporation pursuant to a transaction closed November 4, 2005. The preferential right claimed is under an operating agreement dated July 7, 2000. The Company contends, among other things, that Navasota neither properly nor timely exercised any preferential right election it may have had with respect to the inter-dependent Chesapeake transaction. In July 2006, the District Court of Leon County, Texas issued a summary judgment in favor of the Company and Chesapeake. Navasota filed a Notice of Appeal to the Tenth Court of Appeals in Waco. Oral argument was heard on September 26, 2007 and the Court of Appeals issued its opinion on January 9, 2008 reversing the trial court’s rulings, rendering judgment in favor of Navasota on its claims for breach of contract and specific performance, and remanding the case for further proceedings on Navasota’s other counts, which include claims for suit to quiet title, trespass to try title, tortious interference with contract, conversion, money had and received, and declaratory relief. The Company and Chesapeake filed a motion for rehearing on February 6, 2008, which was denied on March 18, 2008. The Company and Chesapeake filed a joint Petition for Review in the Texas Supreme Court on May 13, 2008. On August 28, 2008, the Texas Supreme Court requested briefing on the merits. On January 9, 2009, the Texas Supreme Court denied the Petition for Review. On January 26, 2009, the Company and Chesapeake jointly filed a motion for rehearing in the Texas Supreme Court on its denial of the Petition for Review. On April 24, 2009, the Texas Supreme Court denied the Petition for Review.

Pursuant to a provision in the November 4, 2005 Purchase and Sale and Exploration Development Agreement with Chesapeake, Chesapeake acknowledged the existence of the Navasota lawsuit and claims and further agreed that if Navasota were to prevail on its claims, that Chesapeake would convey the affected interests it purchased from the Company to Navasota upon receipt of the purchase price and/or other consideration paid by Navasota. Therefore, the Company believes that if Navasota seeks to exercise rights of specific performance, its doing so should impact only Chesapeake’s assigned leasehold interests. However, in December 2008, Chesapeake stated to the Company that if the Texas Supreme Court were not to reverse the decision of the Tenth Court of Appeals, Chesapeake would seek rescission of the 2005 transaction and restitution of consideration paid. Chesapeake may assert such rescission and restitution as to the November 4, 2005 Purchase and Sale and Exploration Development Agreement; a November 4, 2005 Exploration and Development Agreement; and a November 4, 2005 Common Share Purchase Agreement. In its December 2008 communication, Chesapeake did not identify particular sums as to which it may seek restitution, but amounts paid to the Company in connection with the 2005 transaction could be asserted to include the $76.0 million paid by Chesapeake for the purchase of 27.2 million common shares as part of the transaction in 2005 and/or other amounts. Chesapeake has not further advised the Company of its intentions with respect to any rescission or restitution claim since the Texas Supreme Court issued its denial of the Petition for Review. If Chesapeake were to seek rescission or restitution, the Company would vigorously defend any such action.

On or about June 9, 2009, Navasota filed and served its Fourth Amended Petition, essentially re-pleading its previously-asserted claims against the Company and Chesapeake. Navasota has also requested information relative to exercising its preferential right to purchase the affected interests.

In addition, while the Navasota Resources litigation is pending, it is possible that expenditures incurred, or authorizations for proposed expenditures, for drilling activities on leases which include the disputed interest may remain unpaid or not be authorized by the non-operators asserting competing ownership rights, which could require the Company to either fund a disproportionate amount of drilling costs at its own risk or postpone its drilling program on affected leases.

Craig S. Tillotson v. S. David Plummer 2 nd , Spencer Plummer 3 rd , Tony Ferguson, John Parrott, Thomas Robinson, GeoStar Corporation, First Source Wyoming, Inc. GeoStar Financial Services Corporation, Gastar Exploration Ltd., Zeus Investments, LLC and John Does 1-10 (Civil No. 080412334). This lawsuit was filed on July 7, 2008 in Utah state court by Craig S. Tillotson (“Tillotson”), in which he alleges that he was fraudulently induced to invest in a mare leasing program operated by Classic Star LLC, (“ClassicStar”) a subsidiary of GeoStar Corporation (“GeoStar”), on the basis of certain verbal representations, and to convert interests in that program into shares of a working interest in the Powder River Basin. Tillotson asserts causes of action against all defendants including common law fraud, fraudulent inducement, statutory securities fraud under Utah state law, civil conspiracy, and negligent misrepresentation, and asserts certain additional causes of action only against GeoStar, a GeoStar affiliate, and David and Spencer Plummer. The Company has not been served and has not yet answered or otherwise responded. The Company intends to vigorously defend the suit.

 

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Fridkin-Kaufman Ltd. v. Gastar Exploration Texas L.P. f/k/a First Source Gas L.P., Gastar Exploration Ltd., First Texas Gas, L.P., First Source Texas, Inc., Gastar Exploration Texas, Inc. f/k/a First Texas Development, Inc., and Navasota Resources, Ltd. f/k/a Navasota Resources, Inc. ; in the District Court of Harris County, Texas, 281 st Judicial District (Case No. 2008-74765). This lawsuit was filed on December 19, 2008, alleging that the defendants failed to properly pay royalty on production from the Fridkin-Kaufman #1 well in Leon County, Texas during the period September 2004 to present. Plaintiff seeks damages of approximately $463,000, plus interest and attorney’s fees. The Company has answered denying all claims. Discovery is underway in the case, which is set for trial on November 9, 2009. The Company is vigorously defending the suit.

In re ClassicStar Mare Lease Litigation and Gregory R. Raifman, individually and as Trustee of the Raifman Family Revocable Trust Dated 7/2/03, Susan Raifman, individually and as Trustee of the Raifman Family Revocable Trust Dated 7/2/03, and Gekko Holdings, LLC, d/b/a Gekko Breeding and Racing v. ClassicStar LLC, ClassicStar Farms, LLC, Strategic Opportunity Solutions, LLC d/b/a Buffalo Ranch, GeoStar Corporation, S. David Plummer, Spencer D. Plummer III, Tony Ferguson, Thomas Robinson, John Parrot, Karren Hendrix, Stagg Allen & Company, P.C. f/k/a Karren Hendrix & Associates, P.C., Terry L. Green, ClassicStar Farms, Inc., Gastar Exploration, Ltd. and Does 1-1,000; In the United States District Court for the Eastern District of Kentucky (Cause No. 5:07-cv-347-JMH, Master File No. 5:07-cv-353-JMH). This lawsuit was filed on February 2, 2009 in federal court in Kentucky as part of a multi-district litigation proceeding, naming the Company as one of the several defendants. The plaintiffs allege that they were induced to participate in a mare leasing program operated by the defendants, and had been promised options to convert interests in the mare leasing program for working interests in wells or shares of Company stock owned by defendants other than the Company. The plaintiffs assert several causes of action against all defendants, including violations of the RICO Act, common law fraud, negligent misrepresentation, constructive trust, unjust enrichment, and negligence. The plaintiffs also assert additional causes of action only against the ClassicStar defendants, David and Spencer Plummer, Karren Hendrix, Terry Green, Strategic Opportunity Solutions, and Does 1-1,000. On June 5, 2009, the Company filed a motion to dismiss the suit for failure to state a claim and for want of personal and subject matter jurisdiction. The briefing on the motion to dismiss is not yet complete. The Company intends to vigorously defend the suit.

In re ClassicStar Mare Lease Litigation and West Hill Farms, LLC, et al. v. ClassicStar LLC, ClassicStar Farms, LLC, ClassicStar 2004, LLC, National Equine Lending Co., LLC, New NEL, LLC, GeoStar Corp., GeoStar Equine Energy, Inc., Tony Ferguson, David Plummer, ClassicStar Thoroughbreds, LLC, Spencer Plummer, Karren Hendrix Stagg Allen & Co., Thom Robinson, John Parrot, First Equine Energy Partners, LLC, Strategic Opportunity Solutions, LLC d/b/a Buffalo Ranch, ClassicStar 2005 Powerfoal Stables, LLC, ClassicStar Farms, Inc., GeoStar Financial Services Corp., Gastar Exploration, Ltd., and John Does 1-3; In the United States District Court for the Eastern District of Kentucky (Cause No. 06-243-JMH, Master File No. 5:07-cv-353-JMH). This lawsuit was filed on February 2, 2009 in federal court in Kentucky as part of a multi-district litigation proceeding, naming the Company as one of several defendants. The plaintiffs allege that they were induced to participate in a mare leasing program operated by the defendants, and had been promised options to convert interests in the mare leasing program for working interests in wells or shares of Company stock owned by defendants other than the Company. The plaintiffs assert several causes of action against the majority of the defendants, including the Company. These causes of action include violations of the RICO Act, common law fraud, negligent misrepresentation, theft by deception, unjust enrichment, conspiracy, aiding and abetting, and fraudulent transfer. The plaintiffs also assert additional causes of action against certain defendants other than the Company for breach of contract, state and federal securities fraud, anticipatory breach, and conversion. On March 19, 2009, the Company filed a motion to dismiss the suit for failure to state a claim and for want of personal and subject matter jurisdiction. The briefing on the motion to dismiss is not yet complete. The Company intends to vigorously defend the suit.

In re ClassicStar Mare Lease Litigation and AA-J Breeding, LLC, Su-Sim, LLC, Derby Stakes, LLC, Uri Halfon, and Ora-Oli Halfon v. GeoStar Corp., GeoStar Financial Services Corp., First Source Wyoming, Inc., ClassicStar, LLC, ClassicStar Farms, LLC, ClassicStar Farms, Inc., Karren Hendrix, Stagg, Allen, & Company, P.C., f/k/a Karren, Hendrix & Assoc. P.C., Handler, Thayer, & Duggan, LLC, Thomas J. Handler, J.D., P.C., S. David Plummer, Spencer D. Plummer III, Tony Ferguson, Terry L. Green, and Gastar Exploration, Ltd.; In the

 

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United States District Court for the Eastern District of Kentucky (Cause No. 5:08-cv-79-JMH, Master File No. 5:07-cv-353-JMH) . This lawsuit was filed on February 6, 2009 in federal court in Kentucky as part of a multi-district litigation proceeding, naming the Company as one of several defendants. The plaintiffs allege that they were induced to participate in a mare leasing program operated by the defendants, and had been promised options to convert interests in the mare leasing program for working interests in wells or shares of Company stock. The plaintiffs assert several causes of action against all defendants, including violations of the RICO Act, breach of contract, common law fraud, misrepresentation, constructive trust, unjust enrichment, accounting, and conversion. The plaintiffs also assert additional causes of action only against Karren Hendrix, Handler, Thayer, & Duggan, LLC, and Thomas J. Handler. On May 22, 2009, the Company filed a motion to dismiss the suit for failure to state a claim and for want of personal and subject matter jurisdiction. The briefing on the motion to dismiss is not yet complete. The Company intends to vigorously defend the suit.

In re ClassicStar Mare Lease Litigation and John Goyak, Dana Goyak, John Goyak & Associates, Inc., and Jupiter Ranches, LLC, v. ClassicStar Racing Stable, LLC, ClassicStar 2003 Racing Partnership, LLC, GeoStar Financial Services Corporation, GeoStar Corporation, Private Consulting Group, Inc., S. David Plummer, Spencer Plummer, Thomas Bissmeyer, Thomas Williams, Gary Thornhill, Robert Holt, Elizabeth Holt, David Lieberman, Tony Ferguson, John Parrott, Thom Robinson, Strategic Opportunity Solutions d/b/a Buffalo Ranch, and First Source Wyoming; In the United States District Court for the Eastern District of Kentucky (Cause No. 08-cv-0053, Master File No. 5:07-cv-353-JMH). On July 15, 2009, the Court granted the plaintiffs leave to amend their pleadings in order to add the Company to the suit as one of several defendants. The plaintiffs allege that they were induced to participate in a mare leasing program operated by the defendants, and had been promised options to convert interests in the mare leasing program for working interests in wells or shares of Company stock owned by defendants other than the Company. The plaintiffs assert several causes of action including violations of the RICO Act, common law fraud, breach of contract, unjust enrichment, common law conspiracy, constructive trust, and fraud. The plaintiffs also assert additional causes of action against certain defendants other than the Company. The Company has accepted service but has not yet answered or otherwise responded. If the suit is filed, the Company intends to vigorously defend it.

In re ClassicStar Mare Lease Litigation and James D. Lyon, Chapter 7 Trustee of ClassicStar LLC v. Tony P. Ferguson, S. David Plummer, Spencer D. Plummer III, Shane D. Plummer, Jennifer Stahle, Boyce J. Sanderson, Thomas E. Robinson, John W. Parrott, Frederick J. Lambert, ClassicStar Farms, Inc., Tartan Business L.C., Dinosaur Enterprises, L.L.C., Cadillac Farms, Inc., ClassicStar Farms LLC, Geostar Corporation, First Source Texas, Inc., First Source Bossier, L.L.C., First Texas Gas, LP, CBM Resources Pty, Ltd., Associated Geophysical Services, Inc., Conquest Group Operating Company, West Virginia Development, Inc., West Virginia Gas Corporation, Squaw Creek Development, Inc., Arkoma Basin Development, Inc., Royalty Acquisition Company, BNG Producing & Drilling, Geostar Financial Corporation, Geostar Financial Services Corporation, Geostar Leasing Corporation, Conquest Exploration, Inc., First Source Wyoming, Inc., Squaw Creek, Inc., Strategic Opportunity Solutions, LLC d/b/a Buffalo Ranch, National Equine Lending Co., L.C., New NEL, LLC, First Equine Energy Partners LLC, Geostar Equine Energy, Inc., Private Consulting Group, Inc., Gastar Exploration, Ltd., Gastar Exploration USA, Inc. f/k/a First Sourcenergy Wyoming, Inc., Gastar Exploration Victoria, Inc. f/k/a First Sourcenergy Victoria, Inc., Gastar Exploration Texas, Inc. f/k/a First Texas Development, Inc., Gastar Exploration Texas LLC f/k/a Bossier Basin, LLC, Gastar Exploration Texas, LP f/k/a First Source Gas, LP, Gastar Exploration New South Wales, Inc. f/k/a First Sourcenergy Group, Inc., Gastar Exploration Power Pty, Ltd., Eastern Star Gas, Limited, Brookstone Development, Ltd., Debora D. Plummer, Viking Real Estate, L.C., Crown Jewels Limited Partnership, Woodford Thoroughbreds LLC and Does 1-100, including, but not limited to, various subsidiaries and affiliates of Geostar Corporation and various subsidiaries and affiliates of Gastar Exploration, Ltd. and various entities affiliated or associated with S. David Plummer and/or Debora D. Plummer; In the United States District Court for the Eastern District of Kentucky (Cause No. 5:09-cv-215-JMH, Master File No. 5:07-cv-353-JMH). This lawsuit was filed June 16, 2009 in federal court in Kentucky as part of a multi-district litigation proceeding. The suit, brought by the Chapter 7 liquidation bankruptcy trustee for ClassicStar, names more than 50 defendants, including the Company and seven of its subsidiaries. The trustee alleges that cash from investors in ClassicStar’s mare leasing programs was systematically diverted from ClassicStar over a six year period by various defendants, among them the former officers, directors, managers, and members of ClassicStar, with the assistance and participation of various other defendants including ClassicStar affiliates; entities controlled by ClassicStar’s former officers and affiliates; GeoStar; current or former officers or shareholders of GeoStar; and GeoStar’s subsidiaries,

 

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former subsidiaries, or formerly controlled companies, including the Company and its subsidiaries. The defendants include officers and former officers of GeoStar who also served as officers or directors of the Company and its subsidiaries, or who were Company shareholders. No current officer or director of the Company has been named as a defendant. The trustee alleges that the Company and its subsidiaries were beneficiaries of an unspecified amount of the allegedly diverted ClassicStar funds while allegedly under the control of GeoStar and its officers. The trustee further alleges that the Company and its subsidiaries, along with other defendants, aided and abetted breaches of fiduciary duties owed to ClassicStar by some of the defendants. The Company defendants, along with other defendants, are also alleged to have participated in, or were the beneficiaries of, or aided or abetted in, intentional or constructive fraudulent transfers of ClassicStar funds. The complaint also makes claims for an accounting and conversion of all funds diverted from ClassicStar by any of the defendants and makes certain additional state law claims, including claims under Utah’s UPUA law (similar to RICO), breach of contract, unjust enrichment, civil conspiracy, and alter ego. The trustee alleges that as a result of the acts complained of (including the alleged transfer of at least $330.0 million in cash from ClassicStar to various defendants), at least $1 billion in claims have been made against the ClassicStar estate. The trustee seeks damages in excess of $1 billion in compensatory damages, $330.0 million in punitive damages, costs, attorney’s fees, and interest. The lawsuit is consolidated for pretrial purposes in federal court in Kentucky as part of the previously disclosed multi-district litigation proceeding involving multiple actions filed by purported investors in the ClassicStar mare leasing programs, some of which name Gastar as one of several defendants. The Company and its seven subsidiary defendants have been served but have not yet answered or otherwise responded. The Company intends to vigorously defend the suit.

Gastar Exploration Texas L.P. vs. J. Ken Welch d/b/a W-S-M Oil Company, et al; Cause No. 0-09-117 in the 87 th Judicial District Court of Leon County, Texas. This lawsuit, filed on March 12, 2009, is a suit for trespass to try title and, in the alternative, to quiet title, to an undivided mineral interest under several Company oil and gas leases covering approximately 4,273.70 gross acres (the “Leases”). In this suit the Company contends that certain oil and gas leases claimed by the defendants’ have expired according to their terms and that the defendants’ failure to release those leases constitutes a trespass upon and cloud on the Leases. The Defendants have responded with a General Denial and produced a portion of the documents the Company sought in its Request for Production of Documents. The Company will continue to vigorously pursue this claim.

15. Statement of Cash Flows – Supplemental Information

The following is a summary of supplemental cash paid and non-cash transactions disclosed in the notes to the consolidated financial statements:

 

     For the Six Months
Ended June 30,
 
     2009     2008  
     (in thousands)  

Cash paid for interest

   $ 9,744      $ 8,069   

Non-cash transactions:

    

Non-cash capital expenditures excluded from accounts payable and accrued drilling costs

   $ (5,002   $ (2,253

Asset retirement obligation included in oil and gas properties

   $ 210      $ 320   

Drilling advances application

   $ 7,144      $ 1,793   

Litigation settlement

   $ —        $ 13,779   

 

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16. Comprehensive Loss

The Company’s comprehensive loss for the periods indicated was as follows:

 

     For the Six Months
Ended June 30,
 
     2009     2008  
     (in thousands)  

Net income (loss)

   $ (72,580   $ 1,633   

Change in:

    

Commodity hedging activities – current period reclassification to earnings

     (1,685     (12,098

Foreign currency translation adjustments

     (15     57   
                

Comprehensive loss

   $ (74,280   $ (10,408
                

17. Subsequent Events

Sale of Petroleum Exploration Licenses 238, 433, and 434 and Repayment of Debt

On July 13, 2009, Gastar Exploration New South Wales, Inc. (“GENSW”) and Gastar USA, each wholly-owned subsidiaries of the Company, completed the sale of all of the Company’s interest in Petroleum Exploration Licenses 238, 433, and 434 in New South Wales, Australia and the concurrent sale of the Company’s common shares of Gastar Power Pty Ltd., a wholly owned subsidiary, (“Gastar Power”), the entity holding the Company’s 35% interest in the Wilga Park Power Station (collectively, the “Australian Assets”), to Santos QNT Pty Ltd. and Santos International Holdings Pty Ltd. (collectively, “Santos”). The sale was made pursuant to a definitive agreement dated July 2, 2009 (the “Sale Agreement”) by and among GENSW, Gastar USA and Santos.

The Australian Assets include the Company’s 35% interest in PEL 238, a coal bed methane exploratory property covering approximately 2.2 million gross (761,400 net) acres, located in the Gunnedah Basin of New South Wales, as well as 1.9 million gross (664,000 net) acres in PEL 433 and approximately 1.9 million gross (669,000 net) acres in PEL 434. In February 2009, the Company, through its subsidiary Gastar Power, acquired the 35% interest in the Wilga Park Power Station.

At closing, Gastar received approximately $217.0 million (AU$280.0 million), excluding taxes and transaction expenses and including release from escrow a $15.0 million deposit made by Santos upon the execution of the Sale Agreement, of the aggregate approximate $232.5 million (AU$300.0 million) purchase price and is scheduled to receive the balance upon receipt of certain government approvals. In the event such governmental approvals are not obtained within nine months of the closing date, Santos will retain the remaining approximate $15.5 million (AU$20.0 million) and will take all necessary actions to transfer the participating interests, excluding PEL 238, to GENSW. The Company may be paid, assuming current foreign exchange rates, an additional approximate $16.0 million (AU$20.0 million) in early 2010 if certain gross reserve certification targets for the PEL 238 coalbed methane project are achieved by Santos and the operator of the properties, Eastern Star Gas. The Sale Agreement also acknowledges the Company’s retention of its right to future cash payments of up to $10.0 pursuant to a pre-existing farm-in agreement in the event certain production thresholds are reached on PEL 238.

The Company used the proceeds from the sale of the Australian Assets to (i) repay the $13.0 million outstanding on its secured Revolving Credit Facility, (ii) repay in full its Term Loan as described below and (iii) plans to repurchase all of its outstanding $100.0 million 12  3 / 4 % Senior Secured Notes at a price of 106.375% of par, plus accrued and unpaid interest as described below.

Repayment and Termination of Term Loan

On July 13, 2009, the Company used approximately $27.5 million of the approximately $217.0 million (AU$280.0 million) aggregate net proceeds from the sale of the Australian Assets described above to repay in full and thereby terminate its Term Loan.

 

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The Term Loan was set to mature on February 15, 2012. Pursuant to the terms and conditions of the Term Loan, the Company was required to pay a prepayment premium of 10% of the amount outstanding under the Term Loan in an amount totaling $2.5 million for repayment prior to December 31, 2009.

Asset Sale Offer

On July 13, 2009, Gastar USA launched an offer (the “Asset Sale Offer”) to purchase any and all of its outstanding 12  3 / 4 % Senior Secured Notes from the holders thereof upon the terms and subject to the conditions set forth in the Asset Sale Offer Statement, dated July 13, 2009 (the “Asset Sale Offer Statement”). The Asset Sale Offer Statement was in accordance with and the Asset Sale Offer was made pursuant to the terms of the Indenture, dated as of November 29, 2007, as amended by the Supplemental Indenture dated as of February 16, 2009, by and among the Company, Gastar USA, certain other subsidiaries of the Company and Wells Fargo Bank, National Association, as trustee, pursuant to which the 12  3 / 4 % Senior Secured Notes were originally issued (the “Indenture”).

The purpose of the Asset Sale Offer was to comply with the provisions of Section 2.4 of the Supplemental Indenture and Section 3.09 of the Indenture, whereby if the Company has uninvested Major Asset Sale Excess Proceeds (as defined therein) following the receipt of net proceeds from a sale of assets, the Company is required to offer to purchase the maximum principal amount of 12  3 / 4 % Senior Secured Notes that may be purchased with such Major Asset Sale Excess Proceeds.

On August 6, 2009, the note holder’s tendered to the Company the outstanding $100.0 million principal amount of the 12  3 / 4 % Senior Secured Notes at 106.375% of the principal amounts, plus accrued and unpaid interest. The Company expects to retire the 12  3 / 4 % Senior Secured Notes in full by tendering payment of $108.7 million on August 7, 2009.

Delisting from the Toronto Exchange

Effective July 6, 2009, we elected to voluntarily de-list our shares from trading on the Toronto Stock Exchange (TSX) following the completion of the sale of the Australian Asset, described below. We decided to delist from the TSX because trading on two exchanges had become unduly costly and burdensome without providing any significant additional liquidity for our shareholders.

1-for-5 Reverse Common Share Split

On June 20, 2008, the Company’s shareholders approved a proposal for a reverse stock split at a Special Meeting of Shareholders of one (1) common share for up to five (5) common shares or such fewer number of common shares as the Board of Directors, in its sole discretion, approve at a later date. Subsequently, the Board of Directors approved the implementation of a 1 for 5 Reverse Split at a meeting held June 29, 2009 to be effective at the opening of trading on the NYSE Amex on August 3, 2009, and on July 23, 2009, the Company filed an article of amendment it its Articles of Incorporation with the Registrar of Corporations of Alberta for the purpose of affecting the consolidation. Upon the exercise of any stock options or warrants, resulting shares issued will be issued on a post-consolidation basis with the corresponding adjustment to the stock option and warrant exercise prices. No scrip or fractional certificates were issued in connection with the reverse stock split. Shareholders who otherwise would have been entitled to receive fractional shares because they hold a number of common shares not evenly divisible by five received a number of shares after rounding up to the next common share.

All common share and per share amounts in this Form 10-Q have been adjusted for the 1-for-5 Reverse Split.

 

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18. Issuer Subsidiaries Condensed Consolidating Financial Statements

The following table presents condensed consolidating balance sheets as of June 30, 2009 and December 31, 2008 and the related condensed consolidating statements of operations and condensed consolidating statements of cash flows for the six month periods ended June 30, 2009 and 2008 of Gastar Exploration Ltd. (“Parent”), Gastar Exploration USA, Inc. (“Issuer”) and Gastar Exploration Texas, Inc., Gastar Exploration Texas LP, Gastar Exploration Texas LLC, Gastar Exploration New South Wales, Inc., Gastar Exploration Victoria, Inc. and Gastar Power Pty Ltd., each a minor non-guarantor subsidiary included in issuer subsidiaries, (collectively referred to as “Issuer Subsidiaries”). Each of the Parent and the Issuer Subsidiaries, except for Gastar Power Pty Ltd., have fully and unconditionally guaranteed, on a joint and severally basis, the $100.0 million 12  3 / 4 % Senior Secured Notes sold in November 2007, the Revolving Credit Facility and the Term Loan. Interest charged on intercompany receivables and payables between the Parent and Issuer are eliminated.

 

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Condensed Consolidating Parent and Issuer Subsidiaries Balance Sheets

As of June 30, 2009

 

     Parent     Issuer     Issuer
Subsidiaries
    Reclassifications
and
Eliminations
    Gastar
Exploration Ltd.
and

Subsidiaries
 
     (in thousands)  
ASSETS  

CURRENT ASSETS:

          

Cash and cash equivalents

   $ 51      $ 5,666      $ 6,782      $ —        $ 12,499   

Accounts receivable, net

     3        —          2,940        —          2,943   

Commodity derivative contracts

     —          —          2,986        —          2,986   

Due from related parties

     —          —          1,197        —          1,197   

Prepaid expenses

     126        —          326        —          452   
                                        

Total current assets

     180        5,666        14,231        —          20,077   

PROPERTY, PLANT AND EQUIPMENT:

          

Natural gas and oil properties, full cost method of accounting:

          

Unproved properties, not being amortized

     —          29,062        130,120        —          159,182   

Proved properties

     8        58,085        269,069        —          327,162   
                                        

Total natural gas and oil properties

     8        87,147        399,189        —          486,344   

Furniture and equipment

     —          53        957        —          1,010   
                                        

Total property, plant and equipment

     8        87,200        400,146        —          487,354   

Accumulated depreciation, depletion and amortization

     (7     (51,805     (227,710     —          (279,522
                                        

Total property, plant and equipment, net

     1        35,395        172,436        —          207,832   

OTHER ASSETS:

          

Restricted cash

     25        —          508        —          533   

Commodity derivative contracts

     —          —          213        —          213   

Deferred charges, net

     188        6,749        —          —          6,937   

Drilling advances

     —          —          1,999        —          1,999   

Intercompany receivable and investment in subsidiaries

     73,270        132,719        —          (205,989     —     

Other

     —          100        —          —          100   
                                        

Total other assets

     73,483        139,568        2,720        (205,989     9,782   
                                        

TOTAL ASSETS

   $ 73,664      $ 180,629      $ 189,387      $ (205,989   $ 237,691   
                                        
LIABILITIES AND SHAREHOLDERS’ EQUITY   

CURRENT LIABILITIES:

          

Accounts payable

   $ 2      $ —        $ 6,279      $ —        $ 6,281   

Revenue payable

     —          —          5,660        —          5,660   

Accrued interest

     416        1,618        —          —          2,034   

Accrued drilling and operating costs

     —          340        1,662        —          2,002   

Commodity derivative contracts

     —          440        859        —          1,299   

Other accrued liabilities

     72        —          1,660        —          1,732   

Due to related parties

     —          —          1,060        —          1,060   

Current portion of long-term debt

     30,300        138,525        —          —          168,825   
                                        

Total current liabilities

     30,790        140,923        17,180        —          188,893   
                                        

LONG-TERM LIABILITIES:

          

Long-term debt

     —          —          —          —          —     

Commodity derivative contracts

     —          101        172        —          273   

Asset retirement obligation

     6        2,747        2,728        —          5,481   

Intercompany payable

     —          —          36,774        (36,774     —     
                                        

Total long-term liabilities

     6        2,848        39,674        (36,774     5,754   

TOTAL SHAREHOLDERS’ EQUITY

     42,868        36,858        132,533        (169,215     43,044   
                                        

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 73,664      $ 180,629      $ 189,387      $ (205,989   $ 237,691   
                                        

 

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Condensed Consolidating Parent and Issuer Subsidiaries Balance Sheets

As of December 31, 2008

 

     Parent     Issuer     Issuer
Subsidiaries
    Reclassifications
and
Eliminations
    Gastar
Exploration Ltd.
and

Subsidiaries
 
     (in thousands)  
ASSETS  

CURRENT ASSETS:

          

Cash and cash equivalents

   $ 39      $ 25      $ 6,089      $ —        $ 6,153   

Accounts receivable, net

     2        —          5,294        —          5,296   

Commodity derivative contracts

     —          15        9,814        —          9,829   

Due from related parties

     —          —          2,382        —          2,382   

Prepaid expenses

     245        84        550        —          879   
                                        

Total current assets

     286        124        24,129        —          24,539   

PROPERTY, PLANT AND EQUIPMENT:

          

Natural gas and oil properties, full cost method of accounting:

          

Unproved properties, not being amortized

     —          30,832        111,028        —          141,860   

Proved properties

     8        51,132        257,963        —          309,103   
                                        

Total natural gas and oil properties

     8        81,964        368,991        —          450,963   

Furniture and equipment

     —          49        948        —          997   
                                        

Total property, plant and equipment

     8        82,013        369,939        —          451,960   

Accumulated depreciation, depletion and amortization

     (7     (44,412     (155,014     —          (199,433
                                        

Total property, plant and equipment, net

     1        37,601        214,925        —          252,527   

OTHER ASSETS:

          

Restricted cash

     25        —          45        —          70   

Deferred charges, net

     433        6,416        —          —          6,849   

Drilling advances

     —          —          4,352        —          4,352   

Intercompany receivable and investment in subsidiaries

     132,666        192,012        —          (324,678     —     

Other

     —          100        —          —          100   
                                        

Total other assets

     133,124        198,528        4,397        (324,678     11,371   
                                        

TOTAL ASSETS

   $ 133,411      $ 236,253      $ 243,451      $ (324,678   $ 288,437   
                                        
LIABILITIES AND SHAREHOLDERS’ EQUITY   

CURRENT LIABILITIES:

          

Accounts payable

   $ 9      $ —        $ 14,247      $        $ 14,256   

Revenue payable

     —          —          5,005        —          5,005   

Accrued interest

     401        1,104        —          —          1,505   

Accrued drilling and operating costs

     —          471        2,444        —          2,915   

Commodity derivative contracts

     —          78        1,043        —          1,121   

Other accrued liabilities

     60        13        3,058        —          3,131   

Due to related parties

     —          —          2,143        —          2,143   

Current portion of long-term debt

     33,226        118,458        —          —          151,684   
                                        

Total current liabilities

     33,696        120,124        27,940        —          181,760   
                                        

LONG-TERM LIABILITIES:

          

Asset retirement obligation

     6        2,621        2,468        —          5,095   

Intercompany payable

     —          2,379        19,752        (22,131     —     
                                        

Total long-term liabilities

     6        5,000        22,220        (22,131     5,095   

TOTAL SHAREHOLDERS’ EQUITY

     99,709        111,129        193,291        (302,547     101,582   
                                        

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

   $ 133,411      $ 236,253      $ 243,451      $ (324,678   $ 288,437   
                                        

 

30


Table of Contents

GASTAR EXPLORATION LTD. AND SUBSIDIARIES

(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

Condensed Consolidating Parent and Issuer Subsidiaries Statements of Operations

For the Three Months Ended June 30, 2009

(Unaudited)

 

     Parent     Issuer     Issuer
Subsidiaries
    Reclassifications
and
Eliminations
   Gastar
Exploration Ltd.
and

Subsidiaries
 
     (in thousands)  

REVENUES:

           

Natural gas and oil revenues

   $ 1      $ 1,096      $ 10,865      $ —      $ 11,962   

Unrealized natural gas hedge loss

     —          (99     (4,327     —        (4,426
                                       

Total revenues

     1        997        6,538        —        7,536   

EXPENSES:

           

Production taxes

     —          82        10        —        92   

Lease operating expenses

     2        543        904        —        1,449   

Transportation and treating

     —          325        —          —        325   

Depreciation, depletion and amortization

     —          459        2,902        —        3,361   

Accretion of asset retirement obligation

     —          45        43        —        88   

General and administrative expenses

     285        3        3,199        —        3,487   
                                       

Total expenses

     287        1,457        7,058        —        8,802   
                                       

LOSS FROM OPERATIONS

     (286     (460     (520     —        (1,266

OTHER (EXPENSES) INCOME:

           

Interest expense

     (903     (213     (21     —        (1,137

Investment income and other

     73        (69     6        —        10   

Equity earnings in subsidiaries

     (1,273     (531     —          1,804      —     

Foreign transaction gain (loss)

     (4     —          4        —        —     
                                       

LOSS BEFORE INCOME TAXES

     (2,393     (1,273     (531     1,804      (2,393

Provision for income taxes

     —          —          —          —        —     
                                       

NET LOSS

   $ (2,393   $ (1,273   $ (531   $ 1,804    $ (2,393
                                       

 

31


Table of Contents

GASTAR EXPLORATION LTD. AND SUBSIDIARIES

(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

Condensed Consolidating Parent and Issuer Subsidiaries Statements of Operations

For the Three Months Ended June 30, 2008

(Unaudited)

 

     Parent     Issuer     Issuer
Subsidiaries
    Reclassifications
and
Eliminations
    Gastar
Exploration Ltd.
and

Subsidiaries
 
     (in thousands)  

REVENUES:

          

Natural gas and oil revenues

   $ —        $ 3,744      $ 12,140      $ —        $ 15,884   

Unrealized natural gas hedge loss

     —          140        (653     —          (513
                                        

Total revenues

     —          3,884        11,487        —          15,371   

EXPENSES:

          

Production taxes

     —          421        53        —          474   

Lease operating expenses

     —          702        1,706        —          2,408   

Transportation and treating

     —          498        —          —          498   

Depreciation, depletion and amortization

     —          —          5,890        —          5,890   

Accretion of asset retirement obligation

     —          44        38        —          82   

General and administrative expenses

     292        (26     3,798        —          4,064   
                                        

Total expenses

     292        1,639        11,485        —          13,416   
                                        

INCOME (LOSS) FROM OPERATIONS

     (292     2,245        2        —          1,955   

OTHER (EXPENSES) INCOME:

          

Interest expense

     (943     (947     1        —          (1,889

Investment income and other

     17        (7     471        —          481   

Equity earnings in subsidiaries

     1,765        474        —          (2,239     —     

Foreign transaction loss

     (1     —          —          —          (1
                                        

INCOME BEFORE INCOME TAXES

     546        1,765        474        (2,239     546   

Provision for income taxes

     —          —          —          —          —     
                                        

NET INCOME

   $ 546      $ 1,765      $ 474      $ (2,239   $ 546   
                                        

 

32


Table of Contents

GASTAR EXPLORATION LTD. AND SUBSIDIARIES

(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

Condensed Consolidating Parent and Issuer Subsidiaries Statements of Operations

For the Six Months Ended June 30, 2009

(Unaudited)

 

     Parent     Issuer     Issuer
Subsidiaries
    Reclassifications
and
Eliminations
   Gastar
Exploration Ltd.
and

Subsidiaries
 
     (in thousands)  

REVENUES:

           

Natural gas and oil revenues

   $ 1      $ 2,607      $ 22,815      $ —      $ 25,423   

Unrealized natural gas hedge loss

     —          (478     (4,144     —        (4,622
                                       

Total revenues

     1        2,129        18,671        —        20,801   

EXPENSES:

           

Production taxes

     —          229        20        —        249   

Lease operating expenses

     2        1,175        2,149        —        3,326   

Transportation and treating

     —          818        —          —        818   

Depreciation, depletion and amortization

     —          1,181        10,179        —        11,360   

Impairment of natural gas and oil properties

     —          6,212        62,517        —        68,729   

Accretion of asset retirement obligation

     —          90        85        —        175   

General and administrative expenses

     556        51        5,838        —        6,445   
                                       

Total expenses

     558        9,756        80,788        —        91,102   
                                       

LOSS FROM OPERATIONS

     (557     (7,627     (62,117     —        (70,301

OTHER (EXPENSES) INCOME:

           

Interest expense

     (1,839     (395     (65     —        (2,299

Investment income and other

     93        (85     15        —        23   

Equity earnings in subsidiaries

     (70,271     (62,164     —          132,435      —     

Foreign transaction gain (loss)

     (6     —          3        —        (3
                                       

LOSS BEFORE INCOME TAXES

     (72,580     (70,271     (62,164     132,435      (72,580

Provision for income taxes

     —          —          —          —        —     
                                       

NET LOSS

   $ (72,580   $ (70,271   $ (62,164   $ 132,435    $ (72,580
                                       

 

33


Table of Contents

GASTAR EXPLORATION LTD. AND SUBSIDIARIES

(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

Condensed Consolidating Parent and Issuer Subsidiaries Statements of Operations

For the Six Months Ended June 30, 2008

(Unaudited)

 

     Parent     Issuer     Issuer
Subsidiaries
    Reclassifications
and
Eliminations
    Gastar
Exploration Ltd.
and

Subsidiaries
 
     (in thousands)  

REVENUES:

          

Natural gas and oil revenues

   $ 1      $ 6,878      $ 25,851      $ —        $ 32,730   

Unrealized natural gas hedge loss

     —          (76     (1,850     —          (1,926
                                        

Total revenues

     1        6,802        24,001        —          30,804   

EXPENSES:

          

Production taxes

     —          769        (26     —          743   

Lease operating expenses

     —          1,406        2,544        —          3,950   

Transportation and treating

     —          957        —          —          957   

Depreciation, depletion and amortization

     —          —          12,299        —          12,299   

Accretion of asset retirement obligation

     —          84        80        —          164   

General and administrative expenses

     589        16        7,734        —          8,339   
                                        

Total expenses

     589        3,232        22,631        —          26,452   
                                        

INCOME (LOSS) FROM OPERATIONS

     (588     3,570        1,370        —          4,352   

OTHER (EXPENSES) INCOME:

          

Interest expense

     (1,887     (2,093     (5     —          (3,985

Investment income and other

     38        (17     1,283        —          1,304   

Equity earnings in subsidiaries

     4,114        2,654        —          (6,768     —     

Foreign transaction (loss) gain

     (44     —          6        —          (38
                                        

INCOME BEFORE INCOME TAXES

     1,633        4,114        2,654        (6,768     1,633   

Provision for income taxes

     —          —          —          —          —     
                                        

NET INCOME

   $ 1,633      $ 4,114      $ 2,654      $ (6,768   $ 1,633   
                                        

 

34


Table of Contents

GASTAR EXPLORATION LTD. AND SUBSIDIARIES

(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

Condensed Consolidating Parent and Issuer Subsidiaries Statements of Cash Flows

For the Six Months Ended June 30, 2009

(Unaudited)

 

    Parent     Issuer     Issuer
Subsidiaries
    Reclassifications
and
Eliminations
    Gastar
Exploration Ltd.
and

Subsidiaries
 
    (in thousands)  

CASH FLOWS FROM OPERATING ACTIVITIES:

         

Net loss

  $ (72,580   $ (70,271   $ (62,164   $ 132,435      $ (72,580

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

         

Depreciation, depletion and amortization

    —          1,181        10,179        —          11,360   

Impairment of natural gas and oil properties

    —          6,212        62,517        —          68,729   

Stock-based compensation

    —          —          2,134        —          2,134   

Unrealized natural gas hedge income

    —          478        4,144        —          4,622   

Monetization of derivative contracts

    —          —          2,465        —          2,465   

Amortization of other comprehensive income

    —          —          (1,685     —          (1,685

Amortization of deferred financing costs and debt discount

    269        1,139        —          —          1,408   

Accretion of asset retirement obligation

    —          90        85        —          175   

Equity in loss of issuer subsidiaries

    70,271        62,164        —          (132,435     —     

Changes in operating assets and liabilities, exclusive of effects of acquisition:

         

Accounts receivable

    (1     —          3,475        —          3,474   

Prepaid expenses

    119        84        165        —          368   

Accounts payable and accrued liabilities

    20        849        (5,937     —          (5,068
                                       

Net cash provided by (used in) operating activities

    (1,902     1,926        15,378        —          15,402   
                                       

CASH FLOWS FROM INVESTING ACTIVITIES:

         

Development and purchases of natural gas and oil properties

    —          (5,626     (27,403     —          (33,029

Drilling advances

    —          —          (4,791     —          (4,791

Purchase of furniture and equipment

    —          (4     (9     —          (13

Subsidiary equity investment/repayments

    —          —          17,990        (17,990     —     
                                       

Net cash used in investing activities

    —          (5,630     (14,213     (17,990     (37,833
                                       

CASH FLOWS FROM FINANCING ACTIVITIES:

         

Proceeds from the issuance of common shares

    13,819        —          —          —          13,819   

Repayment of revolving credit facility

    —          (4,975     —          —          (4,975

Repayment of subordinated unsecured notes

    (2,950     —          —          —          (2,950

Proceeds from term loan

    —          25,000        —          —          25,000   

Subsidiary equity investment/repayments

    (8,740     (9,250     —          17,990        —     

Increase in restricted cash

    —          —          (463     —          (463

Deferred financing charges

    —          (1,430     —          —          (1,430

Other

    (215     —          (9     —          (224
                                       

Net cash provided by (used in) financing activities

    1,914        9,345        (472     17,990        28,777   
                                       

NET INCREASE IN CASH AND CASH EQUIVALENTS

    12        5,641        693        —          6,346   

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

    39        25        6,089        —          6,153   
                                       

CASH AND CASH EQUIVALENTS, END OF PERIOD

  $ 51      $ 5,666      $ 6,782      $ —        $ 12,499   
                                       

 

35


Table of Contents

GASTAR EXPLORATION LTD. AND SUBSIDIARIES

(NOTES TO CONSOLIDATED FINANCIAL STATEMENTS) – (Continued)

 

Condensed Consolidating Parent and Issuer Subsidiaries Statements of Cash Flows

For the Six Months Ended June 30, 2008

(Unaudited)

 

     Parent     Issuer     Issuer
Subsidiaries
    Reclassifications
and
Eliminations
    Gastar
Exploration Ltd.
and

Subsidiaries
 
     (in thousands)  

CASH FLOWS FROM OPERATING ACTIVITIES:

          

Net income

   $ 1,633      $ 4,114      $ 2,654      $ (6,768   $ 1,633   

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

          

Depreciation, depletion and amortization

     —          —          12,299        —          12,299   

Stock based compensation

     —          —          1,711        —          1,711   

Unrealized natural gas hedge loss

     —          76        1,850        —          1,926   

Amortization of deferred financing costs and debt discount

     269        679        —          —          948   

Accretion of asset retirement obligation

     —          84        80        —          164   

Equity in income of issuer subsidiaries

     (4,114     (2,654     —          6,768        —     

Changes in operating assets and liabilities, exclusive of effects of acquisition:

          

Restricted cash for hedging program

     1,000        —          —          —          1,000   

Accounts receivable

     6        (370     (4,355     —          (4,719

Prepaid expenses

     143        (76     158        —          225   

Accounts payable and accrued liabilities

     (183     470        8,784        —          9,071   
                                        

Net cash provided by (used in) operating activities

     (1,246     2,323        23,181        —          24,258   
                                        

CASH FLOWS FROM INVESTING ACTIVITIES:

          

Development and purchases of natural gas and oil properties

     —          (8,683     (57,507     —          (66,190

Drilling advances

     —          —          (1,551     —          (1,551

Purchase of furniture and equipment

     —          —          (131     —          (131

Subsidiary equity investment repayments

     —          —          (7,987     7,987        —     

Other

     —          (50     —          —          (50
                                        

Net cash used in investing activities

     —          (8,733     (67,176     7,987        (67,922
                                        

CASH FLOWS FROM FINANCING ACTIVITIES:

          

Subsidiary equity investment repayments

     1,342        6,645        —          (7,987     —     

Increase (decrease) in restricted cash

     4        —          (1     —          3   

Deferred financing charges and other

     6        (235     52        —          (177