DPTR Delta Petroleum Corp. (MM)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2011

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

For the transition period from                      to                     

Commission file number 0-16203

DELTA PETROLEUM CORPORATION

(Exact name of registrant as specified in its charter)

Delaware		84-1060803
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
370 17th Street, Suite 4300
Denver, Colorado		80202
(Address of principal executive offices)		(Zip Code)

(303) 293-9133
(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 þ No o

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

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

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o

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

28,870,167 shares of common stock, $.01 par value per share, were outstanding as of November 1, 2011.

 

 

INDEX

		Page No.
PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets – September 30, 2011 and December 31, 2010 (unaudited)			1
Consolidated Statements of Operations – Three Months Ended September 30, 2011 and 2010 (unaudited)			2
Consolidated Statements of Operations – Nine Months Ended September 30, 2011 and 2010 (unaudited)			3
Consolidated Statement of Changes in Equity – Nine Months Ended September 30, 2011 (unaudited)			4
Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2011 and 2010 (unaudited)			5
Notes to Consolidated Financial Statements (unaudited)			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
Item 3. Quantitative and Qualitative Disclosures About Market Risk			46
Item 4. Controls and Procedures			47
PART II OTHER INFORMATION
Item 1. Legal Proceedings			47
Item 1A. Risk Factors			48
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			49
Item 5. Other Information			49
Item 6. Exhibits			50
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

The terms “Delta,” “Company,” “we,” “our,” and “us” refer to Delta Petroleum Corporation and its consolidated entities unless the context suggests otherwise.

I 

PART I FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

		September 30,				December 31,
		2011				2010
		(In thousands, except share data)
ASSETS
Current assets:
Cash and cash equivalents		$	2,101			$	14,190
Short-term restricted deposits			100,000				100,000
Trade accounts receivable, net of allowance for doubtful accounts of $175 and $100, respectively			7,598				7,373
Assets held for sale – DHS subsidiary			70,819				108,218
Deposits and prepaid assets			1,790				1,720
Inventories			153				3,446
Derivative instruments			1,463				—
Other current assets			1,344				4,821
Total current assets			185,268				239,768
Property and equipment:
Oil and gas properties, successful efforts method of accounting:
Unproved			72,190				229,943
Proved			684,539				671,041
Pipeline and gathering systems			63,842				93,558
Other			11,713				13,556
Total property and equipment			832,284				1,008,098
Less accumulated depreciation and depletion			(469,762	)			(232,493	)
Net property and equipment			362,522				775,605
Long-term assets:
Investments in unconsolidated affiliates			3,599				3,376
Deferred financing costs			1,299				1,832
Other long-term assets			1,583				3,531
Total long-term assets			6,481				8,739
Total assets		$	554,271			$	1,024,112
LIABILITIES AND EQUITY
Current liabilities:
Credit facility – Delta		$	21,000			$	—
Installment payable on property acquisition			99,785				97,874
3 3 / 4 % Senior convertible notes – current			112,167				—
Accounts payable			18,152				27,616
Liabilities related to assets held for sale – DHS subsidiary			78,829				82,852
Other accrued liabilities			12,662				11,066
Derivative instruments			—				574
Total current liabilities			342,595				219,982
Long-term liabilities:
7% Senior notes			149,741				149,684
3 3 / 4 % Senior convertible notes			—				108,593
Credit facility – Delta			—				29,130
Asset retirement obligations			3,354				2,709
Derivative instruments			319				2,419
Total long-term liabilities			153,414				292,535
Commitments and contingencies
Equity:
Preferred stock, $.01 par value: authorized 3,000,000 shares, none issued			—				—
Common stock, $.01 par value: authorized 200,000,000 shares, issued 28,870,000 shares at September 30, 2011 and 28,513,800 shares at December 31, 2010 (1)			289				285
Additional paid-in capital			1,640,591				1,635,783
Treasury stock at cost; zero shares at September 30, 2011 and 3,300 shares at December 31, 2010 (1)			—				(279	)
Accumulated deficit			(1,579,578	)			(1,121,342	)
Total Delta stockholders’ equity			61,302				514,447
Non-controlling interest			(3,040	)			(2,852	)
Total equity			58,262				511,595
Total liabilities and equity		$	554,271			$	1,024,112

See accompanying notes to consolidated financial statements.

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

		Three Months Ended
		September 30,
		2011				2010
		(In thousands, except per share amounts)
Revenue:
Oil and gas sales		$	16,546			$	12,653
Loss on property sales			—				(1	)
Total revenue			16,546				12,652
Operating expenses:
Lease operating expense			3,577				4,555
Transportation expense			3,367				3,298
Production taxes			633				667
Exploration expense			53				368
Dry hole costs and impairments			420,447				(1,164	)
Depreciation, depletion, amortization and accretion			10,701				11,522
General and administrative expense			6,065				7,872
Executive severance expense, net			—				(674	)
Total operating expenses			444,843				26,444
Operating loss			(428,297	)			(13,792	)
Other income and (expense):
Interest expense and financing costs, net			(6,727	)			(7,567	)
Other income (expense)			(1,857	)			508
Realized gain (loss) on derivative instruments, net			79				(418	)
Unrealized gain on derivative instruments, net			6,749				7,124
Income (loss) from unconsolidated affiliates			80				(90	)
Total other expense			(1,676	)			(443	)
Loss from continuing operations before income taxes and discontinued operations			(429,973	)			(14,235	)
Income tax expense			64				86
Loss from continuing operations			(430,037	)			(14,321	)
Discontinued operations:
Gain from results of operations and sale of discontinued operations, net of tax			1,309				25,054
Net income (loss)			(428,728	)			10,733
Less net (gain) loss attributable to non-controlling interest included in discontinued operations			(702	)			3,209
Net income (loss) attributable to Delta common stockholders		$	(429,430	)		$	13,942
Amounts attributable to Delta common stockholders:
Loss from continuing operations		$	(430,037	)		$	(14,321	)
Gain from discontinued operations, net of tax			607				28,263
Net income (loss)		$	(429,430	)		$	13,942
Basic loss attributable to Delta common stockholders per common share: (1)
Loss from continuing operations		$	(15.42	)		$	(0.52	)
Discontinued operations			0.02				1.03
Net income (loss)		$	(15.40	)		$	0.51
Diluted loss attributable to Delta common stockholders per common share: (1)
Loss from continuing operations		$	(15.42	)		$	(0.51	)
Discontinued operations			0.02				1.00
Net income (loss)		$	(15.40	)		$	0.49

See accompanying notes to consolidated financial statements.

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

		Nine Months Ended
		September 30,
		2011				2010
		(In thousands, except per share amounts)
Revenue:
Oil and gas sales		$	51,143			$	47,138
Loss on property sales			—				(539	)
Total revenue			51,143				46,599
Operating expenses:
Lease operating expense			10,535				15,082
Transportation expense			10,935				10,940
Production taxes			2,094				2,358
Exploration expense			329				952
Dry hole costs and impairments			420,863				29,762
Depreciation, depletion, amortization and accretion			33,180				35,410
General and administrative expense			19,165				28,770
Executive severance expense, net			—				(674	)
Total operating expenses			497,101				122,600
Operating loss			(445,958	)			(76,001	)
Other income and (expense):
Interest expense and financing costs, net			(21,530	)			(24,050	)
Other income (expense)			(1,693	)			686
Realized loss on derivative instruments, net			(5,371	)			(5,132	)
Unrealized gain on derivative instruments, net			4,137				28,072
Income from unconsolidated affiliates			294				893
Total other income and (expense)			(24,163	)			469
Loss from continuing operations before income taxes and discontinued operations			(470,121	)			(75,532	)
Income tax expense (benefit)			(4,568	)			564
Loss from continuing operations			(465,553	)			(76,096	)
Discontinued operations:
Gain (loss) from results of operations and sale of discontinued operations, net of tax			7,092				(81,644	)
Net loss			(458,461	)			(157,740	)
Less net loss attributable to non-controlling interest included in discontinued operations			225				9,134
Net loss attributable to Delta common stockholders		$	(458,236	)		$	(148,606	)
Amounts attributable to Delta common stockholders:
Loss from continuing operations		$	(465,553	)		$	(76,096	)
Gain (loss) from discontinued operations, net of tax			7,317				(72,510	)
Net loss		$	(458,236	)		$	(148,606	)
Basic loss attributable to Delta common stockholders per common share: (1)
Loss from continuing operations		$	(16.59	)		$	(2.76	)
Discontinued operations			0.26				(2.64	)
Net loss		$	(16.33	)		$	(5.40	)
Diluted loss attributable to Delta common stockholders per common share: (1)
Loss from continuing operations		$	(16.59	)		$	(2.76	)
Discontinued operations			0.26				(2.64	)
Net loss		$	(16.33	)		$	(5.40	)

See accompanying notes to consolidated financial statements.

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(Unaudited)

										Additional												Accu-				Total Delta				Non-
		Common stock								paid-in				Treasury stock								mulated				stockholders’				controlling				Total
		Shares (1)				Amount				capital				Shares (1)				Amount				deficit				equity				interest				equity
		(In thousands)
Balance, December 31, 2010			28,514			$	285			$	1,635,783				3			$	(279	)		$	(1,121,342	)		$	514,447			$	(2,852	)		$	511,595
Net loss			—				—				—				—				—				(458,236	)			(458,236	)			(225	)			(458,461	)
Employee vesting of treasury stock held by subsidiary			—				—				(135	)			(3	)			279				—				144				(59	)			85
Issuance of vested stock			598				6				(6	)			—				—				—				—				—				—
Shares repurchased for withholding taxes			(216	)			(2	)			(1,016	)			—				—				—				(1,018	)			—				(1,018	)
Forfeitures			(26	)			—				—				—				—				—				—				—				—
Stock based compensation			—				—				5,965				—				—				—				5,965				96				6,061
Balance, September 30, 2011			28,870			$	289			$	1,640,591				—			$	—			$	(1,579,578	)		$	61,302			$	(3,040	)		$	58,262

See accompanying notes to consolidated financial statements.

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

		Nine Months Ended
		September 30,
		2011				2010
		(In thousands)
Cash flows from operating activities:
Net loss		$	(458,461	)		$	(157,740	)
Adjustments to reconcile net loss to cash provided by (used in) operating activities:
Loss on property sales			112				—
Depreciation, depletion, amortization – oil and gas			33,180				35,410
Depreciation, depletion, amortization – discontinued operations			5,464				39,565
(Gain) loss on sale of drilling assets – discontinued operations			(2,470	)			782
Gain on sale of oil and gas assets – discontinued operations			(8,946	)			(28,372	)
Impairments – discontinued operations			—				93,260
Dry hole costs and impairments			420,863				29,762
Stock based compensation			6,497				8,808
Executive severance – stock-based awards forfeited			—				(2,274	)
Amortization of deferred financing costs, bond discount, and installments payable discount			8,748				10,930
Increase in allowance for bad debt			—				1,437
Unrealized gain on derivative contracts			(4,137	)			(28,072	)
Income from unconsolidated affiliates			(294	)			(893	)
Deferred income tax expense			717				564
Other			1,144				47
Net changes in operating assets and liabilities:
Increase in trade accounts receivable			(303	)			(318	)
Increase in deposits and prepaid assets			(108	)			(242	)
Increase in inventories			(68	)			—
(Increase) decrease in other current assets			(13	)			919
Increase (decrease) in accounts payable			969				(20,627	)
Increase (decrease) in other accrued liabilities			2,134				(8,904	)
Increase in assets held for sale working capital, net			1,492				—
Net cash provided by (used in) operating activities			6,520				(25,958	)
Cash flows from investing activities:
Additions to property and equipment			(50,752	)			(24,959	)
Additions to drilling and trucking equipment – assets held for sale			(1,529	)			(1,322	)
Proceeds from sale of oil and gas properties			42,085				115,180
Proceeds from sale of drilling assets – assets held for sale			3,429				547
Proceeds from sale of other fixed assets			61				54
Proceeds from sale of unconsolidated affiliates			1,517				3,879
Proceeds from escrow deposit			—				1,380
Increase (decrease) in other long-term assets			(7	)			81
Net cash provided by (used in) investing activities			(5,196	)			94,840
Cash flows from financing activities:
Proceeds from borrowings			55,202				86,500
Repayments of borrowings			(66,617	)			(200,716	)
Payment of deferred financing costs			(979	)			(1,641	)
Stock repurchased for withholding taxes			(1,019	)			(746	)
Net cash used in financing activities			(13,413	)			(116,603	)
Net decrease in cash and cash equivalents			(12,089	)			(47,721	)
Cash at beginning of period			14,190				61,918
Cash at end of period		$	2,101			$	14,197
Supplemental cash flow information:
Cash paid for interest and financing costs		$	10,448			$	17,177
DHS interest payable capitalized to principal balance (non-cash financing transaction)		$	5,573			$	—

See accompanying notes to consolidated financial statements.

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES

Notes to Consolidated Financial Statements

Three and Nine Months Ended September 30, 2011 and 2010

(Unaudited)

(1) Nature of Organization and Basis of Presentation

Delta Petroleum Corporation (“Delta”), a Delaware corporation, and its consolidated subsidiaries (collectively, the “Company”) are principally engaged in acquiring, exploring, developing and producing oil and gas properties. The Company’s core area of operations is the Rocky Mountain Region in which the majority of its proved reserves, production and long-term growth prospects are concentrated.

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, in accordance with those rules, do not include all the information and notes required by generally accepted accounting principles for complete financial statements. As a result, these unaudited consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto previously filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. In the opinion of management, all adjustments, consisting only of normal recurring accruals, considered necessary for a fair presentation of the financial position of the Company and the results of its operations have been included. Operating results for interim periods are not necessarily indicative of the results that may be expected for the complete fiscal year. Subsequent events were evaluated through the date of issuance of these consolidated financial statements at the time this quarterly report on Form 10-Q was filed with the Securities and Exchange Commission (“SEC”). For a more complete understanding of the Company’s operations and financial position, reference is made to the consolidated financial statements of the Company, and related notes thereto, filed with the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, previously filed with the SEC.

(2) Going Concern

The accompanying financial statements have been prepared assuming the Company will continue as a going concern.

During the nine months ended September 30, 2011, the Company experienced a net loss attributable to Delta common stockholders of $458.2 million, and at September 30, 2011 had a working capital deficiency, excluding discontinued operations, of $149.3 million, including $21.0 million outstanding under the Third Amended and Restated Credit Agreement (the “MBL Credit Agreement”) with Macquarie Bank Limited (“MBL”) as administrative agent and issuing lender (which is classified as a current liability in the accompanying balance sheet). On June 28, 2011, the Company closed on a transaction with Wapiti Oil & Gas, L.L.C. (“Wapiti”) to sell its remaining interests in various non-core assets primarily located in Texas and Wyoming (the “2011 Wapiti Transaction”) for gross cash proceeds of approximately $43.2 million. Proceeds from the 2011 Wapiti Transaction were used to further reduce amounts outstanding under the MBL Credit Agreement, as well as to fund capital expenditures. The MBL Credit Agreement, as amended, provides for a revolving loan and a term loan, each with a maturity date of January 31, 2012. At September 30, 2011, $6.0 million was outstanding under the revolving loan and $15.0 million was outstanding under the term loan. In addition to the amounts outstanding under the MBL Credit Agreement which are due on January 31, 2012, the holders of the Company’s $115.0 million 3 ³ / ₄ % senior convertible notes have the option to require the Company to repurchase the notes at par on May 1, 2012 and thus, such amount is also classified as a current liability in the accompanying balance sheet.

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three and Nine Months Ended September 30, 2011 and 2010
(Unaudited)

(2) Going Concern, Continued

While the 2011 Wapiti Transaction and the MBL Credit Agreement provided capital to the Company that helped to improve its financial position at that time, the Company does not currently have adequate capital to repay its credit facility borrowings due on January 31, 2012 or fund the purchase of convertible notes if the holders of such notes elect to require the Company to repurchase such notes on May 1, 2012, as expected.

In July 2011, the Board of Directors of the Company announced that it had engaged Macquarie Capital (USA) Inc. and Evercore Group, L.L.C. to act as advisors to the Company in conducting a strategic alternatives process in order to maximize shareholder value and address the 2012 debt maturities. In the strategic alternatives process, the board of directors has considered a wide variety of possible transactions, including the sale of the company, issuances of equity or debt securities, sales of assets, joint ventures and volumetric production payment financing, as well as other potential corporate transactions. With respect to a potential sale of the company or its assets, the Company solicited offers from a significant number of potential purchasers, including domestic and foreign industry participants and private equity firms, and has engaged in substantive negotiations with several such potential purchasers. However, the Company has not received any definitive offer with respect to an acquisition of the company or its assets that implies a value of the assets that is greater than its aggregate indebtedness, and has not been able to identify any significant source of additional financing that is likely to be available on acceptable terms. Accordingly, based on the results of the process to date, the Company believes that a restructuring of the Company’s indebtedness is likely to be necessary. The Company is continuing to discuss potential transactions with potential purchasers and expects to engage in discussions with certain holders of its outstanding senior notes. There can be no assurance that these discussions will lead to a definitive agreement on acceptable terms, or at all, with any party. Any transaction that is agreed to could be highly dilutive to existing stockholders. If the Company is unsuccessful in consummating a transaction or transactions that address the Company’s liquidity issues, the Company will be required to seek protection under chapter 11 of the U.S. Bankruptcy Code.

The timing, structure, terms, size, and pricing of any transaction consummated as a result of the strategic alternatives process will depend many factors beyond the Company’s control, and there can be no assurance that the Company will be able to obtain any such financing or consummate any such transaction, and if so, that it will be on terms satisfactory to the Company. These factors along with the liquidity issues discussed above raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the uncertainty regarding the Company’s ability to raise additional capital, sell assets, or otherwise obtain sufficient funds to meet its obligations.

The Company believes that the amounts available under the MBL Credit Agreement, as amended, combined with projected net cash from operating activities, will provide sufficient liquidity to fund its operating expenses, the limited Vega Area capital development plan, and maintain current debt service obligations until the January 2012 maturity of the Company’s credit facility.

The DHS Drilling Company (“DHS”) credit facility debt of $71.9 million at September 30, 2011 is included in the accompanying consolidated balance sheets as a component of liabilities related to assets held for sale. The DHS facility is non-recourse to Delta. During the first quarter of 2011, the Board of Directors of DHS engaged transaction advisors to commence a strategic alternatives process, focused on a sale of DHS or substantially all of its assets. Subsequent to quarter end, Delta sold its stock in DHS to DHS’s lender, Lehman Commercial Paper, Inc. (“LCPI”), for $500,000. See Note 15, Subsequent Events.

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three and Nine Months Ended September 30, 2011 and 2010
(Unaudited)

(3) Summary of Significant Accounting Policies

Principles of Consolidation and Basis of Presentation

The consolidated financial statements include the accounts of Delta and its consolidated subsidiaries (collectively, the “Company”). All inter-company balances and transactions have been eliminated in consolidation. Certain of the Company’s oil and gas activities are conducted through partnerships and joint ventures, including CRB Partners, LLC (“CRBP”) and through the date of the divestiture in 2010 to Wapiti, PGR Partners, LLC (“PGR”). The Company includes its proportionate share of assets, liabilities, revenues and expenses from these entities in its consolidated financial statements. The Company does not have any off-balance sheet financing arrangements (other than operating leases) or any unconsolidated special purpose entities.

Investments in operating entities where the Company has the ability to exert significant influence, but does not control the operating and financial policies, are accounted for using the equity method. The Company’s share of net income of these entities is recorded as income (losses) from unconsolidated affiliates in the consolidated statements of operations.

Certain reclassifications have been made to amounts reported in the previous periods to conform to the current presentation. Among other items, revenues and expenses on certain properties that were sold or held for sale during the three and nine months ended September 30, 2011 have been reclassified from continuing operations to discontinued operations for all periods presented. In addition, the assets and liabilities of DHS, and oil and gas properties that were sold or held for sale, have been separately reflected in the accompanying consolidated balance sheets as assets held for sale and liabilities related to assets held for sale. Such reclassifications had no effect on net loss (See Note 4, “Discontinued Operations”).

Property and Equipment

The Company accounts for its natural gas and crude oil exploration and development activities under the successful efforts method of accounting. Under such method, costs of productive exploratory wells, development dry holes and productive wells and undeveloped leases are capitalized. Oil and gas lease acquisition costs are also capitalized. Exploration costs, including personnel costs, certain geological or geophysical expenses and delay rentals for gas and oil leases, are charged to expense as incurred. Exploratory drilling costs are initially capitalized, then evaluated quarterly and charged to expense if and when the well is determined not to have found reserves in commercial quantities. The sale of a partial interest in a proved property is accounted for as a cost recovery and no gain or loss is recognized as long as this treatment does not significantly affect the units-of-production amortization rate. A gain or loss is recognized for all other sales of producing properties.

Unproved properties with significant acquisition costs are assessed quarterly on a property-by-property basis and any impairment in value is charged to expense. If the unproved properties are determined to be productive, the related costs are transferred to proved gas and oil properties. Proceeds from sales of partial interests in unproved leases are accounted for as a recovery of cost without recognizing any gain or loss until all costs have been recovered.

Depreciation and depletion of capitalized acquisition, exploration and development costs are computed on the units-of-production method by individual fields as the related proved reserves are produced.

Gathering systems and other property and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives ranging from three to 40 years.

Impairment of Long-Lived Assets

Long-lived assets are reviewed for impairment when events or changes in circumstances indicate that the carrying value of such assets may not be recoverable.

Estimates of expected future cash flows represent management’s best estimate based on reasonable and supportable assumptions and projections. For proved properties, if the expected future cash flows exceed the carrying value of the

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three and Nine Months Ended September 30, 2011 and 2010
(Unaudited)

(3) Summary of Significant Accounting Policies, Continued

asset, no impairment is recognized. If the carrying value of the asset exceeds the expected future cash flows, an impairment exists and is measured by the excess of the carrying value over the estimated fair value of the asset. Any impairment provisions recognized are permanent and may not be restored in the future.

The Company assesses proved properties on an individual field basis for impairment on at least an annual basis. For proved properties, the review consists of a comparison of the carrying value of the asset with the asset’s expected future undiscounted cash flows without interest costs. For the three and nine months ended 2010, the expected future undiscounted cash flows of the assets exceeded the carrying value of the corresponding asset and as such no impairment provisions were recognized.

For unproved properties, the need for an impairment charge is based on the Company’s plans for future development and other activities impacting the life of the property and the ability of the Company to recover its investment. When the Company believes the costs of the unproved property are no longer recoverable, an impairment charge is recorded based on the estimated fair value of the property. For the three and nine months ended September 30, 2010, zero and $25.7 million, respectively, of unproved property impairments were recorded.

During the three months ended September 30, 2011, the Company evaluated the fair value of its properties based on market indicators in conjunction with the progression of the strategic alternatives evaluation process. The Company has not received any definitive offer with respect to an acquisition of the Company or its assets that implies a value of the assets that is greater than the Company’s aggregate indebtedness. As a result, the Company recorded an impairment of $157.5 million to its Vega unproved leasehold, $239.8 million to its Vega area proved properties, $20.5 million to its Vega area gathering system and facilities, and $2.1 million to its Vega area surface acreage.

Exploratory Well Costs

		Nine Months Ended
		September 30, 2011
		(in thousands)
Balance at beginning of year		$	6,200
Additions to capitalized exploratory well costs pending the determination of proved reserves			6,200
Exploratory well costs included in property divestitures			—
Reclassified to proved oil and gas properties based on the determination of proved reserves			(6,200	)
Capitalized exploratory well costs charged to dry hole expense			—
Balance at end of period		$	6,200
Exploratory well costs capitalized for one year or less after after completion of drilling			6,200
Exploratory well costs capitalized for greater than one year after completion of drilling			—
Balance at end of period		$	6,200

The table does not include amounts that were capitalized and either subsequently expensed or reclassified to producing well costs in the same period. During 2010, the Company spud a deep test well in the Vega Area to explore the Company’s Piceance leasehold below the currently productive Williams Fork zone. Completion activities on the well began in February 2011 and the well was completed as a producing well with proved reserves during the three months ended September 30, 2011. A second deep test well was spud and completed as a producing well with proved reserves during the nine months ended September 30, 2011 and therefore is not included in the table above. A third deep test well was spud during the second quarter of 2011 and remains in progress.

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three and Nine Months Ended September 30, 2011 and 2010
(Unaudited)

(3) Summary of Significant Accounting Policies, Continued

Asset Retirement Obligations

The Company’s asset retirement obligations arise from the plugging and abandonment liabilities for its oil and gas wells.

The following is a reconciliation of the Company’s asset retirement obligations from January 1, 2011 to September 30, 2011 (in thousands):

Asset retirement obligation – January 1, 2011		$	5,146
Reclassification for assets held for sale			(1,215	)
Adjusted asset retirement obligation – January 1, 2011			3,931
Accretion expense			211
Change in estimate			(98	)
Obligations incurred (from new wells)			375
Obligations settled			(20	)
Obligations on sold properties			(359	)
Asset retirement obligation – September 30, 2011			4,040
Less: Current portion of asset retirement obligation			(686	)
Long-term asset retirement obligation		$	3,354

Notes Receivable from Disposition of Unconsolidated Affiliates

During the third quarter of 2011, the Company entered into a settlement agreement with a third party to mutually release all claims associated with several prior agreements. In consideration of this settlement, Delta assigned its interest in the note receivable related to the sale of Delta Oilfield Tank Company (“DOTC”) to the third party. A loss of $1.6 million is included as a component of other expense for the three months ended September 30, 2011.

During the third quarter of 2011, the Company accepted a prepayment of $500,000 as payment in full for the outstanding note receivable related to the sale of Ally Equipment (“Ally”), forgoing $11,000 of accrued interest.

Comprehensive Income (Loss)

Comprehensive income (loss) includes all changes in equity during a period except those resulting from investments by owners and distributions to owners, if any. For the three months ended September 30, 2011 and 2010, comprehensive income (loss) attributable to Delta common stockholders was ($429.4) million and $13.9 million, respectively. For the nine months ended September 30, 2011 and 2010, comprehensive loss attributable to Delta common stockholders was ($458.2) million and ($148.6) million, respectively.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles 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. Significant estimates include oil and gas reserves, bad debts, depletion and impairment of oil and gas properties, income taxes, derivatives, asset retirement obligations, contingencies and litigation accruals. Actual results could differ from these estimates.

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three and Nine Months Ended September 30, 2011 and 2010
(Unaudited)

(4) Discontinued Operations

During the third quarter of 2010, the Company closed a transaction with Wapiti (the “2010 Wapiti Transaction”), selling all or a portion of the Company’s interest in various non-core assets primarily located in Colorado, Texas, and Wyoming for gross proceeds of $130.0 million. During the second quarter of 2011, the Company closed the 2011 Wapiti Transaction, selling the remaining portion of its interests in non-core assets primarily located in Texas and Wyoming for gross cash proceeds of approximately $43.2 million. In accordance with accounting standards, the results of operations relating to these properties have been reflected as discontinued operations for all periods presented. In addition, the assets and liabilities related to the oil and gas properties in the 2011 Wapiti Transaction have been separately reflected in the accompanying consolidated balance sheet as of December 31, 2010 as assets held for sale and liabilities related to assets held for sale.

In separate transactions in 2010, the Company sold its interest in the Howard Ranch field and the Laurel Ridge field and has included these properties in discontinued operations as well.

During the three months ended March 31, 2011, the Board of Directors of DHS engaged transaction advisors to commence a strategic alternatives process, focused on a sale of DHS or substantially all of its assets. As such, in accordance with accounting standards, the results of operations relating to DHS have been reflected as discontinued operations. In addition, the assets and liabilities of DHS have been separately reflected in the accompanying consolidated balance sheets as assets held for sale and liabilities related to assets held for sale. See Note 15, Subsequent Events regarding the sale of DHS which occurred subsequent to quarter end.

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three and Nine Months Ended September 30, 2011 and 2010
(Unaudited)

(4) Discontinued Operations, Continued

The following table shows the oil and gas segment and drilling segment revenues and expenses included in discontinued operations as described above for the three months ended September 30, 2011 and 2010 (in thousands):

		Three Months Ended												Three Months Ended
		September 30, 2011												September 30, 2010
		Oil & Gas				Drilling				Total				Oil & Gas				Drilling				Total
Revenues:
Oil and gas sales		$	197			$	—			$	197			$	8,924			$	—			$	8,924
Contract drilling and trucking fees			—				14,757				14,757				—				15,204				15,204
Total Revenues			197				14,757				14,954				8,924				15,204				24,128
Operating Expenses:
Lease operating expense			(212	)			—				(212	)			1,843				—				1,843
Transportation expense			(28	)			—				(28	)			270				—				270
Production taxes			(35	)			—				(35	)			446				—				446
Depreciation, depletion, amortization and accretion – oil and gas			—				—				—				2,921				—				2,921
Impairment provision (1)			—				—				—				902				—				902
Drilling and trucking operating expenses			—				11,086				11,086				—				12,041				12,041
Depreciation and amortization – drilling and trucking (2)			—				—				—				—				4,801				4,801
General and administrative expense			—				722				722				—				2,473				2,473
Total operating expenses			(275	)			11,808				11,533				6,382				19,315				25,697
Operating income (loss)			472				2,949				3,421				2,542				(4,111	)			(1,569	)
Other income and (expense):
Interest expense and financing costs, net			—				(2,075	)			(2,075	)			—				(1,743	)			(1,743	)
Other income (expense)			—				137				137				—				(544	)			(544	)
Total other income and (expense)			—				(1,938	)			(1,938	)			—				(2,287	)			(2,287	)
Income (loss) from discontinued operations			472				1,011				1,483				2,542				(6,398	)			(3,856	)
Income tax expense (3)			(174	)			—				(174	)			—				—				—
Income (loss) from results of operations of discontinued operations, net of tax			298				1,011				1,309				2,542				(6,398	)			(3,856	)
Gain on sales of discontinued operations, net of tax (4)			—				—				—				28,910				—				28,910
Gain (loss) from results of operations and sale of discontinued operations, net of tax		$	298			$	1,011			$	1,309			$	31,452			$	(6,398	)		$	25,054

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three and Nine Months Ended September 30, 2011 and 2010
(Unaudited)

(4) Discontinued Operations, Continued

The following table shows the oil and gas segment and drilling segment revenues and expenses included in discontinued operations as described above for the nine months ended September 30, 2011 and 2010 (in thousands):

		Nine Months Ended												Nine Months Ended
		September 30, 2011												September 30, 2010
		Oil & Gas				Drilling				Total				Oil & Gas				Drilling				Total
Revenues:
Oil and gas sales		$	10,131			$	—			$	10,131			$	37,219			$	—			$	37,219
Contract drilling and trucking fees			—				41,150				41,150				—				36,200				36,200
Total Revenues			10,131				41,150				51,281				37,219				36,200				73,419
Operating Expenses:
Lease operating expense			2,305				—				2,305				8,497				—				8,497
Transportation expense			(6	)			—				(6	)			1,714				—				1,714
Production taxes			367				—				367				2,013				—				2,013
Depreciation, depletion, amortization and accretion – oil and gas			2,795				—				2,795				23,966				—				23,966
Impairment provision (1)			—				—				—				93,260				—				93,260
Drilling and trucking operating expenses			—				33,593				33,593				—				28,053				28,053
Depreciation and amortization – drilling and trucking (2)			—				2,669				2,669				—				15,599				15,599
General and administrative expense			—				2,806				2,806				—				4,602				4,602
Total operating expenses			5,461				39,068				44,529				129,450				48,254				177,704
Operating income (loss)			4,670				2,082				6,752				(92,231	)			(12,054	)			(104,285	)
Other income and (expense):
Interest expense and financing costs, net			—				(6,204	)			(6,204	)			—				(5,376	)			(5,376	)
Other income (expense)			—				2,625				2,625				—				(893	)			(893	)
Total other income and (expense)			—				(3,579	)			(3,579	)			—				(6,269	)			(6,269	)
Income (loss) from discontinued operations			4,670				(1,497	)			3,173				(92,231	)			(18,323	)			(110,554	)
Income tax expense (3)			(1,724	)			—				(1,724	)			—				—				—
Income (loss) from results of operations of discontinued operations, net of tax			2,946				(1,497	)			1,449				(92,231	)			(18,323	)			(110,554	)
Gain on sales of discontinued operations (4)			5,643				—				5,643				28,910				—				28,910
Gain (loss) from results of operations and sale of discontinued operations, net of tax		$	8,589			$	(1,497	)		$	7,092			$	(63,321	)		$	(18,323	)		$	(81,644	)

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three and Nine Months Ended September 30, 2011 and 2010
(Unaudited)

(5) DHS Drilling

The carrying value of DHS’s drilling rigs and related equipment is assessed for impairment whenever circumstances indicate an impairment may exist. No such impairment provisions were recorded during the three and nine months ended September 30, 2011 and 2010. Subsequent to quarter end, Delta sold its stock in DHS to DHS’s lender, LCPI, for $500,000. See Note 15, Subsequent Events.

In January 2010, DHS entered into a daywork drilling contract with Desarrollos y Perforaciones De Mexico (“DPM”) to drill geothermal wells for the benefit of the Mexican national electric company (“CFE”) in the state of Puebla. The rig was released in July after drilling two wells. A total of $3.7 million has been invoiced to DPM for the project with $1.6 million being collected to date. The balance of $2.1 million has been reserved as a doubtful account due to concerns regarding collection, which is included as a component of assets held for sale – DHS subsidiary. Legal action is being taken to collect the amount owed to DHS and the rig is currently under contract.

(6) Long Term Debt

Installments Payable on Property Acquisition

On February 28, 2008, the Company closed a transaction with EnCana to jointly develop a portion of EnCana’s leasehold in the Vega Area of the Piceance Basin. The remaining installment payable that was due on November 1, 2011 is recorded in the accompanying consolidated financial statements as a current liability at a discounted value and was paid subsequent to quarter end. The discount is being accreted on the effective interest method over the term of the installments, including accretion of $600,000 and $1.3 million for the three months ended September 30, 2011 and 2010, respectively, and accretion of $1.9 million and $3.8 million for the nine months ended September 30, 2011 and 2010, respectively.

7% Senior Unsecured Notes, due 2015

On March 15, 2005, the Company issued 7% senior unsecured notes for an aggregate principal amount of $150.0 million. The Company was in compliance with the covenants under the indenture as of September 30, 2011 (See Note 13, “Guarantor Financial Information”). The fair value of the Company’s senior unsecured notes at September 30, 2011 was approximately $111.0 million.

3 ³ / 4 % Senior Convertible Notes, due 2037

On April 25, 2007, the Company issued $115.0 million aggregate principal amount of 3 ³ / 4 % Senior Convertible Notes due 2037 for net proceeds of $111.6 million after underwriters’ discounts and commissions of approximately $3.4 million. The convertible notes will mature on May 1, 2037 unless earlier converted, redeemed or repurchased, but each holder of convertible notes has the option to require the Company to purchase any outstanding convertible notes on each of May 1, 2012, May 1, 2017, May 1, 2022, May 1, 2027 and May 1, 2032 at a price equal to 100% of the principal amount of the convertible notes to be purchased, payable in cash. The convertible notes were recorded based on the estimated fair value of the liability component and the equity component. The debt discount on the liability component is accreted over the expected life of the convertible notes, including $1.2 million and $1.2 million of accretion for the three months ended September 30, 2011 and 2010, respectively, and $3.6 million and $3.4 million of accretion for the nine months ended September 30, 2011 and 2010, respectively. Combined with the amortization of debt discount, the convertible notes had an effective interest rate of approximately 8.0% and 7.8% with total interest costs of $2.3 million and $2.2 million for the three months ended September 30, 2011 and 2010, respectively, and interest costs of $6.8 million and $6.6 million for the nine months ended September 30, 2011 and 2010, respectively. The fair value of the convertible notes at September 30, 2011 was approximately $101.2 million.

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three and Nine Months Ended September 30, 2011 and 2010
(Unaudited)

(6) Long Term Debt, Continued

Credit Facility – Delta

On December 29, 2010, the Company entered into the MBL Credit Agreement, which provides for a revolving loan and a term loan, each with a maturity date of January 31, 2012. As a combined result of amendments on March 14, 2011 to increase the amount available under the term loan and June 28, 2011 to reduce the borrowing base for the revolving loan and reduce the amount available under the term loan in conjunction with the divestiture of assets, the revolving loan currently has a borrowing base of $18.0 million and the term loan is limited to $15.0 million. The revolving loan bears interest at prime plus 6% per annum for prime rate advances and LIBOR plus 7% per annum for LIBOR advances, while the term loan bears interest at prime plus 9.5% through September 30, 2011 and prime plus 11.0% thereafter for prime rate advances and at LIBOR plus 10.5% for LIBOR advances through September 30, 2011 and LIBOR plus 12.0% thereafter for LIBOR advances. The March 14, 2011 amendment removed the requirement that advances under the term loan be subject to approval of a development plan. In addition, so long as Delta is not in default under the MBL Credit Agreement, Delta is not required to comply with certain cash management provisions, including the previous requirement to repay any term loan advances outstanding on a monthly basis with 100% of net operating cash flows.

At September 30, 2011, $6.0 million was outstanding under the revolving loan and $15.0 million was outstanding under the term loan. The revolving loan and the term loan are subject to quarterly financial covenants, in each case as defined in the MBL Credit Agreement and described in summary here, including maintenance of a minimum current ratio of 1:1, minimum quarterly net operating cash flow of $8.6 million, and maximum quarterly general and administrative expenses (excluding equity based compensation) of $5.0 million. In addition, the Company may not permit its trade payables to be outstanding more than 90 days following the receipt of applicable invoices. At September 30, 2011, the Company was not in compliance with the minimum current ratio covenant under the MBL Credit Agreement. However, a waiver of the covenant violation was obtained subsequent to quarter end from MBL at no cost to the Company.

Credit Facility – DHS

The DHS credit facility debt of $71.9 million at September 30, 2011 is included in the accompanying consolidated balance sheets as a component of liabilities related to assets held for sale. The DHS credit facility is non-recourse to Delta. Subsequent to quarter end, Delta sold its stock in DHS to DHS’s lender, LCPI, for $500,000. See Note 15, Subsequent Events.

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three and Nine Months Ended September 30, 2011 and 2010
(Unaudited)

(7) Fair Value Measurements

The Company follows accounting guidance which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and requires additional disclosures about fair value measurements. As required, the Company applied the following fair value hierarchy:

Level 1 – Assets or liabilities for which the item is valued based on quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 – Assets or liabilities valued based on observable market data for similar instruments.

Level 3 – Assets or liabilities for which significant valuation assumptions are not readily observable in the market; instruments valued based on the best available data, some of which is internally-developed, and considers risk premiums that a market participant would require.

The level in the fair value hierarchy within which the fair value measurement in its entirety falls shall be determined based on the lowest level input that is significant to the fair value measurement in its entirety.

Derivative liabilities consist of future oil, gas, and natural gas liquids commodity swap contracts valued using both quoted prices for identically traded contracts and observable market data for similar contracts (NYMEX WTI oil, CIG gas, and Mont Belvieu natural gas liquids swaps – Level 2).

Proved property impairments — The fair values of the proved properties are estimated using internal discounted cash flow calculations based upon the Company’s estimates of reserves and are considered to be level 3 fair value measurements.

Asset retirement obligations — The initial fair values of the asset retirement obligations are estimated using internal discounted cash flow calculations based upon the Company’s asset retirement obligations, including revisions of the estimated fair values during the nine months ended September 30, 2011 and 2010, and are considered to be Level 3 fair value measurements.

The following table lists the Company’s fair value measurements by hierarchy as of September 30, 2011 and December 31, 2010 (in thousands):

		Fair Value Measurements
		Quoted Prices				Significant				Significant
		in Active Markets				Other Observable				Unobservable
		for Identical Assets				Inputs				Inputs
Assets (Liabilities)		(Level 1)				(Level 2)				(Level 3)				Total
Recurring
Derivative assets – September 30, 2011		$	—			$	1,144			$	—			$	1,144
Derivative liabilities – December 31, 2010			—				(2,993	)			—				(2,993	)

DELTA PETROLEUM CORPORATION
AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Three and Nine Months Ended September 30, 2011 and 2010
(Unaudited)

(8) Commodity Derivative Instruments

The Company periodically enters into commodity price risk transactions to manage its exposure to oil, gas, and natural gas liquids price volatility. These transactions may take the form of futures contracts, collar agreements, swaps or options. The purpose of the transactions is to provide a measure of stability to the Company’s cash flows in an environment of volatile oil and gas prices. The Company has not elected hedge accounting and recognizes mark-to-market gains and losses in earnings currently.

The Company is exposed to the fluctuations in natural gas, natural gas liquids, or crude oil prices due to the nature of business in which the Company is primarily involved. In order to mitigate the risks associated with uncertain cash flows from volatile commodity prices and to provide stability and predictability in the Company’s future revenues, the Company periodically enters into commodity price risk management transactions to manage its exposure to gas and oil price volatility.

On June 28, 2011, as required by the amendment to the MBL Credit Agreement completed in conjunction with the 2011 Wapiti Transaction, the Company paid $3.3 million cash to settle a portion of its oil derivative contracts outstanding from July 2011 to December 2013. The table below reflects the remaining open derivative contracts after consideration of this early termination.

At September 30, 2011, all of the Company’s outstanding derivative contracts were fixed price swaps. Under the swap agreements, the Company receives the fixed price and pays the floating index price. The Company’s swaps are settled in cash on a monthly basis. By entering into swaps, the Company effectively fixes the price that it will receive for a portion of its production.

The following table summarizes the Company’s open derivative contracts at September 30, 2011:

																Net Fair Value
												Remaining				Asset (Liability) at
Commodity		Volume						Fixed Price				Term		Index Price		September 30, 2011
																(In thousands)
Crude oil			203			Bbls / Day		$	57.70			Oct ’11 - Dec ’11		NYMEX – WTI		$	(425	)
Crude oil			62			Bbls / Day		$	91.05			Oct ’11 - Dec ’11		NYMEX – WTI			56
Crude oil			230			Bbls / Day		$	91.05			Jan ’12 - Dec ’12		NYMEX – WTI			843
Crude oil			162			Bbls / Day		$	91.05			Jan ’13 - Dec ’13		NYMEX – WTI			446
Natural gas			12,000			MMBtu / Day		$	5.150			Oct ’11 - Dec ’11		CIG			1,637
Natural gas			3,253			MMBtu / Day		$	5.040			Oct ’11 - Dec ’11		CIG			411
Natural gas			12,052			MMBtu / Day		$	4.440			Jan ’12 - Dec ’12		CIG			1,993
Natural gas			10,301			MMBtu / Day		$	4.440			Jan ’13 - Dec ’13		CIG			(208	)
Natural gas liquids (1)			34,367			Gallons / Day		$	0.913			Oct ’11 - Dec ’11		MT. BELVIEU			(921	)
Natural gas liquids (1)			30,617			Gallons / Day		$	0.832			Jan ’12 - Dec ’12		MT. BELVIEU			(2,114	)
Natural gas liquids (1)			12,286			Gallons / Day		$	0.767			Jan ’13 - Dec ’13		MT. BELVIEU			(574	)
																$	1,144