BATTALION OIL CORP - Quarter Report: 2012 June (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

For the quarterly period ended June 30, 2012

 

OR

 

 

For the transition period from                     to                    

 

Commission File Number: 001-35467

 

 

Halcón Resources Corporation

(Exact name of registrant as specified in its charter)

 

 

 

1000 Louisiana Street, Suite 6700, Houston, TX 77002

(Address of principal executive offices)

 

(832) 538-0300

(Registrant’s telephone number, including area code)

 

 

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

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  o

 

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

 

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

 

 

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

 

At August 1, 2012, 211,836,319 shares of the Registrant’s Common Stock were outstanding.

 

 

Table of Contents

 

Second Quarter 2012 Form 10-Q Report

 

TABLE OF CONTENTS

 

	Page
PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (unaudited)
Condensed Consolidated Statements of Operations — Three and Six Months Ended June 30, 2012 and 2011	5
Condensed Consolidated Balance Sheets —June 30, 2012 and December 31, 2011	6
Condensed Consolidated Statements of Stockholders’ Equity — Six Months Ended June 30, 2012 and Year Ended December 31, 2011	7
Condensed Consolidated Statements of Cash Flows — Six Months Ended June 30, 2012 and 2011	8
Notes to Condensed Consolidated Financial Statements	10
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	35
ITEM 4. CONTROLS AND PROCEDURES	35
PART II — OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS	36
ITEM 1A. RISK FACTORS	36
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	40
ITEM 3. DEFAULTS UPON SENIOR SECURITIES	40
ITEM 4. MINE SAFETY DISCLOSURES	40
ITEM 5. OTHER INFORMATION	40
ITEM 6. EXHIBITS	40
SIGNATURES	43

 

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Special note regarding forward-looking statements

 

This Quarterly Report on Form 10-Q contains, and we may from time to time otherwise make in other public filings, press releases and presentations, forward-looking statements within the meaning of the federal securities laws. All statements, other than statements of historical facts, concerning, among other things, planned capital expenditures, potential increases in oil and natural gas production, the number and location of wells to be drilled in the future, future cash flows and borrowings, pursuit of potential acquisition opportunities, our financial position, business strategy and other plans and objectives for future operations, are forward-looking statements. These forward-looking statements are identified by their use of terms and phrases such as “may,” “expect,” “estimate,” “project,” “plan,” “believe,” “intend,” “achievable,” “anticipate,” “will,” “continue,” “potential,” “should,” “could” and similar terms and phrases. Although we believe that the expectations reflected in these forward-looking statements are reasonable, they do involve certain assumptions, risks and uncertainties. Actual results could differ materially from those anticipated in these forward-looking statements. One should consider carefully the statements under the “Risk Factors” section of the previously filed Annual Report on Form 10-K for the year ended December 31, 2011, and the other disclosures contained herein and therein, which describe factors that could cause our actual results to differ from those anticipated in the forward-looking statements, including, but not limited to, the following factors:

 

·                  volatility in commodity prices for oil and natural gas;

 

·                  our ability to successfully identify and acquire oil and natural gas properties, prospects and leaseholds, including undeveloped acreage in new and emerging resource plays;

 

·                  our ability to successfully integrate acquired oil and natural gas businesses and operations, including our recently closed acquisition of GeoResources, Inc. (“GeoResources”) and the East Texas Assets;

 

·                  our ability to profitably deploy our capital;

 

·                  the possibility that our industry may be subject to future regulatory or legislative actions (including any additional taxes and changes in environmental regulation);

 

·                  the presence or recoverability of estimated oil and natural gas reserves and the actual future production rates and associated costs;

 

·                  the potential for production decline rates on our wells to be greater than we expect;

 

·                  our ability to generate sufficient cash flow from operations, borrowings or other sources to enable us to develop our undeveloped acreage positions;

 

·                  our ability to economically replace oil and natural gas reserves;

 

·                  environmental risks;

 

·                  drilling and operating risks;

 

·                  exploration and development risks;

 

·                  competition, including competition for acreage in resource play areas;

 

·                  management’s ability to execute our plans to meet our goals;

 

·                  our ability to attract and retain key members of senior management and key technical employees;

 

·                  the cost and availability of goods and services, such as drilling rigs, fracture stimulation services and tubulars;

 

·                  access to and availability of water and other treatment materials to carry out planned fracture stimulations of our wells;

 

·                  access to adequate gathering systems and transportation take-away capacity to handle our expected production;

 

·                  our ability to secure firm transportation and other marketing outlets for the natural gas, natural gas liquids and crude oil and condensate we produce and to sell these products at market prices;

 

·                  general economic conditions, whether internationally, nationally or in the regional and local market areas in which we do business, may be less favorable than expected, including the possibility that the economic conditions in the United States will worsen and that capital markets are disrupted, which could adversely affect demand for oil and natural gas and/or make it difficult to access financial markets;

 

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·                  our merger with GeoResources not achieving its intended results or benefits, such as cost savings and operating efficiencies, or failure of effective integration resulting in increased costs, decreases in the amount of expected revenues generated by the combined company and diversion of management’s time and energy and could have an adverse effect on the combined company’s financial position, results of operations or cash flows;

 

·                  difficulty attracting, motivating and retaining key employees in light of the GeoResources merger, as employees may feel uncertain about their future roles with the combined company, and resulting potential departure of certain employees could reduce the anticipated benefits of the merger;

 

·                  our stockholders were diluted by the merger with GeoResources as we have incurred substantial transaction and merger-related costs in connection with the merger, and the net benefit of the elimination of certain duplicative costs, as well as the realization of efficiencies related to the integration of the two businesses offsetting the incremental merger-related costs over time, may not be achieved in the near-term or at all;

 

·                  social unrest, political instability, armed conflict, or acts of terrorism or sabotage in oil and natural gas producing regions, such as the Middle East and Africa, or our markets; and

 

·                  other economic, competitive, governmental, legislative, regulatory, geopolitical and technological factors that may negatively impact our business, operations or pricing.

 

All forward-looking statements are expressly qualified in their entirety by the cautionary statements in this paragraph and elsewhere in this document. Other than as required under the securities laws, we do not assume a duty to update these forward-looking statements, whether as a result of new information, subsequent events or circumstances, changes in expectations or otherwise.

 

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PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements (Unaudited)

 

HALCÓN RESOURCES CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(In thousands, except per share amounts)

 

		Three Months Ended						Six Months Ended
		June 30,						June 30,
		2012			2011			2012			2011
Operating revenues:
Oil and natural gas sales
Oil		$	20,383		$	22,783		$	43,380		$	43,195
Natural gas		1,240			2,812			2,908			5,704
NGLs		1,623			2,523			3,792			4,938
Total oil and natural gas sales		23,246			28,118			50,080			53,837
Other		35			34			71			85
Total operating revenues		23,281			28,152			50,151			53,922
Operating expenses:
Production:
Lease operating		8,663			7,812			16,610			15,653
Workover		540			362			1,261			896
Taxes		1,352			1,478			2,922			2,889
Restructuring		903			—			1,007			—
General and administrative		13,087			4,621			33,421			9,168
Depletion, depreciation and accretion		5,956			5,608			11,935			11,283
Total operating expenses		30,501			19,881			67,156			39,889
Income (loss) from operations		(7,220		)	8,271			(17,005		)	14,033
Other income (expenses):
Net gain (loss) on derivative contracts		13,671			8,268			8,726			(5,982		)
Interest expense and other, net		(4,179		)	(4,361		)	(17,176		)	(10,863		)
Total other income (expenses)		9,492			3,907			(8,450		)	(16,845		)
Income (loss) before income taxes		2,272			12,178			(25,455		)	(2,812		)
Income tax provision (benefit)		(5,387		)	3,242			208			(1,837		)
Net income (loss)		7,659			8,936			(25,663		)	(975		)
Non-cash preferred dividend		(87,343		)	—			(88,445		)	—
Net income (loss) available to common stockholders		$	(79,684	)	$	8,936		$	(114,108	)	$	(975	)
Net income (loss) per common share:
Basic		$	(0.59	)	$	0.34		$	(1.11	)	$	(0.04	)
Diluted		$	(0.59	)	$	0.34		$	(1.11	)	$	(0.04	)
Weighted average common shares outstanding:
Basic		136,066			26,278			102,441			26,199
Diluted		136,066			26,278			102,441			26,199

 

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

 

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HALCÓN RESOURCES CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(In thousands, except share and per share amounts)

 

		June 30,			December 31,
		2012			2011
Current assets:
Cash		$	219,208		$	49
Accounts receivable		9,340			10,288
Receivables from derivative contracts		4,507			260
Deferred income taxes		2,161			2,601
Inventory		4,477			4,310
Prepaids and other		2,513			2,729
Total current assets		242,206			20,237
Oil and natural gas properties (full cost method):
Evaluated		734,551			715,666
Unevaluated		461,620			—
Gross oil and natural gas properties		1,196,171			715,666
Less - accumulated depletion and impairment		(512,538		)	(501,993		)
Net oil and natural gas properties		683,633			213,673
Other operating property and equipment:
Other operating assets and equipment		12,825			9,979
Less - accumulated depreciation		(6,963		)	(7,133		)
Net other operating property and equipment		5,862			2,846
Other noncurrent assets:
Receivables from derivative contracts		2,719			—
Debt issuance costs, net of amortization		5,525			5,966
Deferred income taxes		24,405			24,102
Funds in escrow		29,945			560
Other		491			418
Total assets		$	994,786		$	267,802
Current liabilities:
Accounts payable and accrued liabilities		$	36,774		$	25,061
Liabilities from derivative contracts		—			265
Asset retirement obligations		1,446			1,010
Total current liabilities		38,220			26,336
Long-term debt		242,579			202,000
Other noncurrent liabilities:
Liabilities from derivative contracts		—			805
Asset retirement obligations		33,088			32,703
Other		10			10
Commitments and contingencies
Stockholders’ equity:
Preferred stock: 1,000,000 shares of $0.0001 par value authorized; no shares issued or outstanding		—			—
Common stock: 336,666,666 and 33,333,333 shares of $0.0001 par value authorized; 145,681,457 and 27,694,583 shares issued; 144,031,546 and 26,244,452 outstanding at June 30, 2012 and December 31, 2011, respectively		15			3
Additional paid-in capital		932,145			229,414
Treasury stock: 1,649,911 and 1,450,131 shares at June 30, 2012 and December 31, 2011, respectively, at cost		(9,298		)	(7,159		)
Accumulated deficit		(241,973		)	(216,310		)
Total stockholders’ equity		680,889			5,948
Total liabilities and stockholders’ equity		$	994,786		$	267,802

 

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

 

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HALCÓN RESOURCES CORPORATION

 CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Unaudited)

(In thousands)

 

		Year Ended December 31, 2011 and
		Six Months Ended June 30, 2012
												Additional
		Preferred Stock					Common Stock					Paid-In			Treasury Stock					Accumulated			Stockholders’
		Shares		Amount			Shares		Amount			Capital			Shares		Amount			Deficit			Equity
BALANCE, December 31, 2010		—		$	—		27,533		$	3		$	226,047		1,404		$	(6,976	)	$	(214,907	)	$	4,167
Long term incentive plan grants		—		—			280		—			—			—		—			—			—
Long term incentive plan forefeitures		—		—			(118	)	—			—			—		—			—			—
Net loss		—		—			—		—			—			—		—			(1,403		)	(1,403		)
Repurchase of stock		—		—			—		—			—			46		(183		)	—			(183		)
Share-based compensation		—		—			—		—			3,367			—		—			—			3,367
BALANCE, December 31, 2011		—		—			27,695		3			229,414			1,450		(7,159		)	(216,310		)	5,948
Warrants issued		—		—			—		—			43,590			—		—			—			43,590
Sale of common stock		—		—			73,333		7			274,993			—		—			—			275,000
Reverse-stock-split rounding		—		—			4		—			—			—		—			—			—
Sale of preferred stock		4		311,556			—		—			—			—		—			—			311,556
Preferred stock conversion		(4	)	(385,476		)	44,445		5			385,471			—		—			—			—
Offering costs		—		(14,525		)	—		—			(4,592		)	—		—			—			(19,117		)
Net loss		—		—			—		—			—			—		—			(25,663		)	(25,663		)
Preferred beneficial conversion feature		—		—			—		—			88,445			—		—			—			88,445
Non-cash preferred dividend		—		88,445			—		—			(88,445		)	—		—			—			—
Long-term incentive plan grants		—		—			204		—			—			—		—			—			—
Repurchase of stock		—		—			—		—			—			200		(2,139		)	—			(2,139		)
Share-based compensation		—		—			—		—			3,269			—		—			—			3,269
BALANCE, June 30, 2012		—		$	—		145,681		$	15		$	932,145		1,650		$	(9,298	)	$	(241,973	)	$	680,889

 

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

 

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HALCÓN RESOURCES CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)

 

		Six Months Ended
		June 30,
		2012			2011
Cash flows from operating activities:
Net loss		$	(25,663	)	$	(975	)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depletion, depreciation and accretion		11,935			11,283
Deferred income tax provision (benefit)		136			(1,953		)
Share-based compensation		2,465			1,355
Unrealized (gain) loss on derivatives contracts		(8,036		)	5,892
Amortization and write-off of deferred loan costs		6,299			2,990
Non-cash interest and amortization of discount		7,733			362
Other income		(17		)	(22		)
Changes in assets and liabilities:
Accounts receivable		948			49
Inventory		(167		)	(430		)
Prepaid expenses and other		(1,646		)	222
Accounts payable and accrued liabilities		3,500			(5,012		)
Other		(195		)	(718		)
Net cash (used in) provided by operating activities		(2,708		)	13,043
Cash flows from investing activities:
Evaluated oil and natural gas capital expenditures		(14,996		)	(13,500		)
Unevaluated oil and natural gas capital expenditures		(453,201		)	—
Other operating property and equipment capital expenditures		(3,573		)	(469		)
Proceeds received from sales of property and equipment		346			473
Funds held in escrow		(29,385		)	—
Net cash used in investing activities		(500,809		)	(13,496		)
Cash flows from financing activities:
Proceeds from borrowings		237,410			231,166
Repayments of borrowings		(208,000		)	(223,185		)
Debt issuance costs		(5,053		)	(7,003		)
Offering costs		(18,133		)	—
Common stock repurchased		(2,139		)	(108		)
Preferred stock issued		311,556			—
Preferred beneficial conversion feature		88,445			—
Common stock issued		275,000			—
Warrants issued		43,590			—
Net cash provided by financing activities		722,676			870
Net increase in cash		219,159			417
Cash at beginning of period		49			37
Cash at end of period		$	219,208		$	454

 

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

 

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HALCÓN RESOURCES CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Continued

(In thousands)

 

		Six Months Ended
		June 30,
		2012			2011
Supplemental cash flow information:
Cash paid for income taxes		$	199		$	481
Cash paid for interest		3,445			8,706
Disclosure of non-cash investing and financing activities:
Asset retirement obligations		46			(129		)
Preferred dividend		88,445			—
Payment-in-kind interest		8,865			362

 

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

 

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HALCÓN RESOURCES CORPORATION

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. FINANCIAL STATEMENT PRESENTATION

 

Halcón Resources Corporation (“Halcón” or the “Company”) is an independent energy company engaged in the exploration, development and production of crude oil and natural gas properties located in the United States. The unaudited condensed consolidated financial statements include the accounts of all subsidiaries. All intercompany accounts and transactions have been eliminated. These unaudited condensed consolidated financial statements reflect, in the opinion of the Company’s management, all adjustments, consisting only of normal and recurring adjustments, necessary to present fairly the financial position as of, and the results of operations for, the periods presented. During interim periods, Halcón follows the accounting policies disclosed in its 2011 Annual Report on Form 10-K, filed with the United States Securities and Exchange Commission (“SEC”). Please refer to the notes in the 2011 Annual Report on Form 10-K, when reviewing interim financial results.

 

Use of Estimates

 

The preparation of the Company’s unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires the Company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, if any, at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the respective reporting periods. Estimates and assumptions that, in the opinion of management of the Company, are significant include oil and natural gas reserves, amortization relating to oil and natural gas properties, asset retirement obligations, fair value estimates, beneficial conversion feature estimates and income taxes. The Company bases its estimates and judgments on historical experience and on various other assumptions and information that are believed to be reasonable under the circumstances. Estimates and assumptions about future events and their effects cannot be perceived with certainty and, accordingly, these estimates may change as new events occur, as more experience is acquired, as additional information is obtained and as the Company’s operating environment changes. Actual results may differ from the estimates and assumptions used in the preparation of the Company’s unaudited condensed consolidated financial statements.

 

Interim period results are not necessarily indicative of results of operations or cash flows for the full year and accordingly, certain information normally included in financial statements prepared in accordance with accounting principles, generally accepted in the United States, has been condensed or omitted. The Company has evaluated events or transactions through the date of issuance of these unaudited condensed consolidated financial statements.

 

Recently Issued Accounting Pronouncements

 

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in the U.S. Generally Accepted Accounting Principles (“GAAP”) and International Financial Accounting Reporting Standards (“IFRS”)”. This pronouncement was issued to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between GAAP and IFRS. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements. This update is effective for reporting periods beginning on or after December 15, 2011. The adoption of ASU 2011-04 on January 1, 2012 did not have a material impact on the Company’s financial position or results of operations.

 

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income”. ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in stockholders’ equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. This update is effective for fiscal years, and interim periods within those years beginning after December 15, 2011. In December 2011, the FASB issued ASU No. 2011-12, which becomes effective at the same time as ASU 2011-05, to defer the effective date of provisions of ASU 2011-05 that relate to the presentation of reclassification adjustments. Adoption of ASU 2011-05 and ASU 2011-12 did not have an impact on the Company’s financial position or results of operations.

 

In December 2011, the FASB issued ASU No. 2011-11 which will enhance disclosures by requiring an entity to disclose information about netting arrangements, including rights of offset, to enable users of its financial statements to understand the effect of those arrangements on its financial position. This pronouncement was issued to facilitate comparison between financial statements prepared on the basis of GAAP and IFRS. This update is effective for annual and interim reporting periods

 

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beginning on or after January 1, 2013 and is to be applied retroactively for all comparative periods presented. The adoption of ASU 2011-11 is not expected to have a significant impact on the Company’s financial position or results of operations.

 

2. RECAPITALIZATION

 

On December 21, 2011, the Company entered into a Securities Purchase Agreement (the “Purchase Agreement”) with HALRES LLC (formerly, Halcón Resources, LLC). Pursuant to the Purchase Agreement, (i) HALRES LLC purchased and the Company sold 73,333,333 shares of the Company’s common stock (the “Shares”) for a purchase price of $275,000,000 and (ii) HALRES LLC purchased and the Company issued a senior convertible promissory note in the principal amount of $275,000,000 (the “8% Note”), together with five year warrants (the “Warrants”) to purchase 36,666,666 shares of the Company’s common stock at an exercise price of $4.50 per share, subject to adjustment under certain circumstances. The 8% Note is convertible after February 8, 2014 into 61,111,111 shares of common stock at a conversion price of $4.50 per share, subject to adjustment under certain circumstances. The Company and HALRES LLC closed the transaction contemplated by the Purchase Agreement on February 8, 2012 (the “Closing”).

 

During January 2012, shareholders holding a majority of the Company’s outstanding shares of common stock approved the issuance of the Shares, the 8% Note and the Warrants pursuant to the terms of the Purchase Agreement. Additionally, the Board of Directors approved, effective upon the Closing (i) the amendment of the Company’s certificate of incorporation to (A) increase the Company’s authorized shares of common stock from 100,000,000 shares to 1,010,000,000 shares, both of which are before the one-for-three reverse stock split; (B) a one-for-three reverse stock split of the Company’s common stock (which reduced the Company’s authorized shares of common stock from 1,010,000,000 to 336,666,666 shares); and (C) a name change from RAM Energy Resources, Inc. to Halcón Resources Corporation; (ii) the amendment of the Company’s 2006 Long-Term Incentive Plan (the “Plan”) to increase the number of shares that may be issued under the Plan from 2,466,666 to 3,700,000 shares; and (iii) on an advisory (non-binding) basis, the payments made to the Company’s named executive officers in connection with the transactions contemplated by the Purchase Agreement.

 

The Closing of the transaction resulted in a change in control of the Company. Material events and items resulting from the transaction include the following:

 

·                         completion of transactions contemplated by the Purchase Agreement and shareholder approval as discussed above;

 

·                         the resignation and termination of the Company’s four executive officers and the resignation of certain other officers;

 

·                         change in control payments of $4.6 million to the officers of the Company recorded in general and administrative expense;

 

·                         change in control payment of $0.8 million pursuant to a retainer agreement with the Company’s outside law firm recorded in general and administrative expense;

 

·                         accelerated vesting of all unvested employee restricted stock shares and accelerated vesting and exercise of all unvested stock appreciation rights resulting in $4.3 million of share-based compensation expense recorded in general and administrative expense;

 

·                         payoff and termination of the Company’s revolving credit facility of $133.0 million plus accrued interest, as well as the expensing of the related unamortized debt issue costs of $2.9 million;

 

·                         payoff and termination of the Company’s second lien term facility of $75.0 million plus accrued interest and a prepayment fee of $1.5 million, as well as the expensing of the related unamortized debt issue costs of $2.9 million; and

 

·                         closing costs of $11.2 million related to engagement fees and various professional fees including $2.5 million recorded in general and administrative expense related to a termination fee pursuant to a previous engagement.

 

During January 2012, the Company approved a one-for-three reverse stock split, which was implemented on February 10, 2012. Retroactive application of the reverse stock split is required and all share and per share information included for all periods presented in these financial statements reflects the reverse stock split.

 

During February 2012, the transaction with HALRES LLC resulted in an “ownership change” as defined under Section 382 of the Internal Revenue Code. As a consequence, the Company will have additional limitations on its ability to use the net operating losses it accrued before the change-in-control as a deduction against any taxable income the Company realizes after the change-in-control.

 

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3. RESTRUCTURING

 

During March 2012, the Company announced its intention to close the Plano, Texas office and begin the process of relocating key administrative functions to Houston, Texas (the “Restructuring”). As part of the Restructuring, the Company offered certain severance and retention benefits (collectively, the “Severance Program”) to the affected employees. The estimated total expense of the Severance Program is approximately $3.2 million and related costs will be recognized as restructuring expense over the requisite service periods through May 2013, as applicable.  The Company recorded a restructuring liability of $0.1 million as of March 31, 2012.  During the three months ended June 30, 2012, the Company increased the restructuring liability by an additional $0.9 million to reflect the accrual of expense over the requisite period and decreased the liability by $0.2 million for actual expenditures, resulting in a liability of $0.8 million at June 30, 2012.

 

4. ACQUISITIONS

 

Unevaluated Properties

 

On June 28, 2012, the Company completed the acquisition of acreage in Eastern Ohio, prospective for the Utica/Point Pleasant formations.  Pursuant to the terms of an Agreement of Sale and Purchase dated May 8, 2012 with NCL Appalachian Partners, L.P. (“NCL”), the Company acquired a working interest in approximately 27,000 net acres for an adjusted purchase price of approximately $164.0 million.  The Company funded the acquisition with cash on hand.  No oil or natural gas production or proved reserves are currently attributable to the acquired assets.

 

In addition to the NCL acquisition, during 2012 the Company incurred approximately $274.5 million in capital expenditures on unevaluated oil and gas leaseholds through numerous leasing and acquisition transactions.  No oil or natural gas production or proved reserves are currently attributable to the leasehold assets which were primarily located in Texas, Louisiana, Ohio and Pennsylvania.

 

Other Acquisitions and Merger

 

See Note 15, “Subsequent Events — Acquisitions” for discussion of the recently closed acquisition of producing and nonproducing acreage in east Texas (the “East Texas Assets”) and the GeoResources, Inc. (“GeoResources”) merger.

 

5. OIL AND NATURAL GAS PROPERTIES

 

The Company uses the full cost method of accounting for its investment in oil and natural gas properties. Under this method of accounting, all costs of acquisition, exploration and development of oil and natural gas reserves (including such costs as leasehold acquisition costs, geological expenditures, dry hole costs, tangible and intangible development costs and direct internal costs) are capitalized as the cost of oil and natural gas properties when incurred. To the extent capitalized costs of evaluated oil and natural gas properties, net of accumulated depletion, exceed the discounted future net revenues of proved oil and natural gas reserves, net of deferred taxes, such excess capitalized costs are charged to expense.

 

The Company assesses all items classified as unevaluated property on a quarterly basis for possible impairment or reduction in value. The Company assesses properties on an individual basis or as a group, if properties are individually insignificant. The assessment includes consideration of the following factors, among others: intent to drill; remaining lease term; geological and geophysical evaluations; drilling results and activity; the assignment of proved reserves; and the economic viability of development if proved reserves are assigned. During any period in which these factors indicate an impairment, the cumulative drilling costs incurred to date for such property and all or a portion of the associated leasehold costs are transferred to the full cost pool and are then subject to amortization.

 

Investments in unevaluated oil and gas properties and exploration and development projects for which depletion expense is not currently recognized, and for which exploration or development activities are in progress, qualify for interest capitalization.  The capitalized interest is determined by multiplying the Company’s weighted-average borrowing cost on debt by the average amount of qualifying costs incurred that are excluded from the full cost pool; however, the amount of capitalized interest cannot exceed the amount of gross interest expense incurred in any given period.  The capitalized interest amounts are recorded as additions to unevaluated oil and natural gas properties on our condensed consolidated balance sheet.  As the costs excluded are transferred to the full cost pool, the associated capitalized interest is also transferred to the full cost pool.  For the three and six months ended June 30, 2012, the Company capitalized interest costs of $3.3 million and $3.4 million, respectively.

 

At June 30, 2012 the ceiling test value of the Company’s reserves was calculated based on the first day average of the 12-months ended June 30, 2012 of the West Texas Intermediate (“WTI”) spot price of $95.67 per barrel, adjusted by lease or field for quality, transportation fees, and regional price differentials, and the first day average of the 12-months ended June 30, 2012 of the Henry Hub price of $3.15 per million British thermal units (“Mmbtu”), adjusted by lease or field for energy content, transportation fees, and regional price differentials. Using these prices, the Company’s net book value of oil and natural gas properties at June 30, 2012, did not exceed the ceiling amount. Changes in production rates, levels of reserves, future development costs, and other factors will determine the Company’s actual ceiling test calculation and impairment analyses in future periods.

 

At June 30, 2011 the ceiling test value of the Company’s reserves was calculated based on the first day average of the 12-months ended June 30, 2011 of the WTI posted price of $90.09 per barrel, adjusted by lease or field for quality,

 

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transportation fees, and regional price differentials, and the first day average of the 12-months ended June 30, 2011 of the Henry Hub price of $4.21 per Mmbtu, adjusted by lease or field for energy content, transportation fees, and regional price differentials. Using these prices, the Company’s net book value of oil and natural gas properties at June 30, 2011, did not exceed the ceiling amount.

 

6. LONG-TERM DEBT

 

Long-term debt as of June 30, 2012 and December 31, 2011 consisted of the following (in thousands):

 

		June 30,			December 31,
		2012			2011
8% senior convertible note (1)		$	242,579		$	—
Revolving credit facility		—			127,000
Term loan facility		—			75,000
		$	242,579		$	202,000

 

(1)                                  Amount is net of a $41.3 million unamortized discount at June 30, 2012. See “8% Senior Convertible Note” below for more details.

 

8% Senior Convertible Note

 

On February 8, 2012, the Company issued a $275.0 million principal amount 8% Note together with Warrants for an aggregate purchase price of $275.0 million. The 8% Note bears interest at a rate of 8% per annum, payable quarterly on March 31, June 30, September 30 and December 31 of each year. Through the March 31, 2014 interest payment date, the Company may elect to borrow and add to principal of the 8% Note, all or any portion of the interest due on the 8% Note. At June 30, 2012 and March 31, 2012, the Company elected to pay in-kind $5.7 and $3.2 million, respectively, of interest incurred during the first six months of 2012 by increasing the 8% Note. The 8% Note matures on February 8, 2017. At any time after February 8, 2014, the noteholder may elect to convert all or any portion of the principal amount and accrued but unpaid interest into common stock. Each $4.50 of principal and accrued but unpaid interest is convertible into one share of the Company’s common stock. The 8% Note is a senior unsecured obligation of the Company and ranks equally with all of its future senior unsubordinated indebtedness.

 

The Company allocated the proceeds received for the 8% Note and Warrants on a relative fair value basis. Consequently, the Company recorded a discount of $43.6 million to be amortized over the remaining life of the 8% Note utilizing the effective interest rate method. The remaining unamortized discount was $41.3 million at June 30, 2012.

 

Senior Unsecured Notes

 

See Note 15, “Subsequent Events — 9.75% Senior Notes” for discussion on debt issuance subsequent to June 30, 2012.

 

February 2012 Credit Facility

 

On February 8, 2012, the Company entered into a $500.0 million, five-year, senior secured revolving credit agreement with JPMorgan Chase Bank, N.A. (“JPMorgan”) as the administrative agent and lead arranger, which replaces the Company’s March 2011 credit facility. The agreement increased the revolving borrowing base to $225.0 million and matures on February 8, 2017. The borrowing base will be redetermined semi-annually, with the Company and the lenders each having the right to one interim unscheduled redetermination between any two consecutive semi-annual redeterminations. The borrowing base is subject to a reduction equal to the product of 0.25 multiplied by the stated principal amount (without regard to any initial issue discount) of any future notes or other long-term debt securities that the Company may issue. Funds advanced under the revolving credit agreement may be paid down and re-borrowed during the five-year term of the revolver. The pricing on the agreement is LIBOR plus a margin ranging from 1.5% to 2.5% based on a percentage of usage. Advances under the revolving credit agreement are secured by liens on substantially all properties and assets of the Company and its subsidiaries. The revolving credit agreement contains representations, warranties and covenants customary in transactions of this nature including restrictions on the payment of dividends on the Company’s capital stock and financial covenants relating to current ratio and minimum interest coverage ratio. The Company maintains commodity hedges of not more than 100% of its projected production for the first 24 months, 75% of its projected production for the next 25 to 36 months and 50% of projected production for the next 37 to 48 months. At June 30, 2012, the Company is in compliance with the financial debt covenants under this agreement. At June 30, 2012, the Company had no indebtedness outstanding under the $500.0 million senior revolving credit agreement, $1.3 million of letters of credit outstanding and $223.7 million of borrowing

 

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capacity available. See Note 15, “Subsequent Events — Credit Facility Amendment” for discussion on the amendment of the February 2012 credit facility subsequent to June 30, 2012.

 

March 2011 Credit Facilities

 

The Company’s March 2011 facilities included a $250.0 million first lien revolving credit facility and a $75.0 million second lien term loan facility, replacing the November 2007 facility. SunTrust Bank was the administrative agent for the revolving facility, and Guggenheim Corporate Funding, LLC was the administrative agent for the term loan facility. The initial borrowing base under the revolving credit facility was $150.0 million. This revolving credit facility allowed for funds advanced to be paid down and re-borrowed during the five-year term of the revolver, and bore interest at LIBOR plus a margin ranging from 2.5% to 3.25% based on a percentage of usage. The term loan credit facility provided for payments of interest only during its 5.5-year term, with the interest rate being LIBOR plus 9.0% with a 2.0% LIBOR floor, or if any period the Company elected to pay a portion of the interest under its term loan “in kind”, then the interest rate would have been LIBOR plus 10.0% with a 2.0% LIBOR floor, and with 7.0% of the interest amount paid in cash and the remaining 3.0% paid in kind by being added to principal. At December 31, 2011, $127.0 million was outstanding under the revolving credit facility and $75.0 million was outstanding under the term loan credit facility. On February 8, 2012, the Company paid in full the outstanding balances under the revolving credit facility and the term loan facility and both facilities were terminated, with a resulting $1.5 million charge to interest expense related to an early termination penalty.

 

Debt Issuance Costs

 

The Company capitalizes certain direct costs associated with the issuance of long-term debt and amortizes such costs over the lives of the respective debt. During the first quarter of 2012, the Company capitalized approximately $3.3 million and $2.0 million in costs associated with the issuance of the 8% Note and February 2012 credit facility, respectively. During February 2012, the Company expensed $5.8 million of debt issuance costs as a result of the pay off and termination of the March 2011 revolving credit and term loan facilities.  The Company expensed the remaining debt issuance cost associated with the November 2007 facility totaling approximately $2.7 million in the first quarter 2011. At June 30, 2012 and December 31, 2011, the Company had approximately $5.5 million and $6.0 million, respectively, of unamortized debt issuance costs.  See Note 15, “Subsequent Events — 9.75% Senior Notes” for discussion of the debt issuance costs related to the issuance of the 9.75% senior unsecured notes.

 

7. INCOME TAXES

 

Under guidance contained in Topic 740 of the Accounting Standard Codification TM (the “ASC”), deferred taxes are determined by applying the provisions of enacted tax laws and rates for the jurisdictions in which the Company operates to the estimated future tax effects of the differences between the tax basis of assets and liabilities and their reported amounts in the Company’s financial statements. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that the related tax benefits will not be realized.

 

The Company estimates its annual effective income tax rate in recording its quarterly provision for income taxes in the various jurisdictions in which the Company operates. Statutory tax rate changes and other significant or unusual items are recognized as discrete items in the quarter in which they occur. During the three and six months ended June 30, 2012 and 2011, the Company analyzed and made no adjustment to the valuation allowance.

 

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The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate to income before provision for income taxes. The significant differences between pre-tax book income and taxable book income relate to non-deductible expenses, state income taxes, change in valuation allowances, Section 382 net operating loss limitations and other adjustments to deferred tax balances. The sources and tax rates of the differences for the six months ended June 30 are as follows:

 

		2012		2011
Income tax at the federal statutory rate		34.0	%	34.0	%
State income tax benefit (expense), net of federal benefit		(0.7	)	20.0
Non-deductible dues and entertainment		(0.3	)	8.5
Non-deductible interest and expense on Note		(18.7	)	—
Reduction in deferred tax asset		(5.2	)	—
Share-based compensation		(0.4	)	2.8
Non-deductible compensation		(4.3	)	—
Non-deductible basis in other operating property and equipment		(0.9	)	—
Merger costs		(4.3	)	—
		(0.8	)%	65.3	%

 

The Company has calculated an estimated effective annual tax rate for the current annual reporting period, excluding any discrete items, of 4.4% as of June 30, 2012. Additionally, the Company recorded a discrete item of $1.3 million related to the reduction in net operating losses due to additional limitations created by a change in control prior to the recapitalization of the Company in February 2012. The recapitalization created an “ownership change” and as a result the net operating losses of the Company will be subject to additional limitations. The discrete item of $1.3 million decreases the effective tax rate to a negative tax rate of 0.8%.  The estimated annual effective tax rate differs from the statutory rate primarily due to non-deductible interest expense on the 8% Note issued as part of the recapitalization of the Company.  Based on the estimated effective annual tax rate, the Company has recorded a tax provision of $0.2 million on a pre-tax loss of $25.5 million for the six months ended June 30, 2012. For the six months ended June 30, 2011, the Company recorded income tax benefit of $1.8 million on a pre-tax loss of $2.8 million, resulting in an effective tax rate of 65.3%.

 

For the six months ended June 30, 2012 the Company has net operating losses of $56.4 million that are not expected to be limited due to the limitations created by the “ownership change” on February 8, 2012.

 

8. FAIR VALUE MEASUREMENTS

 

Pursuant to ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), the Company’s determination of fair value incorporates not only the credit standing of the counterparties involved in transactions with the Company resulting in receivables on the Company’s unaudited condensed consolidated balance sheets, but also the impact of the Company’s nonperformance risk on its own liabilities. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy assigns the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (“Level 1”) and the lowest priority to unobservable inputs (“Level 3”). Level 2 measurements are inputs that are observable for assets or liabilities, either directly or indirectly, other than quoted prices included within Level 1. The Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable. The Company classifies fair value balances based on the observability of those inputs.

 

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The following tables set forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value as of June 30, 2012 and December 31, 2011 (in thousands). As required by ASC 820, a financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. There were no transfers between fair value hierarchy levels for the six months ended June 30, 2012 and for the year ended December 31, 2011.

 

		June 30, 2012
		Level 1			Level 2			Level 3			Total
Assets:
Receivables from derivative contracts		$	—		$	7,226		$	—		$	7,226
Liabilities:
Liabilities from derivative contracts		$	—		$	—		$	—		$	—

 

		December 31, 2011
		Level 1			Level 2			Level 3			Total
Assets:
Receivables from derivative contracts		$	—		$	260		$	—		$	260
Liabilities:
Liabilities from derivative contracts		$	—		$	1,070		$	—		$	1,070

 

Derivatives listed above consist of put/call “collars” and sold put options on crude oil and natural gas and interest rate swaps that are carried at fair value. The Company records the net change in the fair value of these positions in “Net gain (loss) on derivative contracts” in the Company’s unaudited condensed consolidated statements of operations. The Company is able to value the assets and liabilities based on observable market data for similar instruments, which resulted in the Company reporting its derivatives as Level 2. This observable data includes the forward curves for commodity prices based on quoted markets prices and implied volatility factors related to changes in the forward curves.

 

As of June 30, 2012 and December 31, 2011, the Company’s derivative contracts were with major financial institutions with investment grade credit ratings which are believed to have a minimal credit risk. As such, the Company is exposed to credit risk to the extent of nonperformance by the counterparties in the derivative contracts discussed above; however, the Company does not anticipate such nonperformance. The counterparty to the Company’s current derivative contracts is a lender in the Company’s senior revolving credit agreement. The Company did not post current collateral under any of these contracts as they are secured under the senior revolving credit agreement.

 

The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of ASC 825, Financial Instruments. The estimated fair value amounts have been 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, accounts receivable and accounts payable approximates their carrying value due to their short-term nature. The estimated fair value of the Company’s senior revolving credit agreement approximates carrying value because the facility’s interest rate approximates current market rates. The estimated fair value of the Company’s fixed interest rate 8% Note as of June 30, 2012, is $773.1 million and exceeded the carrying value of $242.6 million by $530.5 million. The fair value of the 8% Note at June 30, 2012 was calculated using Level 2 criteria.

 

9. ASSET RETIREMENT OBLIGATIONS

 

For wells drilled, the Company records an asset retirement obligation (“ARO”) when the total depth of a drilled well is reached and the Company can reasonably estimate the fair value of an obligation to perform site reclamation, dismantle facilities or plug and abandon costs. The Company records the ARO liability on the unaudited condensed consolidated balance sheets and capitalizes the cost in “Oil and natural gas properties” during the period in which the obligation is incurred. The Company records the accretion of its ARO liabilities in “Depletion, depreciation and accretion” expense in the unaudited condensed consolidated statements of operations. The additional capitalized costs are depreciated on a unit-of-production basis.

 

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