Management's Discussion and Analysis of Financial Condition and Results of
Operations
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction with our
consolidated financial statements and notes thereto contained herein and in our
Form 10-K for the year ended December 31, 2008, along with Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in such Form 10-K. Any terms used but not defined in the following
discussion have the same meaning given to them in the Form 10-K. Our discussion
and analysis includes forward-looking information that involves risks and
uncertainties and should be read in conjunction with "Risk Factors" under
Item 1A of this report, along with "Forward-Looking Information" at the end of
this section for information about the risks and uncertainties that could cause
our actual results to be materially different than our forward-looking
statements.
Overview
We are a growing independent oil and natural gas company engaged in
acquisition, development and exploration activities in the U.S. Gulf Coast
region. We are the largest oil and natural gas producer in Mississippi, own the
largest carbon dioxide ("CO2") reserves east of the Mississippi River used for
tertiary oil recovery, hold interests in the Barnett Shale play near Fort Worth,
Texas, and properties onshore in Louisiana, Alabama and Southeast Texas. Our
goal is to increase the value of acquired properties through a combination of
exploitation, drilling, and proven engineering extraction processes, with our
most significant emphasis relating to tertiary recovery. Our corporate
headquarters are in Plano, Texas (a suburb of Dallas), and we have four primary
field offices located in Laurel, Mississippi; McComb, Mississippi; Jackson,
Mississippi; and Pearland, Texas.
Third Quarter Operating Highlights. During the third quarter of 2009, we
recorded net income of $26.9 million, or $0.11 per basic common share, as
compared to net income of $157.5 million, or $0.64 per basic common share, in
the comparative third quarter of 2008. The reduction in net income between the
periods is primarily due to lower oil and natural gas commodity prices coupled
with reduced natural gas production due to the sale of 60% of the Company's
Barnett Shale natural gas assets in mid-2009, and a $108.4 million net decrease
in the fair value changes in commodity derivative contracts in the comparative
periods.
Oil and natural gas production for the third quarter of 2009 averaged 42,659
BOE/d, a 10% increase from third quarter 2008 production, after adjusting for
the 2009 sale of 60% of the Company's Barnett Shale natural gas assets. The
increase over the prior year third quarter period was primarily due to a 23%
increase in tertiary oil production and production from Hastings Field (2,083
BOE/d in the current year quarter), which we acquired in February 2009, offset
in part by the expected decrease in our non-tertiary Mississippi production. The
non-tertiary Mississippi production decline was primarily from the Selma Chalk
natural gas production as a result of limited drilling activity in 2009 and
non-tertiary Heidelberg oil as additional areas of the field were shut-in in
order to expand the tertiary flooding to those areas. On a sequential quarterly
basis, our oil and natural gas production decreased 4%, primarily due to the
decreases in non-tertiary Mississippi production offset in part by a slight
increase in our tertiary production.
During the third quarter of 2009, our tertiary production averaged 24,347
Bbls/d, which included 829 Bbls/d from tertiary production response at
Heidelberg Field. During the quarter, we also had strong production increases
compared to the prior quarter, at Tinsley (averaging 3,558 Bbls/d, a 5%
increase), Soso (averaging 2,813 Bbls/d, a 9% increase), Lockhart Crossing
(averaging 882 Bbls/d, a 26% increase), and Cranfield (averaging 572 Bbls/d, a
69% increase). These increases were offset in part by planned downtime at
Mallalieu Field for facility expansion during the quarter, and we also expanded
our facilities at Tinsley Field, earlier than originally planned, reducing the
production rate of growth at that field during the third quarter.
In addition to the decrease in our third quarter 2009 production due to the
Barnett Shale sale, our oil and natural gas revenues were 45% lower in the third
quarter of 2009 than in the prior year third quarter, as the average price we
received for our production on a per BOE basis was 41% lower in the current year
period. Since over 80% of our production is oil, oil prices have a much larger
impact on our revenues than natural gas prices. NYMEX oil prices moved from
$44.60 per barrel at December 31, 2008 to as low as $34.00 per barrel in
mid-February 2009, up to $49.66 per barrel at March 31, 2009, $69.89 per barrel
at June 30, 2009 and $70.61 per barrel at September 30, 2009. NYMEX natural gas
prices have decreased from year-end 2008, falling from $5.62 per Mcf at
December 31, 2008 to $3.78 per Mcf at March 31, 2009, $3.84 per Mcf at June 30,
2009, then recovering slightly, and ending the third quarter 2009 at $4.84 per
Mcf.
Cash settlements received on our commodity derivative contracts, which are
not included in our oil and natural gas revenues, were $18.5 million in the
third quarter of 2009, as compared to payments of $24.1 million in the third
quarter of 2008, the prior year amount comprised of payments made of
$11.2 million on oil derivative contracts and $12.9 million on natural gas
derivative contracts.
Table of Contents
DENBURY RESOURCES INC.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Definitive Merger Agreement to Acquire Encore Acquisition Company. On
November 1, 2009, Denbury and Encore Acquisition Company (NYSE: EAC) ("Encore")
announced that they had entered into a definitive merger agreement pursuant to
which Denbury will acquire Encore in a stock and cash transaction valued at
approximately $4.5 billion, including the assumption of debt and the value of
the minority interest in Encore Energy Partners LP (NYSE: ENP) ("Encore MLP").
The combined company will continue to be known as Denbury Resources Inc. and
will be headquartered in Plano, Texas.
The Agreement and Plan of Merger by and between Denbury and Encore dated
October 31, 2009 (the "Merger Agreement") was unanimously approved by the boards
of directors of both Denbury and Encore. The Merger Agreement contemplates a
merger (the "Merger") whereby Encore will be merged with and into Denbury, with
Denbury surviving the Merger. The Merger is subject to the stockholders of each
of Denbury and Encore approving the Merger, including approval by Denbury's
stockholders of the issuance of Denbury common stock to be used as Merger
consideration.
Under the agreement, Encore stockholders will receive $50.00 per share for
each share of Encore common stock, comprised of $15.00 in cash and $35.00 in
Denbury common stock subject to both an election feature and a collar mechanism
on the stock portion of the consideration as set forth in more detail below.
Merger Agreement
Exchange Ratio
In calculating the exchange ratio range for the collar mechanism, the Denbury
common stock was initially valued at $15.10 per share. The collar mechanism is
limited to a 12% upward or downward movement in the Denbury share price. The
final number of Denbury shares to be issued will be adjusted based on the volume
weighted average price of Denbury common stock on the NYSE for the 20 day
trading period ending on the second day prior to closing. Based on this
mechanism, if Denbury stock trades between $13.29 and $16.91, the Encore
stockholders will receive between 2.0698 and 2.6336 shares of Denbury common
stock for each of their shares of Encore common stock, but not higher or lower
than these share amounts if Denbury common stock trades outside this range. If
Denbury common stock trades outside of this range, the value of the shares of
Denbury received will represent either more or less than $35 per share.
Encore stockholders will also have an option to elect to receive all stock or
all cash, subject to a proration feature, such that if Denbury stock trades
within this range, the overall mix of consideration will be 70% Denbury common
stock and 30% cash in the aggregate. Subject to proration, Encore stockholders
electing to receive all cash will receive $50 per share in cash, and Encore
stockholders electing to receive only Denbury common stock will receive for each
Encore share between 2.9568 and 3.7622 shares of Denbury common stock. In
addition, upon completion of the Merger, all Encore stock options will fully
vest and their value will be paid in cash. All Encore restricted stock will vest
and each holder will have the opportunity to make the same elections as other
holders of Encore common stock as described above, except for shares of Encore
restricted stock granted as a 2009 bonus pursuant to the Encore annual incentive
program, which will be converted into restricted shares of Denbury common stock.
Covenants
The Merger Agreement contains customary covenants by each party to the Merger
Agreement. Such covenants include, among others, covenants that both Denbury and
Encore will operate their respective businesses in the ordinary course and in a
manner consistent with past practices, subject to limited exceptions, and
covenants by both Denbury and Encore that their respective boards of directors
not change their recommendations to the stockholders of each of them to vote in
favor of the Merger, subject to exceptions specified in the Merger Agreement.
Encore has also agreed not to solicit or initiate discussions with third parties
regarding other proposals to acquire Encore and to certain restrictions on its
ability to respond to any such proposal.
Conditions to Closing
Consummation of the Merger is subject to customary conditions, including,
among others, (a) the approval of the stockholders of each of Denbury and
Encore, (b) the absence of any material adverse effect, (c) the expiration or
early termination of the applicable Hart-Scott-Rodino Act waiting period,
(d) the absence of any order or injunction prohibiting the consummation of the
Merger, (e) the effectiveness of the registration statement of Denbury filed on
Form S-4, (f) the approval of the listing of the shares of Denbury common stock
to be issued in the Merger on the New York Stock Exchange, (g) the accuracy of
the parties' respective representations and warranties as set forth in the
Merger Agreement, subject, as to certain of the representations and warranties
as specified in the Merger Agreement, to materiality, (h) the receipt of legal
opinions stating, among other things, that the Merger will constitute a
reorganization under Section 368(a) of the Internal Revenue Code of 1986, as
amended, (i) the receipt of all approvals or reviews required by federal and
state regulatory authorities and (j) financing.
Table of Contents
DENBURY RESOURCES INC.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
In connection with the Merger Agreement, Denbury received a commitment letter
from J.P. Morgan Securities Inc. and JPMorgan Chase Bank, N.A., subject to
certain funding conditions, for a proposed new $1.6 billion senior secured
revolving credit facility with a term of four years and a $1.25 billion bridge
facility that will be available to the extent Denbury does not secure alternate
financing prior to the end of the bridge takedown period. The bridge facility,
if drawn, will initially mature on the first anniversary of the closing of the
Merger, at which time the maturity of any outstanding loans thereunder will be
automatically extended to the seventh anniversary of the closing of the Merger,
except to the extent they have been previously exchanged by the lender for
exchange notes due on such seventh anniversary. The new debt financing will be
used to pay the cash consideration in the Merger, repay amounts outstanding
under Denbury's current $900 million revolving credit facility and potentially
retire and replace $825 million of Encore's outstanding subordinated notes, all
of which have a change of control put option at 101%, replace Encore's existing
bank facility which has approximately $180 million currently drawn and
outstanding, and for other fees and expenses. Denbury has also received a
commitment from J. P. Morgan Securities Inc. and JP Morgan Chase Bank to fund a
new $375 million senior secured revolving credit facility to replace an existing
Encore MLP revolving loan facility should Denbury and Encore be unable to obtain
a waiver of covenants and amendment to such loan facility to allow for the
Merger. Fee letters executed in connection with the bank commitment letter
provide for Denbury to pay up to approximately $50 million in fees if the loans
do not close.
Termination
The Merger Agreement contains certain termination rights for both Denbury and
Encore, including, among others, if the Merger is not completed by May 31, 2010.
In the event of a termination of the Merger Agreement under certain
circumstances, Encore may be required to pay Denbury a termination fee of either
$60 million or $120 million, or Denbury may be required to pay Encore a
termination fee of either $60 million, $120 million or $300 million, in each
case depending on the circumstances of the termination. In addition, Encore is
obligated to reimburse Denbury for up to $10 million of its expenses related to
the Merger if specified termination events occur.
Sale of Barnett Shale Natural Gas Assets. In May 2009, we entered into an
agreement to sell 60% of our Barnett Shale assets to Talon Oil and Gas LLC, a
privately held company, for $270 million (before closing adjustments). The
effective date under the agreement was June 1, 2009, and consequently operating
net revenues after June 1, net of capital expenditures, along with any other
purchase price adjustments, were adjustments to the selling price. On June 30,
2009, we completed approximately three-quarters of the sale, and closed the
remaining portion of the sale on July 15, 2009. Net proceeds were $259.8 million
(after closing adjustments, and net of $8.1 million for natural gas swaps
transferred in the sale). We used the net proceeds from the sale to repay bank
debt. We did not record a gain or loss on the sale in accordance with the full
cost method of accounting.
Recent Management Changes. On June 30, 2009, under a management succession
plan adopted by our Board of Directors and announced on February 5, 2009, Gareth
Roberts, the Company's founder, relinquished his position as President and CEO
and became Co-Chairman of the Board of Directors and assumed a non-officer role
as the Company's Chief Strategist. Phil Rykhoek, previously Senior Vice
President and Chief Financial Officer, became Chief Executive Officer; Tracy
Evans, previously Senior Vice President - Reservoir Engineering, became
President and Chief Operating Officer; and Mark Allen, previously Vice President
and Chief Accounting Officer, became Senior Vice President and Chief Financial
Officer.
In connection with Mr. Roberts' retirement as CEO and President of the
Company, Mr. Roberts and the Company entered into a Founder's Retirement
Agreement (the "Agreement"). Under this Agreement, Mr. Roberts received
compensation of (i) $3.65 million in cash, plus (ii) the Company issued him
$6.35 million of the Company's 9.75% Senior Subordinated Notes due 2016. As part
of the Agreement, there are restrictions that prohibit Mr. Roberts from trading
the Notes for two years, and he has entered into a non-compete arrangement with
the Company through 2013. Mr. Roberts will continue to provide services to the
Company as Co-Chairman of the Board of Directors and in a non-officer role as
Chief Strategist.
Purchase of Hastings Field. On February 2, 2009, we closed the acquisition of
Hastings Field located near Houston, Texas for approximately $201 million in
cash. Hastings Field is a significant potential tertiary oil flood that we plan
to flood with CO2 delivered from Jackson Dome using our Green Pipeline, which is
currently under construction. We originally entered into an agreement in
November 2006 with a subsidiary of Venoco, Inc., that gave us the option to
purchase their interest in the Hastings Field. As consideration for the purchase
option, we made total payments of $50 million which makes our aggregate purchase
price $251 million. The seller retained a 2% override and reversionary interest
of approximately 25% following payout, as defined in the purchase agreement. We
plan to commence flooding the field with CO2 beginning in 2011, after completion
of our Green Pipeline and construction of field recycling facilities. Under the
purchase agreement, we are required to make net capital expenditures in this
field totaling $179 million over the next six years, including our first
obligation of $26.8 million during 2010, and are committed to begin
CO2injections averaging 50 MMcf/d by the fourth quarter of 2012. Production from
this field averaged 2,083 BOE/d during the third quarter of 2009, all of which
was non-tertiary production.
Table of Contents
DENBURY RESOURCES INC.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
We have recorded the acquisition of Hastings Field in accordance with the
Financial Accounting Standards Board ("FASB") Accounting Standards
CodificationTM ("FASC") "Business Combinations" topic, which became effective
for acquisitions after December 31, 2008. Based on these new rules, we have
allocated $105.6 million of the $246.8 million adjusted purchase price to proved
properties, approximately $2.4 million to land, oilfield equipment and other
related assets, and the remaining $138.8 million to goodwill. See further
discussion on this acquisition in Note 2 to the Unaudited Condensed Consolidated
Financial Statements.
Subordinated Debt Issuance. On February 13, 2009, we issued $420 million of
9.75% Senior Subordinated Notes due 2016 (the "Notes"). The Notes were sold to
the public at 92.816% of par, plus accrued interest from February 13, 2009,
which equates to an effective yield to maturity of approximately 11.25% (before
offering expenses). Interest on the Notes will be paid on March 1 and September
1 of each year, beginning September 1, 2009. The Notes will mature on March 1,
2016. We used the net proceeds from the offering of approximately $381.4 million
to repay most of the then outstanding debt on our bank credit facility. We
issued an additional $6.35 million of Notes to Mr. Roberts on June 30, 2009 (see
"Recent Management Changes" above).
Capital Resources and Liquidity
In a continuing effort to mitigate the effects of the deterioration in the
capital markets and the steep decline in commodity prices in the last half of
2008, we have taken additional measures during the first nine months of 2009 to
improve our liquidity. In February 2009, we issued $420 million of 9.75% Senior
Subordination Notes and in June and July 2009, we completed the sale of 60% of
our Barnett Shale assets. We used the $381.4 million proceeds from the February
Notes issuance to repay the majority of our then-outstanding bank debt, and we
did the same with the proceeds from our recent Barnett Shale sale, freeing up
our credit line for future capital needs. We also entered into additional
commodity derivative contracts for 2010 to protect our cash flow. Our derivative
contracts as of September 30, 2009 are included in Note 6 to the Unaudited
Condensed Consolidated Financial Statements.
Subsequent to September 30, 2009, we entered into additional costless collar
crude oil commodity derivative contracts to protect our cash flows during 2010
as follows: 5,000 barrels per day during the first quarter of 2010 with a floor
price of $70 per barrel and a ceiling price of $92.20 per barrel; 5,000 barrels
per day during the second quarter of 2010 with a floor price of $70 per barrel
and a ceiling price of $95.25 per barrel; and 5,000 barrels per day during the
third and fourth quarters of 2010 with a floor price of $70 per barrel and a
ceiling price of $96.50 per barrel. Also, in light of the recently announced
acquisition of Encore and our desire to protect our cash flows given the
increased debt levels we expect in connection with the acquisition, we recently
entered into costless collar crude oil commodity derivative contracts for 25,000
barrels per day during 2011 with a floor price of $70 per barrel and a ceiling
price of $102.58 per barrel.
We currently estimate our 2009 capital spending will be approximately
$750 million, excluding capitalized interest and net of equipment leases, plus
$201 million spent for our February 2009 Hastings Field acquisition. Our current
2009 capital budget includes approximately $500 million to be spent on our CO2
pipelines, the majority of which will be spent on the Green Pipeline. The budget
also assumes that we fund approximately $100 million of budgeted equipment
purchases with operating leases, which is dependent upon securing acceptable
financing. Through September 30, 2009, we have completed approximately
$44 million of these leases. If we do not enter into a total of $100 million of
operating leases during 2009, our net capital expenditures would increase
accordingly, and we would anticipate funding those additional capital
expenditures under our bank credit line.
Based on our current cash flow projections using futures prices as of the end
of October 2009, and including the expected cash settlements on our 2009 oil
derivative contracts, we anticipate that these projected 2009 capital
expenditure amounts of approximately $750 million, plus our already closed $201
million Hastings acquisition, could, in the aggregate, exceed projected cash
flow by as much as $450 million to $550 million. This shortfall should be
covered by the $381.4 million of net proceeds from our February 2009
subordinated debt issuance and the estimated $259.8 million of net proceeds
(after closing adjustments and net of $8.1 million for natural gas swaps
transferred in the sale) from the sale of 60% of our Barnett Shale properties.
As part of our semi-annual bank review, on October 1, 2009 our bank borrowing
base and commitment amounts were left unchanged at $900 million and
$750 million, respectively. The borrowing base represents the amount that can be
borrowed from a credit standpoint while the commitment amount is the amount the
banks have committed to fund pursuant to the terms of the credit agreement. We
anticipate this credit line will be sufficient for our 2009 plans, and do not
expect our bank credit line to be reduced by our banks unless commodity prices
were to decrease significantly from current levels. Based on current
projections, we expect to have little or no bank debt drawn at the end of 2009
assuming we achieve our $100 million budgeted equipment leasing program, leaving
up to $750 million available on our bank line.
Although we have not yet set our capital budget for 2010, we do expect to
utilize the net proceeds from our Barnett Shale sale to increase our capital
spending above our projected 2010 cash flow levels. We have structured the
financing for our proposed acquisition with Encore to provide us with an
estimated level of liquidity similar to that expected before the acquisition. We
currently do not anticipate raising any additional capital during 2009 unless
needed for an acquisition or alternate financing associated with the recently
announced merger discussed above in "Overview - Definitive Merger Agreement to
Acquire Encore Acquisition Company." We continually monitor our capital spending
and anticipated cash flows and believe that we can adjust our capital
Table of Contents
DENBURY RESOURCES INC.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
spending up or down depending on cash flows; however, any such reduction in
capital spending could reduce our anticipated production levels in future years.
For 2009, we have contracted for certain capital expenditures, including
construction of most of the Green Pipeline already in progress and two drilling
rigs, and therefore the portion of capital that we could eliminate without
significant penalty is limited (refer to Management's Discussion and Analysis of
Financial Condition and Results of Operations "Off-Balance Sheet Arrangements -
Commitments and Obligations" in our 2008 Form 10-K for further information
regarding these commitments).
Sources and Uses of Capital Resources
Capital Expenditure Summary
The following table of capital expenditures includes accrued capital for each
period. Our cash expenditures were $54.8 million higher in the 2009 period and
$24.3 million lower in the 2008 period than the amounts listed below due to the
increase (decrease) in our capital accruals in those periods.
Nine Months Ended
September 30,
In thousands 2009 2008
Oil and natural gas exploration and development:
Drilling $ 41,150 $ 186,249
Geological, geophysical and acreage 10,713 14,084
Facilities 136,556 117,423
Recompletions 56,251 104,476
Capitalized interest 10,440 13,639
Total oil and natural gas exploration and development
expenditures 255,110 435,871
Oil and gas property acquisitions 197,534 4,262
Total oil and natural gas capital expenditures 452,644 440,133
CO2 capital expenditures
CO2 pipelines 456,590 139,890
CO2 producing fields 28,562 90,658
Capitalized interest 38,259 5,885
Total CO2 capital expenditures 523,411 236,433
Total $ 976,055 $ 676,566
|
During the first nine months of 2009, we have recorded approximately
$833 million of cash used for capital expenditures, which includes $49 million
in capitalized interest and $44 million that was subsequently leased in sale
leaseback transactions. In addition, our liabilities for capital expenditures
were approximately $55 million lower at September 30, 2009 than at December 31,
2008, representing cash outflows related to our capital expenditures actually
incurred in 2008. These amounts net together resulting in $685 million of our
$750 million capital budget. In addition, we have approximately $55 million of
equipment available for sale leaseback financings for the remainder of 2009,
which if completed, would leave $120 million of our 2009 capital expenditure
budget available for the fourth quarter. If we do not complete the full
$55 million of remaining equipment leases in 2009, it is likely that we would
carry those over into 2010.
Our capital expenditures for the first nine months of 2009 were funded with
$406.4 million of cash flow from operations, $259.8 million of net proceeds from
the sale of a portion of our Barnett Shale natural gas assets and $381.4 million
of proceeds from the February 2009 issuance of 9.75% Senior Subordinated Notes.
Our capital expenditures for the first nine months of 2008 were funded with
$632.8 million of cash flow from operations, $225 million from the dropdown of
. . .
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