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HK > SEC Filings for HK > Form 10-Q on 2-Aug-2012All Recent SEC Filings

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Form 10-Q for HALCON RESOURCES CORP


2-Aug-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion is intended to assist in understanding our results of operations for the three and six months ended June 30, 2012 and 2011 and should be read in conjunction with our unaudited condensed consolidated financial statements and the notes thereto included in this Quarterly Report on Form 10-Q and with the consolidated financial statements, notes and management's discussion and analysis included in our Annual Report on Form 10-K for the year ended December 31, 2011.

Statements in this discussion may be forward-looking. These forward-looking statements involve risks and uncertainties, including those discussed below, which could cause actual results to differ from those expressed.

Overview

We are an independent energy company engaged in the acquisition, production, exploration and development of onshore oil and natural gas properties in the United States. Our producing properties are located in basins with long histories of oil and natural gas operations.

Our oil and natural gas assets consist of a combination of developing and mature liquids-weighted reserves and properties. We have mature oil and natural gas reserves located primarily in Wichita, Wilbarger and Starr Counties, Texas, Pontotoc County, Oklahoma, and in several parishes in Louisiana. We have acquired acreage and may acquire more acreage in the Utica Shale/Point Pleasant formations in Ohio and Pennsylvania, the Woodbine/Eagle Ford formations in Texas, the Tuscaloosa Marine Shale formation in Louisiana, the Wilcox formation in Texas and Louisiana and the Mississippi Lime formation in Oklahoma, as well as several other undisclosed locations.

Our average daily oil and natural gas production decreased 6% in the first six months of 2012 compared to the same period in the prior year. During the first six months of 2012, we averaged 3,984 barrels of oil equivalent ("Boe") per day compared to average daily production of 4,238 Boe per day during the first six months of 2011. The decrease in production compared to the prior year period was driven primarily by natural production declines and pipeline operational issues in South Texas. During the first six months of 2012, we drilled or participated in the drilling of 15 gross (14.2 net) wells of which 14 gross (13.3 net) wells were completed as wells capable of production and one gross (0.9 net) well was a dry hole, resulting in a success rate of 93%.

Recent Acquisitions

Merger with GeoResources, Inc.

On August 1, 2012, we acquired GeoResources, Inc., by merger. As consideration, we paid a combination of $20 in cash and issued 1.932 shares of the Company's common stock for each share of GeoResources' common stock that was issued and outstanding on the closing date and also assumed GeoResources' outstanding warrants. GeoResources' oil and natural gas properties include acreage in the Bakken shale and Three Forks formations in North Dakota and Montana, and the Austin Chalk trend and Eagle Ford shale in Texas. As of January 1, 2012, GeoResources reported estimated proved reserves of approximately 29.2 million barrels of oil equivalent ("MMBoe"), of which approximately 67% was oil and 70% was developed. GeoResources' production for the year ended December 31, 2011 was 1.9 MMBoe. Prior to the merger, we and GeoResources operated as separate companies. Accordingly, the discussion and analysis of results of operations and financial condition set forth below relate solely to us. GeoResources' results of operations will be reflected in the Company's results from and after August 1, 2012. Additional details regarding the merger are discussed in Note 15 to the Condensed Consolidated Financial Statements, "Subsequent Events - Acquisitions."

East Texas Assets Acquisition

In early August 2012, the Company acquired an operated interest in approximately 20,000 net acres of oil and gas leasehold in east Texas from several private oil and gas companies for cash of approximately $300.0 million and 20.7 million shares of the Company's common stock. The properties, which the Company refers to as the East Texas Assets, consist of producing and nonproducing acreage prospective for the Woodbine, Eagle Ford and other formations. Net daily production from the acreage was approximately 2,800 Boe per day as of June 1, 2012.


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Acquisition of Unevaluated Acreage

On June 28, 2012, we completed the acquisition of acreage in Eastern Ohio that we believe is prospective for the Utica Shale/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"), we acquired a working interest in approximately 27,000 net acres for an adjusted purchase price of approximately $164.0 million. We funded the acquisition with cash on hand. No oil or natural gas production or proved reserves are currently attributable to the acquired assets. The effective date of the transaction is June 1, 2012.

In addition to the NCL acquisition, during the first six months of 2012 we 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.

Our financial results depend upon many factors, but are largely driven by the volume of our oil and natural gas production and the price that we receive for that production. Our production volumes will decline as reserves are depleted unless we expend capital in successful development and exploration activities or acquire properties with existing production. The amount we realize for our production depends predominately upon commodity prices and our related commodity price hedging activities, which are affected by changes in market demand and supply, as impacted by overall economic activity, weather, pipeline capacity constraints, inventory storage levels, basis differentials and other factors. Accordingly, finding and developing oil and natural gas reserves in an economical manner is critical to our long-term success.

Other Recent Developments

Recapitalization

On February 8, 2012, HALRES LLC (formerly, Halcón Resources, LLC), a newly-formed limited liability company led by Floyd C. Wilson, former Chairman and Chief Executive Officer of Petrohawk Energy Corporation, recapitalized us with a $550.0 million investment structured as the purchase of $275.0 million in new common stock, a $275.0 million five-year 8% convertible note and warrants for the purchase of an additional 36,666,666 million shares of our common stock at an exercise price of $4.50 per share. Information as to our recapitalization is set forth under Note 2 to the Condensed Consolidated Financial Statements.

February 2012 Credit Facility

In connection with the closing of the recapitalization, we entered into a senior revolving credit agreement (the "February 2012 Credit Agreement") with JPMorgan Chase Bank, N.A. ("JPMorgan"), as administrative agent, and other lenders on February 8, 2012. Initially, the February 2012 Credit Agreement provided for a $500.0 million facility with an initial borrowing base of $225.0 million. Amounts borrowed under the February 2012 Credit Agreement will mature on February 8, 2017. The borrowing base will be redetermined semi-annually, with the lenders and us each having the right to one interim unscheduled redetermination between any two consecutive semi-annual redeterminations. The borrowing base takes into account our oil and natural gas properties, proved reserves, total indebtedness, and other relevant factors consistent with customary oil and gas lending criteria. 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 we may issue. Funds advanced under the February 2012 Credit Agreement may be paid down and re-borrowed during the five-year term of the revolver. The initial pricing on the February 2012 Credit Agreement was LIBOR plus a margin ranging from 1.5% to 2.5% based on a percentage of usage. Advances under the February 2012 Credit Agreement are secured by liens on substantially all of our properties and assets. The February 2012 Credit Agreement contains representations, warranties and covenants customary in transactions of this nature including restrictions on the payment of dividends on the capital stock and financial covenants relating to current ratio and minimum interest coverage ratio. Initially, we were required to maintain commodity hedges on a monthly basis of not more than 100% of our projected production for the first 24 months, 75% of our projected production for the next 25 to 36 months and 50% of our projected production for the next 37 to 48 months. At June 30, 2012 and as of the date of this filing, we are in compliance with the financial debt covenants under the February 2012 Credit Agreement. At June 30, 2012, we had no indebtedness outstanding under the $500.0 million credit agreement, $1.3 million of letters of credit outstanding and $223.7 million of borrowing capacity available.

We requested, and were granted, a redetermination of the aggregate amount and borrowing base of the February 2012 Credit Agreement in anticipation of, and contingent upon, the successful completion of the GeoResources and East Texas Assets acquisitions, which in the aggregate are expected to increase our current Boe per day production volumes from approximately 4,000 Boe per day to 14,000 Boe per day. On August 1, 2012, in connection with the closing of the GeoResources, Inc. merger and East Texas Assets acquisition, we entered into the First Amendment to the February 2012 Credit Agreement (the "First Amendment"). The First Amendment increased the commitments under the revolving credit facility to an aggregate amount up to $1.5 billion and the borrowing base from $225.0 million to $525.0 million. The First


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Amendment also modified the requirements for commodity hedging to not more than 85% of our current and anticipated production for 66 months from the date such hedge agreement is created.

Preferred Stock Offering

On March 5, 2012, we sold in a private placement to certain institutional accredited investors 4,444.4511 shares of 8% automatically convertible preferred stock ("Preferred Stock"), par value $0.0001 per share, each share of which automatically converted into 10,000 shares of our common stock on April 17, 2012. We received gross proceeds of approximately $400.0 million, or $9.00 per share of common stock, before offering expenses. No cash dividends were paid on the convertible Preferred Stock as it converted into common stock on or before May 31, 2012. The Preferred Stock was considered to have a beneficial conversion feature because the proceeds per share, approximately $9.00 per share of common stock, were less than the fair value of our common stock of $10.99 per common share on the commitment date. The estimated fair value allocated to the beneficial conversion feature was $88.4 million and was recorded to additional paid-in capital, creating a discount on the Preferred Stock (the "Discount"). The Discount resulting from the allocation of value to the beneficial conversion feature was required to be amortized over the 71 month contractual period from issuance to required redemption, or fully amortized upon an accelerated date of redemption or conversion, by increasing Preferred Stock and recording the offsetting amount as a deemed non-cash Preferred Stock dividend. During the three months ended March 31, 2012, we recorded a non-cash preferred dividend of $1.1 million. Due to the conversion date occurring on April 17, 2012, the remaining $87.3 million of Discount amortization was accelerated to the conversion date and reflected as a non-cash preferred dividend for the three month period ended June 30, 2012.

9.75 % Senior Notes

On July 16, 2012, we completed a private offering of $750.0 million aggregate principal amount of 9.75% senior unsecured notes due 2020 (the "9.75% Notes"), issued at 98.646% of par. The net proceeds from the offering approximated $724.8 million after deducting the initial purchasers' discounts, commissions and offering expenses and were used to fund the cash consideration portion of the GeoResources merger and a portion of the cash component of the East Texas Assets acquisition.

Capital Resources and Liquidity

The proceeds provided by our recent financing activities has enabled us to increase our focus on expanding our leasehold position in liquids-rich resource areas. In addition to the assets acquired through the merger with GeoResources, we have acquired and/or identified several target resource plays for additional leasing, including the Utica Shale/Point Pleasant formations in Ohio and Pennsylvania, the Mississippi Lime formation in Northern Oklahoma and Southern Kansas, the Wilcox formation in Southwest Louisiana, the Woodbine/Eagle Ford formations in East Texas and the Tuscaloosa Marine Shale formation in Louisiana. In addition to our ongoing lease acquisition efforts in our targeted resource plays, we have identified several new exploratory areas we believe are prospective for oil and liquids-rich hydrocarbons. We have made significant progress in all of our target resources style plays. For the six months ended June 30, 2012, we invested $453.2 million on unevaluated properties for oil and natural gas leaseholds, exploration activities and seismic. The majority of these expenditures were for acreage in the Utica Shale/Point Pleasant and, to a lesser extent, Woodbine/Eagle Ford formations.

Our near-term capital spending requirements are expected to be funded with cash flows from operations, proceeds from potential asset dispositions and borrowings under our February 2012 Credit Agreement, for which the borrowing base has been increased from $225.0 million to $525.0 million due to the completed GeoResources merger and the acquisition of the East Texas Assets. As of August 1, approximately $220.0 million was drawn on the borrowing base. We strive to maintain financial flexibility while continuing our aggressive drilling plans and evaluating potential acquisitions, and will therefore likely continue to access capital markets (if on acceptable terms) as necessary to, among other things, maintain substantial borrowing capacity under our February 2012 Credit Agreement, facilitate drilling on our large undeveloped acreage position and permit us to selectively expand our acreage position and infrastructure projects while sustaining sufficient operating cash levels. Our ability to complete future debt and equity offerings and maintain or increase our borrowing base is subject to a number of variables, including our level of oil and natural gas production, reserves and commodity prices, as well as various economic and market conditions that have historically affected the oil and natural gas industry. If oil and natural gas prices decline for a sustained period of time, our ability to fund our capital expenditures, complete acquisitions, reduce debt, meet our financial obligations and become profitable may be materially impacted.

Our future capital resources and liquidity depend, in part, on our success in developing our leasehold interests, growing reserves and production and finding additional reserves. Cash is required to fund capital expenditures necessary to offset inherent declines in our production and proven reserves, which is typical in the capital-intensive oil and natural gas industry. We therefore continuously monitor our liquidity and the capital markets and evaluate our development plans in light of a variety of factors, including, but not limited to, our cash flows, capital resources, acquisition opportunities and drilling success.


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Cash Flow

Our primary source of cash for the six months ended June 30, 2012 was from financing activities. Our primary source of cash for the six months ended June 30, 2011 was from operating activities. Proceeds from our recent convertible Preferred Stock offering and recapitalization, as well as borrowings under our 8% convertible note, were partially offset by repayments of our previous credit facilities and cash used in investing activities to fund our unevaluated leasehold activities and our drilling program. Operating cash flow fluctuations were substantially driven by the increase in general and administrative expenses in the six months ended June 30, 2012 as a result of the recapitalization and related change in control matters. Prices for oil and natural gas have historically been subject to seasonal influences typically characterized by peak demand and higher prices in the winter heating season; however, the impact of other risks and uncertainties have influenced prices throughout recent years. See "Results of Operations" below for a review of the impact of prices and volumes on revenues.

Net increase in cash is summarized as follows (in thousands):

                                                          Six Months Ended
                                                              June 30,
                                                          2012        2011
Cash flows provided by (used in) operating activities   $  (2,708 ) $ 13,043
Cash flows used in investing activities                  (500,809 )  (13,496 )
Cash flows provided by financing activities               722,676        870
Net increase in cash                                    $ 219,159   $    417

Operating Activities. Net cash used in operating activities for the six months ended June 30, 2012 was $2.7 million as compared to cash provided by operating activities for the six months ended June 30, 2011 of $13.0 million.

Net loss for the six months ended June 30, 2012 was a $25.7 million. Non-cash items including depreciation, depletion and accretion of $11.9 million, $7.7 million of non-cash interest and amortization as well as $6.3 million of amortization and write-off of deferred loan costs offset this net loss. The recapitalization, change in control and related activities which occurred during February 2012, coupled with the impact of additional personnel and facilities in support of the rapidly expanding business base, drove a significant increase in general and administrative, which adversely affected operating cash flows.

Investing Activities. The primary driver of cash used in investing activities is capital spending, specifically the acquisition of unevaluated leaseholds in our targeted areas. Cash used in investing activities was $500.8 million and $13.5 million for the six months ended June 30, 2012 and 2011, respectively.

During the first six months of 2012, we spent $468.2 million on oil and natural gas capital expenditures, primarily on the acquisition of unevaluated leasehold. We participated in the drilling of 15 gross (14.2 net) wells of which 14 gross (13.3 net) wells were completed as wells capable of production and one gross (0.9 net) well was a dry hole, and spent an additional $3.5 million on other operating property and equipment capital expenditures, primarily on leasehold improvements, computers and software in our new corporate office in Houston, Texas. Proceeds from sales of oil and gas properties were $0.3 million. We also had funds held in escrow of approximately $29.4 million related to pending acquisitions.

During the first six months of 2011, we spent $13.5 million on oil and natural gas capital expenditures. During the six months ended June 30, 2011, we participated in the drilling of 30 gross (26.5 net) wells, of which 21 gross (19.2 net) wells were capable of production. Nine gross (7.3 net) wells were drilling, testing or waiting on completion as of June 30, 2011. We spent an additional $0.5 million on other operating property and equipment capital expenditures. Proceeds from sales of oil and gas properties were $0.5 million for the six months ended June 30, 2011.

Financing Activities. Net cash flows provided by financing activities were $722.7 million and $0.9 million for the six months ended June 30, 2012 and 2011, respectively.

On February 8, 2012, HALRES LLC recapitalized us with a $550.0 million investment structured as the purchase of $275.0 million in new common stock, a $275.0 million five-year 8% convertible note and warrants for the purchase of an additional 36,666,666 million shares of our common stock at an exercise price of $4.50 per share. The convertible note provided $231.4 million cash flow from borrowings and $43.6 million cash flow from warrants issued.

In connection with the closing of the recapitalization, we entered into the February 2012 Credit Agreement. The February 2012 Credit Agreement provided for a $500.0 million facility with an initial borrowing base of $225.0 million until it was amended in connection with the closing of the GeoResources and East Texas Assets transactions to increase the facility up to


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$1.5 billion and borrowing base from $225.0 million to $525.0 million. Amounts borrowed under the February 2012 Credit Agreement will mature on February 8, 2017. We did not utilize any of the funds available under the credit facility during the first six months of 2012; however, we incurred $2.0 million of debt issuance costs in conjunction with the issuance of the February 2012 Credit Agreement, and $2.5 million of debt issuance costs in connection with the 8% Note. We also incurred approximately $0.6 million of debt issuance costs in connection with the private offering of the 9.75% Notes discussed under "Recent Developments - 9.75% Senior Notes" in Item 2.

On March 5, 2012, we received $400.0 million, subject to certain adjustments, from the private placement sale of the convertible Preferred Stock. See "Recent Developments - Preferred Stock Offering" in Item 2 for a more detailed discussion.

In connection with the closing of the recapitalization transactions and the Preferred Stock private placement, we incurred a total of $18.1 million in equity issuance costs during the six months ended June 30, 2012.

Capital financing was used to repay borrowings under our previous credit facilities. During the first six months of 2012, we borrowed $6.0 million and paid down the $208.0 million balance of the previous credit facilities in connection with the recapitalization. During the first six months of 2011, we refinanced our previous credit facilities, which resulted in $8.0 million in net borrowings on long-term debt offset by $7.0 million in payments for deferred loan costs.

All restricted stock awards were vested as a result of the change in control in February 2012. For the six months ended June 30, 2012 and 2011, we repurchased $2.1 million and $0.1 million, respectively, in common stock from participants under our 2006 Long-Term Incentive Plan to net settle the related withholding tax liability.

On June 29, 2012, we priced $750.0 million aggregate principal amount of 9.75% senior unsecured notes due 2020 in a private offering. Net proceeds from these notes of approximately $724.8 million were funded into escrow on July 16, 2012 and subsequently released from escrow on August 1, 2012 and utilized to fund portions of the GeoResources and East Texas Assets transactions. See "Recent Developments - 9.75% Senior Notes" in Item 2 for a more detailed discussion.

Contractual Obligations

We have no significant long-term commitments associated with our capital expenditure plans. Our level of capital expenditures will vary in future periods depending on the success we experience in our acquisition, development and exploration activities, oil and natural gas price conditions and other related economic factors. We may enter into commitments related to drilling, non-cancelable operating leases or various other contracts in the future. At June 30, 2012, we have non-cancelable operating leases of $40.7 million, primarily related to our corporate office lease in Houston, Texas, which expire on various dates through 2020. Currently, no sources of liquidity or financing are provided by off-balance sheet arrangements or transactions with unconsolidated, limited-purpose entities.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon the unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Preparation of these unaudited condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. There have been no material changes to our critical accounting policies from those described in our Annual Report on Form 10-K for the year ended December 31, 2011.


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Results of Operations

Three Months Ended June 30, 2012 and 2011

We reported net income of $7.7 million and $8.9 million for the three months ended June 30, 2012 and 2011, respectively, resulting in a decline in the net income of $1.2 million. The following tables summarize key items of comparison and their related change for the periods indicated (in thousands, except per unit and Boe amounts).

                                           Three Months Ended
                                                June 30,
                                            2012         2011      Change
Net income                               $    7,659    $  8,936   $ (1,277 )
Operating revenues:
Oil                                          20,383      22,783     (2,400 )
Natural gas                                   1,240       2,812     (1,572 )
NGLs                                          1,623       2,523       (900 )
Other revenue                                    35          34          1
Operating expenses:
Production:
Lease operating                               8,663       7,812        851
Workover                                        540         362        178
Taxes                                         1,352       1,478       (126 )
General and administrative:
General and administrative                   12,558       3,935      8,623
Share-based compensation                        529         686       (157 )
Restructuring                                   903           -        903
Depletion, depreciation and accretion:
Depletion - full cost                         5,183       4,945        238
Depreciation - other                            345         251         94
Accretion                                       428         412         16
Other income (expenses):
Net gain on derivative contracts             13,671       8,268      5,403
Interest expense                             (4,192 )    (3,563 )     (629 )
Other income (expense)                           13        (798 )      811
Income before income taxes                    2,272      12,178     (9,906 )
Income tax provision (benefit)               (5,387 )     3,242     (8,629 )


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