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HK > SEC Filings for HK > Form 10-Q on 8-Nov-2012All Recent SEC Filings

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Form 10-Q for HALCON RESOURCES CORP


8-Nov-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 nine months ended September 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. Historically, our producing properties are located in basins with long histories of oil and natural gas operations. During the current year we have focused on the acquisition of unevaluated leasehold and producing properties to increase our production levels and provide growth potential through exploration and development in prospect areas. As a consequence of these activities, we have extensive drilling opportunities in multiple basins that we believe allow for repeatable successes and production growth. We believe our portfolio of properties and drilling opportunities provides us with broad flexibility to direct our capital resources to projects with the greatest potential returns.

Our oil and natural gas assets consist of a combination of growth and mature liquids-weighted reserves and undeveloped properties. We have mature oil and natural gas reserves located primarily in Texas, North Dakota, Louisiana, Oklahoma, Montana, and Colorado. We have acquired acreage and may acquire additional acreage in the Utica/Point Pleasant formations in Ohio and Pennsylvania, the Woodbine/Eagle Ford formations in Texas, the Bakken/Three Forks formations in North Dakota and Montana, the Tuscaloosa Marine shale formation in Louisiana, the Midway/Navarro formations in Southeast Texas, 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 increased 55% in the first nine months of 2012 compared to the same period in the prior year. During the first nine months of 2012, we averaged 6,401 barrels of oil equivalent ("Boe") per day compared to average daily production of 4,132 Boe per day during the first nine months of 2011. The increase in production compared to the prior year period was driven primarily by the acquisitions of GeoResources, Inc. ("GeoResources") and the East Texas assets (the "East Texas Assets"), partially offset by a slight production decline. The acquisitions of GeoResources and the East Texas Assets combined to contribute approximately 2,460 Boe per day of the increase. During the first nine months of 2012, we participated in the drilling of 82 gross (54.5 net) wells of which 40 gross (35 net) wells were completed and capable of production, 40 gross (17.6 net) wells were drilling or waiting on completion and two gross (1.9 net) wells were dry holes. We also drilled and completed four gross (4 net) salt water disposal wells and completed one gross (1 net) well that we did not drill.

Recent Acquisitions

Merger with GeoResources, Inc.

On August 1, 2012, we acquired GeoResources, Inc., by merger, which we refer to as the GeoResources Merger. As consideration, we paid a combination of $20.00 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 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 and for the six months ended June 30, 2012 was 1.4 MMBoe. Prior to the merger, we and GeoResources operated as separate companies. Accordingly, the comparison to prior period results of operations and financial condition set forth below relate solely to us. GeoResources' results of operations are reflected in the Company's results from and after August 1, 2012. Net daily production from the GeoResources properties was approximately 8,344 Boe per day during August and September of 2012. Information on the merger is set forth under Note 4 to the condensed consolidated financial statements.

East Texas Assets Acquisition

In early August 2012, we acquired an operated interest in 20,628 net acres of oil and gas leaseholds in East Texas from several private oil and gas companies for cash of approximately $301.6 million and 20.8 million shares of the Company's common stock subject to normal closing adjustments. The properties consist of producing and nonproducing acreage believed to be prospective for the Woodbine, Eagle Ford and other formations. The East Texas Assets results of operations are reflected in the Company's results from and after August 1, 2012. Net daily production from the acreage was approximately 2,700 Boe per day during August and


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September of 2012. Information on the East Texas Asset acquisition is set forth under Note 4 to the condensed consolidated financial statements.

Acquisition of Unevaluated Acreage

On June 28, 2012, we acquired a working interest in approximately 27,000 net acres in Eastern Ohio that we believe is prospective for the Utica shale/Point Pleasant formations. The purchase price in the transaction was approximately $164.0 million. We funded the acquisition with cash on hand. No oil or natural gas production or proved reserves were attributable to the acquired assets.

In addition to the forgoing acquisitions, during the first nine months of 2012 we incurred approximately $403.2 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 were attributable to the acquired unevaluated 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

Pending Acquisition of Williston Basin Assets

On October 19, 2012, Halcón Energy Properties, Inc., a wholly owned subsidiary of Halcón, entered into a Reorganization and Interest Purchase Agreement (the "Williston Purchase Agreement") with Petro-Hunt, L.L.C. and Pillar Energy, LLC (collectively, the "Petro-Hunt Parties"), pursuant to which we have agreed to acquire two newly formed wholly owned subsidiaries of the Petro-Hunt Parties, which immediately before closing will own a total of approximately 81,000 net acres prospective for Bakken and Three Forks formations primarily located in Williams, Mountrail, McKenzie and Dunn Counties, North Dakota (the "Williston Basin Assets"). The effective date of the transaction is June 1, 2012 and we expect to close the transaction in mid-December 2012. The purchase price is subject to adjustments for (i) operating expenses, capital expenditures and revenues between the effective date and the closing date, (ii) title and environmental defects, and (iii) other purchase price adjustments customary in oil and gas purchase and sale agreements. Any adjustments to the purchase price at closing would be applied to the cash and convertible preferred stock components of the purchase price in the same proportions. The parties may terminate the Williston Purchase Agreement if any of the above closing conditions have not been satisfied, or if total adjustments to the purchase price exceed $217.5 million or the transaction has not closed on or before December 20, 2012.

The total purchase price of $1.45 billion consists of $700 million in cash and $750 million in newly issued Halcón preferred stock that will automatically convert into approximately 100.7 million shares of Halcón common stock at a conversion price of $7.45 per share following stockholder approval of such conversion and an increase in our authorized common stock. The shares of preferred stock are to be issued to the Petro-Hunt Parties in a private placement pursuant to the exemptions from registration in Regulation D, Rule 506, under Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act").

The preferred stock will accrue dividends at the rate of 8% per annum from the issue date to the extent not converted into common stock within 121 days following issuance. No dividends will be payable if the preferred stock is converted within that period. The conversion rate of the preferred stock will be subject to anti-dilution adjustments in the event of stock splits, stock dividends and under certain other circumstances. See Note 16 "Subsequent Events" to the condensed consolidated financial statements for additional discussion on the acquisition of the Williston Basin Assets.

Common Stock Purchase Agreement

On October 19, 2012, we entered into a Common Stock Purchase Agreement (the "Stock Purchase Agreement") with CPP Investment Board PMI-2 Inc. ("CPPIB"), pursuant to which CPPIB has agreed to purchase 41,899,441 newly issued shares of our common stock at $7.16 per share for a total purchase price of approximately $300.0 million. The net proceeds to Halcón are expected to be approximately $294.0 million following the payment of an approximate $6.0 million capital commitment payment to CPPIB upon closing of the transaction. The shares of Halcón common stock will be issued to CPPIB in a private placement pursuant to the exemptions from registration provided in Regulation D, Rule 506, under
Section 4(2) of the Securities Act. As a result of this transaction, CPPIB is expected to hold approximately 9% of Halcón's outstanding common stock on a fully diluted basis after giving effect to the completion of the Williston Basin Assets acquisition. CPPIB has agreed to a one-year lock-up period, ending October 19, 2013, during which time it will not offer for sale, sell, pledge or otherwise dispose of the shares of Halcón common stock it acquires pursuant to the Stock Purchase Agreement, subject to certain exceptions.

Offering of 8.875% Senior Notes

On November 6, 2012, we sold, in a private offering to eligible purchasers, $750 million aggregate principal amount of its 8.875% Senior Notes due 2021 (the "8.875% Notes"). Net proceeds of $725.6 million from the offering were placed into escrow pending the acquisition of the Williston Basin Assets and will be released upon closing and used to fund the cash portion of the consideration to be paid in the acquisition.

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 (the "8% Note") and warrants for the purchase of an additional 36,666,666 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.


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February 2012 Credit Facility Amendment

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. On August 1, 2012, in connection with the closing of the GeoResources 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 Amendment also modified the requirements for commodity hedging to not more than 85% of our projected proved production forecast for 66 months from the date such hedge agreement is created.

February 2012 Credit Facility

In connection with the closing of the recapitalization, we entered into a senior secured 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 pricing on the February 2012 Credit Agreement is 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 our capital stock and financial covenants relating to current ratio and minimum interest coverage ratio. Initially, prior to the amendment during August 2012, 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 September 30, 2012, we had $185.0 million of indebtedness outstanding, $1.3 million of letters of credit outstanding and $338.7 million of borrowing capacity available under the revolving credit agreement. At September 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.

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 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 during April of 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 $723.1 million after deducting the initial purchasers' discounts, commissions and offering expenses and were used to fund a portion of the cash consideration paid in the GeoResources Merger and East Texas Assets acquisition.


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Capital Resources and Liquidity

The proceeds provided by our recent financing activities have enabled us to increase our focus on expanding our leasehold position in liquids-rich resource areas. We have acquired and/or identified several target resource style plays for additional leasing, including the Bakken/Three Forks formations in North Dakota, Utica/Point Pleasant formations in Ohio and Pennsylvania, the Mississippi Lime formation in Northern Oklahoma and Southern Kansas, the Wilcox formation in Southwest Louisiana, the Midway/Navarro formations in Southeast Texas, 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 nine months ended September 30, 2012, excluding our GeoResources and East Texas Asset acquisitions, we invested $634.6 million in 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 Woodbine/Eagle Ford formations. For the nine months ended September 30, 2012, we invested $93.1 million in the development of our oil and gas properties. Additionally, for the nine months ended September 30 2012, we invested $579.5 million and $296.1 million respectively, in the GeoResources and East Texas Assets acquisitions.

Our near-term capital spending requirements are expected to be partially 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 East Texas Assets acquisition. As of November 5, approximately $415.3 million was drawn on the borrowing base. In addition, and in conjunction with the anticipated December 2012 closing of the Williston Basin Asset transaction the Company will have net proceeds from the $750 million 8.875% Notes and common stock offering to CPPIB of approximately $320 million after satisfying the $700.0 million cash consideration portion of the Williston Basin Assets acquisition and related costs. Furthermore, the closing of the Williston Basin Assets acquisition will result in an increase in our current borrowing base from $525.0 million to $850 million on our February 2012 Credit Facility.

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.

Cash Flow

Our primary source of cash for the nine months ended September 30, 2012 was from financing activities. Our primary source of cash for the nine months ended September 30, 2011 was from operating activities. Proceeds from our convertible Preferred Stock and common stock issuance pursuant to our recapitalization, as well as borrowings under our February 2012 Credit Facility, 8% Note and 9.75% notes, were offset by repayments of our previous credit facilities and cash used in investing activities to fund our unevaluated leasehold activities, our drilling program, and our recent acquisitions. Operating cash flow fluctuations were substantially driven by the increase in general and administrative expenses in the nine months ended September 30, 2012 as a result of the February 2012 recapitalization and change in control matters, as well as transaction costs for business acquisitions and mergers.


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

                                                          Nine Months Ended
                                                            September 30,
                                                           2012         2011
Cash flows provided by operating activities             $    13,568   $ 23,813
Cash flows used in investing activities                  (1,624,006 )  (19,630 )
Cash flows provided by (used in) financing activities     1,628,515     (4,176 )
Net increase in cash                                    $    18,077   $      7

Operating Activities. Net cash provided by operating activities for the nine months ended September 30, 2012 was $13.6 million as compared to cash provided by operating activities for the nine months ended September 30, 2011 of $23.8 million.

Net loss for the nine months ended September 30, 2012 was $45.8 million. Non-cash items, including $34.7 million of depreciation, depletion and accretion, $8.6 million of non-cash interest and amortization and $6.2 million of amortization and write-off of deferred loan costs served to offset this net loss. The recapitalization, including change in control and related activities which occurred during February 2012, merger and acquisition transaction costs and 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 drivers of cash used in investing activities is capital spending, specifically the acquisition of unevaluated leaseholds in our targeted areas, the merger with GeoResources, Inc., and the acquisition of the East Texas Assets. Cash used in investing activities was $1.6 billion and $19.6 million for the nine months ended September 30, 2012 and 2011, respectively.

During the first nine months of 2012, we incurred cash expenditures of $579.5 million, net of cash acquired, on the merger with GeoResources, $296.1 million on the acquisition of the East Texas Assets, $93.1 million on evaluated oil and natural gas capital expenditures, and $634.6 million on the unevaluated leasehold acquisitions seismic and exploratory drilling. We participated in the drilling of 82 gross (54.5 net) wells of which 40 gross (35 net) wells were completed and capable of production, 40 gross (17.6 net) wells were drilling or waiting on completion and two gross (1.9 net) wells were dry holes. We also drilled and completed four gross (4 net) salt water disposal wells and completed one gross (1 net) well that we did not drill during the first nine months of 2012. We spent an additional $18.2 million on other operating property and equipment capital expenditures; $12.1 million of the $18.2 million was spent on pipelines and related infrastructure projects and the remainder was spent on leasehold improvements, computers and software primarily in our corporate office in Houston, Texas. Proceeds from sales of oil and gas properties were $0.6 million.

During the first nine months of 2011, we spent $19.6 million on oil and natural gas capital expenditures. During the nine months ended September 30, 2011, we participated in the drilling of 46 gross (40 net) wells, of which 35 gross (31.5 net) wells were capable of production and 11 gross (8.5 net) wells were drilling, testing or waiting on completion as of September 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 nine months ended September 30, 2011.

Financing Activities. Net cash flows provided by financing activities were $1.6 billion as compared to $4.2 million used in financing activities for the nine months ended September 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 shares of our common stock at an exercise price of $4.50 per share. The convertible note provided $231.4 million cash flow from . . .

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