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RECV > SEC Filings for RECV > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for RECOVERY ENERGY, INC.

Form 10-Q for RECOVERY ENERGY, INC.


9-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Recovery Energy Inc. is a Denver based independent oil and gas company engaged in the acquisition, drilling and production of oil and natural gas properties and prospects within the Denver-Julesburg ("DJ") Basin. Our business strategy is designed to maximize shareholder value by leveraging the knowledge, expertise and experience of our management team and via the future exploration and development of the approximate 126,000 net acres of developed and undeveloped leases that are currently held by the Company, primarily in the northern DJ Basin.

Recent Developments

In February 2011, we issued in a private placement $8.4 million aggregate principal amount of three year 8% senior secured convertible debentures with a group of accredited investors. In March 2012, some investors in the convertible debenture agreed to purchase up to $5.0 million of additional convertible debentures (the "Supplemental Debentures"). The additional capital provided by the Supplemental Debentures has been used to partially fund the 2012 Capital Budget, and specifically for the drilling and development of certain proven undeveloped and other properties held by the Company, and for general corporate purposes. The initial funding under the March 2012 agreement occurred in March and continued through July 2012 in the amount of $3.04 million. These proceeds were used to fund the drilling and development of six new wells, resulting in a total investment of $3.69 million. Five of these wells resulted in commercial production, and one well was plugged and abandoned.

In August 2012, the Company restructured the terms of the Supplemental Debenture offering and concluded the offering by issuing an additional $1.96 million of convertible debentures. On September 8, 2012, the Company issued 50,000 shares, valued at $0.23 million, to T.R. Winston & Company LLC for acting as a placement agent of the Supplemental Debentures.

In February 2012, the Company completed the sale of its Grover Prospect acreage.

In March 2012, Hexagon agreed to extend the maturity of its term loans to June 30, 2013, and in connection therewith, we agreed to make minimum monthly loan payments of $0.33 million, effective immediately. In July 2012, Hexagon agreed to extend the maturity of its term loans to September 30, 2013. In November 2012, Hexagon extended the maturity date to December 31, 2013.

In April, 2012, we made the decision to temporarily abandon one of our unconventional Niobrara wells that was categorized as a well in progress as of December 31, 2011. In conjunction with that decision, all capitalized drilling, completion and allocable lease costs related to this well in the amount of $4.8 million were transferred to developed properties. This transfer of costs contributed to a $3.27 impairment charge of developed properties derived from the ceiling test completed as of March 31, 2012.

On November 5, 2012, the Company liquidated all of its price derivatives for proceeds of $0.60 million.

Results of Operations

Three Months Ended September 30, 2012 compared to the Three Months Ended
September 30, 2011.

The Company reported net losses for the three months ended September 30, 2012
and 2011 of approximately $2.84 million and $3.03 million, respectively.

                                                                 Three months ended September 30,
                                                                     2012                  2011
Revenues and other income:
 Oil sales                                                     $       1,775,383       $   1,650,702
 Gas sales                                                               168,897             161,029
 Realized gain on commodity hedges                                        37,341             733,830
 Unrealized (losses) on commodity price derivatives                    (130,000)                   -
 Other                                                                    42,853              85,372
Total revenues and other income                                        1,894,474           2,630,933
Expenses:
 Production costs                                                        397,793             344,927
 Production taxes                                                        198,781             191,364
 General and administrative                                            1,515,868           1,981,026
 Depreciation, depletion and amortization                              1,069,068           1,052,946
Total expenses                                                         3,181,510           3,570,263
 Loss from continuing operations                                      (1,287,036 )          (939,330 )
 Interest expense                                                     (2,149,931 )        (2,136,950 )
 Other                                                                       333              62,000
 Conversion debenture derivative gain(loss)                              600,000            (13,338)
Net loss                                                       $      (2,836,634 )     $  (3,027,618 )


Oil and Gas Revenues and Production

Oil and gas revenues were $1.94 million for the three months ended September 30, 2012, as compared to $1.81 million for the three months ended September 30, 2011, an increase of $.13 million, or 7.18%. Our production volume on a BOE basis was 33,618 for the three months ended September 30, 2012, as compared to 33,698 for the three months ended September 30, 2011, a nominal decrease that was effected by increased production attributed to five new wells, but offset by normal production declines on more mature properties. Average oil and gas prices during the three months ended September 30, 2012 increased slightly as compared to the prior year.

A comparison of production and average prices for the three months ended September 30, 2012 and 2011, respectively, follows:

                                         Three Months Ended
                                            September 30,
                                          2012          2011
Product:
Oil (Bbls)-volume                          21,151       20,145
Oil (Bbls)- average price (1)          $    83.94     $  81.94

Natural Gas (Mcf)-volume                   29,061       31,579
NGL's-(BOE)                                 7,624        8,290
Natural Gas (Mcf)- average price (2)   $     5.81     $   5.10
Barrels of oil equivalent (BOE)            33,618       33,698
Average daily net production (BOE)            365          366

(1) Does not include the realized price effects of hedges

(2) Includes proceeds from the sale of NGL's.

Oil and gas production expenses, depreciation, depletion and amortization

                             Three Months
                                Ended          Three Months Ended
                            September 30,         September 30,
                                 2012                 2011
                                (per BOE)             (per BOE)
Average price (1)             $       57.83       $           53.76

Production costs                      11.83                   10.23
Production taxes                       5.91                    5.68
Depletion and amortization            31.80                   31.25

Total operating costs                 49.54                   47.16

Gross margin                  $        8.29       $            6.60

Gross margin percentage                14.3 %                  12.2 %

(1) Does not include the realized price effects of hedges

Commodity Price Derivative Activities
Changes in the market price of oil can significantly affect our profitability and cash flow. In the past we have entered into various commodity derivative instruments to mitigate the risk associated with downward fluctuations in oil prices. These derivative instruments consisted exclusively of swaps. The duration and size of our various derivative instruments varies, and depends on our view of market conditions, available contract prices and our operating strategy.


Commodity price derivative net realized gain was $0.04 million during the three months ended September 30, 2012, compared to a realized gain of $0.73 million for the three months ended September 30, 2011, for a decrease in realized gain of $0.69 million, or 95% decrease. We also recorded an unrealized loss on commodity price derivatives of $0.13 million for the three months ended September 30, 2012 compared to no gain or loss during the three months ended September 30, 2011, for a decrease of $0.13 million

Production costs
Production costs were $0.40 million for the three months ended September 30, 2012, as compared to $0.34 million during the three months ended September 30, 2011, a change of $0.06 million, or 18%. Production costs increased due to a larger number of producing wells in the three months ended September 30, 2012 compared to the three months ended September 30, 2011.

Production taxes
Production taxes were $0.20 million for the three months ended September 30, 2012, as compared to $0.19 million during the three months ended September 30, 2011, a change of $0.01 million, or 5%. Production taxes increased due to an increase in oil and gas revenues.

General and administrative expenses
General and administrative expenses were $1.52 million for the three months ended September 30, 2012, as compared to $1.98 million for the three months ended September 30, 2011, a decrease of $0.46 million, or 23%. Our general and administrative expenses for the three months ended September 30, 2012 included approximately $0.54 million in non-cash compensation expense. General and administrative expenses for the three months ended September 30, 2011 included approximately $0.92 million in non-cash compensation expense. Excluding non-cash components, cash general and administrative expenses were $0.94 million for the three months ended September 30, 2012 compared to $1.06 million for the three months ended September 30, 2011. Cash general and administrative expenses during the three months ended September 30, 2012 decreased primarily as a result of a decrease in professional fees and third party fees, but were also affected by general decreases in other general and administrative expense areas.

Depreciation, depletion and amortization Depreciation, depletion and amortization was $1.07 million for the three months ended September 30, 2012, as compared to $1.05 million during the three months ended September 30, 2011, an increase of $0.02 million, or 2%. Depreciation, depletion, and amortization increased due to additional evaluated properties added during the three months ended September 30, 2012 as compared to the three months ended September 30, 2011.

Interest expense
Interest expense was $2.15 million during the three months ended September 30, 2012, compared to $2.14 million during the three months ended September 30, 2011, an increase of $0.01 million, or 0.4%. During the three months ended September 30, 2012, interest included non-cash charges of $1.29 million, compared to $1.50 million in the comparable period of 2011. Excluding non-cash components, cash interest was $0.86 million for the three months ended September 30, 2012 compared to $0.64 in the comparable period of 2011.

Nine Months Ended September 30, 2012 compared to the Nine Months Ended September 30, 2011.

The Company reported a net loss for the nine months ended September 30, 2012 of approximately $12.78 million compared to a net loss of approximately $11.53 million for the nine months ended September 30, 2011.

                                                   Nine months ended September 30,
                                                       2012                 2011
Revenues and other income:
Oil sales                                        $       4,685,713      $   5,534,325
Gas sales                                                  397,298            446,386
Realized gain on commodity hedges                           49,729            402,256
Unrealized gain on commodity price derivatives             445,609            222,788
Other                                                      132,367            110,282
Total revenues and other income                          5,710,711          6,716,037
Expenses:
Production costs                                         1,033,635          1,114,220
Production taxes                                           561,278            630,718
General and administrative                               5,099,932          8,837,802
Depreciation, depletion and amortization                 2,897,156          3,194,301
Impairment of evaluated properties                       3,274,718                  -
Total expenses                                          12,866,719         13,777,041

Loss from continuing operations                         (7,156,009 )       (7,061,004 )
Interest expense                                        (6,320,919 )       (6,123,496 )
Other                                                         (372 )           63,115
Conversion note derivative gain                            700,000          1,587,699
Net loss                                         $     (12,777,299 )    $ (11,533,686 )


Oil and Gas Revenues and Production
Oil and gas revenues were $5.08 million for the nine months ended September 30, 2012, as compared to $5.98 million for the nine months ended September 30, 2011, a decrease of $0.90 million, or 15%. Our production volume on a BOE basis was 80,005 for the nine months ended September 30, 2012, as compared to 101,251 for the nine months ended September 30, 2011 a decrease of 21,246 BOE, or 21%. This decrease is primarily attributable to normal decline curves related to mature properties, but partially offset by production attributable to wells drilled during the nine months ended September 30, 2012. Production declines were also partially offset by slightly higher average prices for both oil and gas.

Production and average prices for the nine months ended September 30, 2012 are presented in the following table:

                                       Nine Months Ended
                                           September 30,
                                        2012         2011
Product:
Oil (Bbls)-volume                       52,658        63,114
Oil (Bbls)-average price (1)          $  88.98     $   87.69

Natural gas (Mcf)-volume                63,746        88,229
NGL's-(BOE)                             16,723        23,433
Natural gas (Mcf)-average price (2)   $   6.23     $    5.06
Barrels of oil equivalent (BOE)         80,005       101,251
Average daily net production (BOE)         291           370

(1) Does not include the realized price effects of hedges

(2) Includes proceeds from the sale of NGL's.

Oil and gas production expenses, depreciation, depletion and amortization

                                                        Nine Months
                             Nine Months Ended             Ended
                               September 30,           September 30,
                                   2012                    2011
                                   (per BOE)             (per BOE)
Average price (1)              $           63.53      $         59.07

Production costs                           12.92                11.00
Production taxes                            7.02                 6.23
Depletion and amortization                 36.21                31.55

Total operating costs                      56.15                48.78

Gross margin                   $            7.38      $         10.29

Gross margin percentage                       12 %                 17 %

(1) Does not include the realized price effects of hedges

Commodity Price Derivative Activities

Changes in the market price of oil can significantly affect our profitability and cash flow. In the past we have entered into various commodity derivative instruments to mitigate the risk associated with downward fluctuations in oil prices. These derivative instruments consisted exclusively of swaps. The duration and size of our various derivative instruments varies, and depends on our view of market conditions, available contract prices and our operating strategy.


Commodity price derivative net realized gain was $0.05 million during the nine months ended September 30, 2012, as compared to a realized gain of $0.40 million for the nine months ended September 30, 2011, for a decrease in realized gain of $0.35 million, or 88%. We also recorded an unrealized gain on commodity price derivatives of $0.45 million for the nine months ended September 30, 2012 compared to a gain of $0.22 million during the nine months ended September 30, 2011, for an increase of $0.23 million, or 105%.

Production costs

Production costs were $1.03 million during the nine months ended September 30, 2012, as compared to $1.11 million for the nine months ended September 30, 2012, a decrease of $0.08 million, or 7%. Production costs decreased due to lower work over expenses during the nine months ended September 30, 2012.

Production taxes

Production taxes were $0.56 million during the nine months ended September 30, 2012, as compared to $0.63 million during the nine months ended September 30, 2011, a decrease of $0.07 million, or 11%. Production taxes decreased due to the decrease in revenues during the nine months ended September 30, 2012.

General and administrative expenses

General and administrative expenses were $5.10 million for the nine months ended September 30, 2012 compared to $8.84 million for the nine months ended September 30, 2011, a decrease of $3.74 million, or 42%. General and administrative expenses for the nine months ended September 30, 2012 included approximately $1.07 million in non-cash compensation expense and $0.71 million for non-cash payment for consulting fees. General and administrative expenses for the nine months ended September 30, 2011 included approximately $5.50 million in non-cash compensation expense. Excluding non-cash components, cash general and administrative expenses were $3.32 million for the nine months ended September 30, 2012 compared to $3.34 million for the nine months ended September 30, 2011. Cash general and administrative expenses during the nine months ended September 30, 2012 decreased primarily as a result of a decrease in payroll, legal and accounting fees and third party fees related to transactions, as well as being offset by general increases in other general and administrative expense areas.

Depreciation, depletion and amortization

Depreciation, depletion, and amortization were $2.90 million during the nine months ended September 30, 2012, as compared to $3.19 million during the nine months ended September 30, 2011, a decrease of $.29 million, or 9%. Depreciation, depletion, and amortization decreased due lower unit volumes of oil and gas sales and a declining cost center.

Expressed in dollars per BOE, depreciation, depletion, and amortization was $36.21 per BOE during the nine months ended September 30, 2012, as compared to $31.55 during the nine months ended September 30, 2011.

Impairment of evaluated properties

Impairment of evaluated properties was $3.27 million during the nine months ended September 30, 2012, as compared to no impairment during the nine months ended September 30, 2011. Impairment of evaluated properties increased due to capitalized costs exceeding the ceiling value as of the quarter ended March 31, 2012.

Interest Expense

Interest expense was $6.32 million during the nine months ended September 30, 2012, compared to $6.12 million during the nine months ended September 30, 2011, an increase of $0.20 million, or 3%. During the nine months ended September 30, 2012, interest included non-cash charges of $3.8 million, compared to $3.70 million for the nine months ended September 30, 2011. Cash interest accruing on debt in 2012 decreased primarily as a result of lower average term loan balances.

Liquidity and Capital Resources

Cash used in operating activities during the nine months ending ended September 30, 2012 was $2.75 million; this use of cash, coupled with the cash used in investing activities, exceeded cash provided by financing activities by $2.0 million, and resulted in a corresponding decrease in cash. This net use of cash also substantially contributed to a $2.20 million decrease in working capital as of September 30, 2012 as compared to working capital as of December 31, 2011.

In the immediate term, the Company expects that additional capital will be required to fund its remaining capital budget for 2012, partially to fund some of its ongoing overhead, and to provide additional capital to generally improve its working capital position. In March 2012, the Company secured commitments to fund up to $5.0 million of additional convertible debentures, all of which had been funded as of September 30, 2012. (See Note 7-Loan Agreements.)

Pursuant to our credit agreements with Hexagon, LLC ("Hexagon"), a substantial portion of our monthly net revenues from our producing properties is required to be used for debt and interest payments. In addition, our debt instruments contain provisions that, absent consent of the lenders, may restrict our ability to raise additional capital. Also, the Hexagon debt is currently due on December 31, 2013 and will need to be extended or retired prior to that date.

The Company will continue to pursue alternatives to address its working capital position and capital structure and to provide funding for the balance of its planned 2012 expenditures.

On November 5, 2012, the Company liquidated all of its price derivatives for proceeds of $0.60 million.


2012 Capital Budget

Our anticipated 2012 capital expenditure budget is currently expected to total $7-$9 million, of which approximately $4.7 million has been expended through September 30, 2012. The remaining 2012 budget is allocated primarily to the drilling and completion of oil and gas wells in the DJ Basin in Wyoming, Nebraska and Colorado targeting the conventional Muddy 'J' sand targets, and to the conventional development of certain Niobrara and Codell properties.

Our 2012 drilling program has remained flexible in order to accommodate both the timing of the securing of adequate capital and to identify suitable well locations. We anticipate funding the remainder of the 2012 capital program through a combination of the issuance of additional equity or debt securities, use of existing working capital and operating cash flows, and from cash provided by potential joint venture participants and/or asset sales.

Other factors that could cause us to further increase our level of activity and adjust our capital expenditure budget include a reduction in service and material costs, the formation of joint ventures with other exploration and production companies, the divestiture of non-strategic assets, a further improvement in commodity prices or well performance that exceeds our forecasts, any of which could positively impact our operating cash flow. Factors that could cause us to reduce level of activity and adjust our capital budget include, but are not limited to, increases in service and materials costs, reductions in commodity prices or under-performance of wells relative to our forecasts, any of which could negatively impact our operating cash flow.

In order to fund the remainder of the 2012 budget, the Company will need to secure additional financing. We may also choose to sell certain non-strategic assets in order to supplement the funding of our 2012 capital budget.

We cannot give assurances that our working capital on hand, our cash flow from operations or any available capital or borrowings, equity offerings or other financings, or sales of non-strategic assets will be sufficient to fund our anticipated capital expenditures. If our existing and potential sources of investment capital are not sufficient to undertake our planned 2012 capital expenditures, we may be required to reduce our 2012 drilling capital budget, curtail our expenditures and/or restructure our operations.

Capital Resources

Currently, the majority of our cash flows from operations are applied to the payment of principal and interest of our loans and to capital expenditures. Due to the continuing operating losses and the large amounts of capital expenditures during 2011 and continuing through 2012, our liquidity and working capital have deteriorated. While we believe that we have sufficient liquidity and capital resources to maintain our staff and continue our current production operations, we require additional capital to resolve our current working capital deficit and will also require substantial additional capital in order to fully test, develop and evaluate our 141,000 gross (126,000 net) undeveloped acres. We expect to obtain this capital through a variety of sources, including, but not limited to, future debt and equity financings and potentially from future joint venture partners. In the absence of near term major debt or equity financing or other similar transaction, we may be required to sell certain assets in order to meet obligations as they arise. We can provide no assurance that we will be able to secure a major financing, nor can we predict the terms of any future potential financing transactions.

Information about our financial position is presented in the following table:

                                                               September 30,      December 31,
                                                                    2012              2011
Financial Position Summary
Cash and cash equivalents                                      $      698,276     $   2,707,722
Working capital                                                $     (907,863 )   $   1,294,706
Balance outstanding on term loans and convertible debentures
payable                                                        $   33,692,339     $  29,680,636
Shareholders' equity                                           $   39,311,760     $  49,668,225

During the nine months ended September 30, 2012, our working capital decreased to $(0.91 million) from $1.29 million at December 31, 2011. The lower working capital and cash position is primarily the result of a combination of cash used in operating and investing activities, but partially offset by cash provided by financing activities.

A summary of cash flow results during the nine months ended September 30, 2012 follows:

                               Nine Months Ended
                                 September 30,
                                     2012
Cash provided by (used in):
Operating activities          $        (2,747,079 )
Investing activities                   (3,274,068 )
Financing activities                    4,011,701

Net change in cash            $        (2,009,446 )


During the nine months ended September 30, 2012, net cash used in operating activities was $2.75 million. The primary changes in operating cash during the . . .

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