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HK > SEC Filings for HK > Form 10-K on 28-Feb-2013All Recent SEC Filings

Show all filings for HALCON RESOURCES CORP

Form 10-K for HALCON RESOURCES CORP


28-Feb-2013

Annual Report


ITEM 7. 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 and our current financial condition. Our consolidated financial statements and the accompanying notes included elsewhere in this Annual Report on Form 10-K contain additional information that should be referred to when reviewing this material.

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 focused on the acquisition, production, exploration and development of onshore liquids-rich oil and natural assets in the United States. We were incorporated in Delaware on February 5, 2004 and were recapitalized on February 8, 2012, as described more fully herein. Historically, our producing properties have been located in basins with long histories of oil and natural gas operations. During 2012, we focused our efforts on the acquisition of unevaluated leasehold and producing properties in selected prospect areas. We now have an extensive drilling inventory in multiple basins that we believe allow for multiple years of profitable production growth and provides us with broad flexibility to direct our capital resources to projects with the greatest potential returns.

At December 31, 2012, our estimated total proved oil and natural gas reserves, as prepared by our independent reserve engineering firm, Netherland, Sewell & Associates, Inc. (Netherland, Sewell), were approximately 108.8 MMBoe, consisting of 87.4 MMBbls of oil, 5.4 MMBbls of natural gas liquids, and 96.1 Bcf of natural gas. Approximately 47% of our proved reserves were classified as proved developed. We maintain operational control of approximately 93% of our proved reserves. Production for the fourth quarter of 2012 averaged 18,348 Boe/d. Full year 2012 production averaged 9,404 Boe/d compared to 4,121 Boe/d in 2011. Our total operating revenues for 2012 were approximately $247.9 million compared to $103.7 million in 2011.

Our oil and natural gas assets consist of a combination of undeveloped acreage positions in unconventional liquids-rich basins/fields and mature liquids-weighted reserves and production in more conventional basins/fields. We have mature oil and natural gas reserves located primarily in Texas, North Dakota, Louisiana, Oklahoma and Montana. 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 East 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 and the Wilcox formation in Texas and Louisiana as well as several other undisclosed locations.


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Our average daily production increased 128% year over year. The increase in production compared to the prior year period was driven by our acquisitions of GeoResources, Inc. (GeoResources), the East Texas Assets (defined below) and the Williston Basin Assets (defined below), partially offset by a slight production decline from existing properties. The acquisition of GeoResources, the East Texas Assets and the Williston Basin Assets combined to contribute approximately 5,320 Boe/d of the increase. In 2012, we participated in the drilling of 192 gross (88.2 net) wells of which 189 gross (85.3 net) wells were completed and capable of production, and 3 gross (2.9 net) wells were dry holes. We also drilled and completed 6 gross (5.0 net) salt water disposal wells.

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 predominantly 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 at economical costs is critical to our long-term success.

For the twelve months ended December 31, 2012 we incurred capital expenditures for drilling, completions and leasehold costs of approximately $1.3 billion as compared to a budget of $1.1 billion. Capital spending was more than budgeted primarily because of increased drilling and completion activity in the Bakken / Three forks formations related to the acquisition of the Williston Basin Assets in addition to increased leasing activity in the Utica / Point Pleasant formations.

We expect to spend approximately $1.2 billion on drilling and completion capital expenditures during 2013. While this amount represents the vast majority of our expected capital expenditures in 2013, we will also incur additional capital expenditures associated with ongoing leasing efforts, transportation, infrastructure and seismic and other expenditures. Of the $1.2 billion budget for drilling and completions, approximately $475 million is planned for the Bakken / Three Forks formations in North Dakota, approximately $490 million is budgeted for Woodbine / Eagle Ford formations in East Texas, approximately $200 million is planned for the Utica / Point Pleasant formations in Ohio and Pennsylvania with the remaining amount planned for various other project areas. Our 2013 drilling and completion budget contemplates six to eight operated rigs running in the Bakken / Three Forks, five to seven operated rigs running in the Woodbine / Eagle Ford and two to three operated rigs running in the Utica / Point Pleasant. Our drilling and completion budget for 2013 is based on our current view of market conditions and current business plans, and is subject to change.

We expect to fund our budgeted 2013 capital expenditures with cash flows from operations, proceeds from potential non-core asset divestitures and borrowings under our Senior Credit Agreement. We strive to maintain financial flexibility and may access capital markets as necessary to maintain substantial borrowing capacity under our Senior Credit Agreement, facilitate drilling on our large undeveloped acreage position and permit us to selectively expand our acreage position and infrastructure projects. In the event our cash flows or proceeds from potential asset dispositions are materially less than anticipated and other sources of capital we historically have utilized are not available on acceptable terms, we may curtail our capital spending.

Recent Acquisitions

Acquisition of Williston Basin Assets

On December 6, 2012, we completed the acquisition of entities owning a total of approximately 81,000 net acres prospective for the Bakken / Three Forks formations primarily located in Williams, Mountrail, McKenzie and Dunn Counties, North Dakota (the Williston Basin Assets), from two


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affiliated privately held companies, Petro-Hunt, L.L.C. and Pillar Energy, LLC (the Petro-Hunt parties) for a total adjusted purchase price of approximately $1.5 billion, consisting of approximately $756.1 million in cash and approximately $695.2 million in newly issued shares of our preferred stock. We issued a total of 10,880 shares of our 8% Automatically Convertible Preferred Stock, par value $0.0001 per share. Following the approval by our stockholders, on January 18, 2013, each outstanding share of our preferred stock converted into 10,000 shares of our common stock at an effective conversion price of approximately $7.45 per share based on the liquidation preference. Accordingly, on that date an aggregate of 108.8 million shares of our common stock was issued to the Petro-Hunt parties. No cash dividends were paid on the convertible preferred stock as it converted into common stock before April 6, 2013. No proceeds were received by us upon conversion of the preferred stock.

The borrowing base for our Senior Credit Agreement was increased to $850.0 million after the closing of the Williston Basin Assets acquisition. Refer to Item 8. Consolidated Financial Statements and Supplementary Data-Note 5, "Acquisitions and Divestitures," for additional information regarding our acquisition of the Williston Basin Assets.

Merger with GeoResources, Inc.

On August 1, 2012, we acquired GeoResources by merger (the Merger) for a total purchase price of $854.4 million. As consideration, we paid a combination of $20.00 in cash, and issued 1.932 shares of our common stock, for each share of GeoResources' common stock that was issued and outstanding on the closing date and also assumed GeoResources' outstanding warrants. We issued a total of approximately 51.3 million shares of common stock and paid approximately $531.5 million in cash to former GeoResources stockholders in exchange for their shares of GeoResources common stock. GeoResources' oil and natural gas properties include acreage in the Bakken / Three Forks formations in North Dakota and Montana, and the Austin Chalk trend and Eagle Ford Shale in Texas. The acquisition expanded our presence in these areas as well as added properties in Oklahoma and Louisiana, which added oil and natural gas reserves and production to our existing asset base. GeoResources' production for the year ended December 31, 2011 was 1.9 MMBoe. Prior to the Merger, we and GeoResources operated as separate companies. GeoResources' results of operations are reflected in our results from and after August 1, 2012. Accordingly, the comparison to prior period results of operations and financial condition set forth below relate solely to us. Refer to Item 8. Consolidated Financial Statements and Supplementary Data-Note 5, "Acquisitions and Divestitures," for additional information regarding the Merger.

East Texas Assets Acquisition

In early August 2012, we acquired an operated interest in 20,628 net acres of oil and natural gas leaseholds in East Texas (the East Texas Assets) from several private oil and natural gas companies for consideration of $426.8 million comprised of approximately $296.1 million in cash and 20.8 million shares of our 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 our results from and after August 1, 2012. Refer to Item 8. Consolidated Financial Statements and Supplementary Data-Note 5, "Acquisitions and Divestitures," for additional information regarding the East Texas Assets acquisition.

Acquisition of Unevaluated Acreage and Other

On December 28, 2012, we completed the acquisition of certain oil and natural gas properties, located in Brazos County, Texas, from a group of private sellers for approximately $83.7 million, before customary closing adjustments, consisting of approximately $8.4 million in cash and approximately $75.3 million in promissory notes. The promissory notes have a maturity date of August 30, 2013. The transaction had an effective date of December 1, 2012. Refer to Item 8. Consolidated Financial


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Statements and Supplementary Data-Note 7, "Long-term debt," for more details regarding the promissory notes.

On September 12, 2012, we completed the acquisition of certain oil and natural gas properties, located in Leon County, Texas from a group of private sellers for approximately $14.0 million, before customary closing adjustments. The transaction had an effective date of September 1, 2012. The acquisition was funded with cash on hand.

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 / 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 2012 we incurred approximately $915.6 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

Offering of Additional 8.875% Senior Notes

On January 14, 2013, we completed the issuance of an additional $600 million aggregate principal amount of our 8.875% senior unsecured notes due 2021 (the Additional 2021 Notes). The Additional 2021 Notes were issued at 105% of par and provided net proceeds of approximately $619.5 million (after deducting offering fees). The net proceeds from this offering were used to repay all of the outstanding borrowings under our Senior Credit Agreement and for general corporate purposes, including funding a portion of our 2013 capital expenditures program. There was no borrowing base reduction to our Senior Credit Agreement as a result of the issuance of the Additional 2021 Notes.

Common Stock Purchase Agreement

On December 6, 2012, we received net proceeds of approximately $294.0 million from the private placement of 41.9 million shares of our common stock with Canada Pension Plan Investment Board (CPPIB), which acquired the shares for a purchase price of approximately $7.16 per share.

Offering of 8.875% Senior Notes

On November 6, 2012, we completed a private offering of $750 million aggregate principal amount of our 8.875% senior notes due 2021 (the 2021 Notes). The 2021 Notes were issued at 99.247% of par and provided net proceeds of approximately $725.6 million (after deducting offering fees and expenses). The net proceeds from this offering were used to fund a portion of the cash consideration paid in our acquisition of the Williston Basin Assets.


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Offering of 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 2020 Notes). The 2020 Notes were issued at 98.646% of par and provided net proceeds of approximately $723.1 million (after deducting offering fees and expenses). The net proceeds from this offering were used to fund a portion of the cash consideration paid in the Merger and East Texas Assets acquisition.

Preferred Stock Offering

On March 5, 2012, we sold in a private placement 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 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 amortized the Discount and 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 the Discount amortization was accelerated to the conversion date and reflected as a non-cash preferred dividend in April 2012.

Recapitalization

On February 8, 2012, HALRES LLC, formerly, Halcón Resources, LLC (HALRES), a newly-formed limited liability company led by Floyd C. Wilson, 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 8.0% convertible note and warrants for the purchase of an additional 36.7 million shares of our common stock at an exercise price of $4.50 per share (Recapitalization). Information regarding our Recapitalization is set forth under Item 8. Consolidated Financial Statements and Supplementary Data-Note 3, "Recapitalization."

Senior Revolving Credit Agreement

In connection with the closing of the Recapitalization, we entered into a senior secured revolving credit agreement (the Senior Credit Agreement) with JPMorgan Chase Bank, N.A., as administrative agent, and other lenders on February 8, 2012. Initially, the Senior Credit Agreement provided for a $500.0 million facility with an initial borrowing base of $225.0 million. Amounts borrowed under the Senior Credit Agreement will mature on February 8, 2017. The borrowing base will be redetermined semi-annually, with us and the lenders 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 natural 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 Senior Credit Agreement may be paid down and re-borrowed during the five-year


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term of the revolver. Amounts outstanding under the Senior Credit Agreement bear interest at specified margins over the base rate of 0.50% to 1.50% for ABR-based loans or at specified margins over LIBOR of 1.50% to 2.50% for Eurodollar-based loans. Advances under the Senior Credit Agreement are secured by liens on substantially all of our properties and assets. The Senior 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.

On August 1, 2012, in connection with the closing of the Merger and East Texas Assets acquisition, we entered into the First Amendment to the Senior Credit Agreement (the First Amendment). The First Amendment increased the commitments under the Senior Credit Agreement to an aggregate amount up to $1.5 billion and the borrowing base from $225.0 million to $525.0 million. On December 6, 2012, the borrowing base was increased from $525.0 million to $850.0 million. At December 31, 2012, we had $298.0 million of indebtedness outstanding, $1.3 million of letters of credit outstanding and $550.7 million of borrowing capacity available under the Senior Credit Agreement.

On January 25, 2013, we entered into the Second Amendment which amends the Senior Credit Agreement with respect to our ability to enter into certain commodity hedging agreements (the Second Amendment). The Second Amendment provides, among other things, that we and our subsidiaries may enter into commodity swap, collar and/or call option agreements with approved counterparties so long as the volumes for such agreements do not exceed 85% of our internally forecasted production (i) from our crude oil, natural gas liquids and natural gas, or (ii) in the case of a proposed acquisition of oil and gas properties, from such oil and gas properties that are the subject of such proposed acquisition, in each case for the 24 months following the date such agreement is entered into. Additionally, we may enter into commodity swap, collar and/or call option agreements so long as the volumes for such agreements do not exceed 85% (i) of the reasonably anticipated projected production from our proved reserves for the period of 25 to 66 months following the date such agreement is entered into, or (ii) in the case of a proposed acquisition of oil and gas properties, of the reasonably anticipated projected production from proved reserves from such oil and gas properties that are the subject of such proposed acquisition for the period of 25 to 48 months following the date such agreement is entered into. The 85% limitations discussed above do not apply to our volumes hedged by using puts, floors and/or basis differential swap agreements.

Prior to the Second Amendment, the volumes for commodity swap, collar and/or call option agreements under the Senior Credit Agreement could not exceed 85% of the reasonably anticipated projected production from our proved reserves (as forecast based upon the most recently delivered reserve report), for each month during the period during which the agreement was in effect for each of crude oil, natural gas liquids and natural gas, for the 66 months following the date such agreement was entered into.


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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 core resource plays for additional leasing, including the Bakken / Three Forks formations in North Dakota, Utica / Point Pleasant formations in Ohio and Pennsylvania and the Woodbine / Eagle Ford formations in East Texas. In addition to our ongoing lease acquisition efforts in our core resource plays, we have identified several new exploratory areas we believe are prospective for oil and liquids-rich hydrocarbons. In 2012, excluding the Merger and acquisitions of the East Texas Assets and Williston Basin Assets, we invested $1.2 billion on oil and natural gas capital expenditures. The majority of these expenditures were for acreage in the Utica / Point Pleasant and Woodbine / Eagle Ford formations. Additionally, in 2012, we paid approximately $579.5 million, $756.1 million and $296.1 million respectively, in the Merger, the Williston Basin Assets Acquisition and the East Texas Assets Acquisition.

Our near-term capital spending requirements are expected to be partially funded with cash flows from operations, proceeds from potential non-core asset dispositions, proceeds from potential capital market transactions and borrowings under our Senior Credit Agreement, which has a current borrowing base of $850.0 million. Our borrowing base is redetermined on a semi-annual basis (with us and the lenders each having the right to one interim unscheduled redetermination between any two consecutive semi-annual redeterminations) and adjusted based on our oil and natural gas properties, reserves, other indebtedness and other relevant factors. Our ability to utilize the full amount of our borrowing capacity is influenced by a variety of factors, including redeterminations of our borrowing base, and covenants under our Senior Credit Agreement and our senior unsecured debt indentures. Our Senior Credit Agreement contains customary financial and other covenants, including minimum working capital levels (the ratio of current assets plus the unused commitment under the Senior Credit Agreement to current liabilities) of not less than 1.0 to 1.0 and minimum coverage of interest expenses (as defined in the Senior Credit Agreement) of not less than 2.5 to 1.0. We are subject to additional covenants limiting dividends and other restricted payments, transactions with affiliates, incurrence of debt, changes of control, asset sales, and liens on properties. Additionally, the indentures governing our senior unsecured debt contain covenants limiting our ability to incur additional indebtedness, including borrowings under our Senior Credit Agreement, unless we meet one of two alternative tests. The first test, the fixed charge coverage ratio test, applies to all indebtedness and requires that after giving effect to the incurrence of additional debt the ratio of our adjusted consolidated EBITDA (as defined in our indentures) to our adjusted consolidated interest expense over the trailing four fiscal quarters will be at least 2.0 to 1.0. The second test allows us to incur additional indebtedness, beyond the limitations of the fixed charge coverage ratio test, as long as this additional debt is incurred under Credit Facilities (as defined in our indentures) and the amount of such additional indebtedness is not more than the greater of a fixed sum of $750 million or 30% of our adjusted consolidated net tangible assets (as defined in all of our indentures), which is determined primarily using discounted future net revenues from proved oil and natural gas reserves as of the end of each year. At December 31, 2012, we had $298.0 million of indebtedness outstanding, $1.3 million of letters of credit outstanding and $550.7 million of borrowing capacity available under the Senior Credit Agreement.

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 Senior 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


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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 . . .

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