Description
Resolute Energy. 10% Owner ADVISORY CORP SPO bought 246,800 shares on 6-04-2012 at $ 8.43
BUSINESS OVERVIEW
Business Overview
Resolute is an independent oil and gas company engaged in the exploration, exploitation and development of its oil and gas properties located in Utah (its “Aneth Field Properties”), Wyoming (its “Wyoming Properties”), North Dakota (its “North Dakota Properties”) and Texas (its “Texas Properties”). The Company’s primary operational focus is on increasing reserves and production from these properties while improving efficiency and controlling operational costs. Resolute plans to further expand its reserve base through an organic growth strategy focused on exploration and exploitation of oil-prone acreage, particularly among its North Dakota and Permian Basin properties, that it believes contain relatively low risk and repeatable drilling opportunities, and through carefully targeted exploration activities, particularly on its Wyoming Properties. Resolute also expects to engage in opportunistic acquisitions in and around its core areas, which may provide economies of scale and take advantage of operational expertise.
Oil sales comprised approximately 90% of revenue during 2011. As of December 31, 2011, Resolute’s estimated net proved reserves were approximately 64.8 million equivalent barrels of oil (“MMBoe”), of which approximately 57% and 44% were proved developed reserves and proved developed producing reserves, respectively. Additionally, approximately 82% of the Company’s estimated net proved reserves were oil and approximately 91% were oil and natural gas liquids (“NGL”). The pre-tax present value discounted at 10% (“PV-10”) of Resolute’s net proved reserves at December 31, 2011, was $1,143.0 million and the standardized measure of its estimated net proved reserves was $816.0 million. For additional information about the calculation of Resolute’s PV-10 and its standardized measure, please read “ Business and Properties — Estimated Net Proved Reserves .”
Business Strategies
Bring Non-Producing Properties in Aneth Field into Production. A primary business strategy of Resolute is to continue the development of the Aneth Field Properties to generate production from our relatively low risk proved developed non-producing and proved undeveloped reserves into production. At December 31, 2011, Resolute had estimated net proved reserves of approximately 36.5 MMBoe that were classified as proved developed non-producing and proved undeveloped. An estimated 32.0 MMBoe, or 88% of those reserves, are attributable to recoveries associated with expansions, extensions and processing of the tertiary recovery CO 2 floods that are currently in operation on Resolute’s Aneth Field Properties.
Focus on Exploitation and Development of Oil and Liquid-Prone Formations on Existing Properti es. In addition to its properties in Aneth Field, Resolute has assembled a portfolio of low-risk properties with acreage in three of the most active oil-focused resource plays in the United States. The Company has active drilling programs in the Bakken trend in the Williston Basin of North Dakota and in the Wolfbone and Wolfberry plays in the Permian Basin of Texas. In the Bakken, Resolute controls approximately 33,000 net acres, has participated in the drilling of 24 gross wells and currently has two active drilling rigs. In the Permian Basin, Resolute controls approximately 9,000 net acres, has interests in 12 gross wells and is currently operating a two-rig drilling program. All of these areas are characterized by relatively low risk drilling, with production heavily weighted toward oil and NGL. Resolute is focused on maximizing returns from these projects by optimizing completion techniques to enhance well performance and ultimate recoveries and accelerating development activity to increase production and reserves.
Pursue Acquisitions of Properties with Development Potential in Core Areas. From inception, the Company’s goal has been to grow its reserve base and production through a focused acquisition strategy of domestic onshore properties. It completed the acquisitions of its Aneth Field Properties in 2004 and 2006, its Wyoming Properties in 2008, its North Dakota Properties in 2010 and 2011 and its Texas Properties in 2011. While a primary business strategy is the continued development of these properties, Resolute also will continue to pursue opportunities to acquire, explore and develop properties that are prospective for production of oil or NGL, particularly in the Permian Basin and Rocky Mountain regions, with the objective of adding scale to its existing operations. It believes its knowledge of various operating areas, strong management and staff and solid industry relationships will allow it to find, capitalize on and integrate strategic acquisition opportunities.
Increase Production and Improve Efficiency of Operations on Resolute’s Properties. Resolute intends to continue its long-term focus on maximizing economic returns on all of its properties through improvements in operational efficiency and cost control. Resolute’s management team has experience in managing operationally intensive oil and gas properties.
Furthermore, as the operator of its Aneth Field Properties, its Wyoming Properties and its Texas Properties, Resolute has
the ability to directly manage its costs, control the timing of its exploitation, drilling and producing activities and effectively implement programs to increase production and improve the efficiency of its operations. Operational control over its properties also allows Resolute to focus on cost control to optimize long-term cash margins.
Identify Future Core Areas Through Focused Exploration Efforts . In addition to its large producing asset in Aneth Field and development drilling activity in the Williston and Permian Basins, Resolute controls acreage in two emerging exploration plays in Wyoming. Resolute has approximately 45,000 net acres in the Powder River Basin in an area that has seen increasing levels of activity by industry participants with targets including the Turner, Niobrara and Mowry formations. All of Resolute’s acreage in this area is held by production from the deeper Muddy formation. The Company is conducting geologic studies of the area including shooting a 3-D seismic program over a large portion of the acreage, integrating well log and core data and mapping the target formations. In the Big Horn Basin of Wyoming, Resolute controls approximately 73,000 acres, almost exclusively on ten year federal leases, most with four or more years remaining. The Company’s primary target in the Big Horn Basin is the Mowry oil shale. Resolute has re-completed one well and drilled a new well to test the productivity of the Mowry. Resolute’s exploration activity is focused on establishing production from these two assets through drilling of additional wells. Resolute will seek to attract industry and financial participants to these activities in order to leverage the Company’s capital and to share risk.
Competitive Strengths
A High Quality Base of Long-Lived Oil Producing Properties. As of December 31, 2011, Resolute had estimated net proved reserves of approximately 64.8 million MMBoe, with a proved developed producing reserves-to-production ratio of 10 years and a proved developed reserves-to-production ratio of 22 years.
The Aneth Field Properties in particular have characteristics that Resolute believes will provide a stable production platform and yield positive free cash flow to fund Resolute’s development and growth activities:
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The properties are expected to have a long productive life. As of December 31, 2011, the proved developed producing reserves had a reserves-to-production ratio of approximately 11 years and total proved reserves had a reserves-to-production ratio of 26 years.
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The light, sweet crude oil produced from its Aneth Field Properties is more attractive to refineries than the heavy or sour crude oil found in many areas.
Additionally, although Resolute’s Texas and North Dakota Properties are in the early stages of development, they are located in oil-prone areas where the industry has achieved economic returns.
Portfolio of Significant Organic Development Opportunities. Resolute controls significant quantities of proved developed non-producing and proved undeveloped reserves as well as development potential which is not currently reflected in the Company’s proved reserves. Within Aneth Field Resolute has estimated net proved reserves of 32.0 MMBoe that are classified as proved developed non-producing or proved undeveloped. These proved reserves are attributable to recoveries associated with expansions, extensions and processing of the tertiary recovery CO 2 floods that are currently in operation. In addition, Resolute’s Texas and North Dakota Properties provide a significant multi-year inventory of low risk drilling opportunities that are expected to contribute significantly to growth in production and proved reserves over the next several years.
Operating Control Over Our Properties. Resolute has the ability to control the timing, scope and costs of development projects undertaken on its various properties. The Company operates its Aneth Field, Wyoming and Texas Properties which constitute approximately 95% of its proved reserves and production. Further, operatorship of its Aneth Field and Wyoming Properties is secured for the foreseeable future as the acreage is held by production. In North Dakota, the Company has assumed operatorship of a portion of its acreage beginning in 2012. With respect to its non-operated North Dakota Properties, Resolute works very closely with its operating partner GeoResources, Inc. (“GeoResources”) in developing drilling and operating plans, ensuring that operating efficiencies and cost controls can also be maintained in that area of operations.
Strong Balance Sheet . Resolute practices a disciplined approach to liquidity and management of leverage and has a capital structure that provides it with the ability to execute its business plan. As of December 31, 2011, outstanding borrowings under Resolute’s credit facility were $170.0 million and unused availability under the borrowing base was $156.9 million. Resolute plans to maintain a capital structure that provides financial flexibility through the prudent use of leverage, aligning capital expenditures to cash flows, and maintaining a strategic hedging program.
Experienced Management and Technical Teams with Extensive Operational, Transactional and Financial Experience in the Energy Industry. With average industry work experience of almost 30 years, the senior management team of Resolute has considerable experience in acquiring, exploring, exploiting, developing and operating oil and gas properties, particularly in operationally intensive oil and gas fields. Three members of its executive management previously worked together as part of the senior management team of HS Resources, Inc., an independent oil and gas company that was listed on the New York Stock Exchange and primarily operated in the Denver-Julesburg Basin in northeast Colorado. HS Resources was acquired by Kerr-McGee Corporation in 2001. Resolute also employs more than 27 oil and gas technical professionals, including geophysicists, geologists, petroleum engineers and production and reservoir engineers, who have an average of approximately 16 years of experience in their respective technical fields. Resolute continually applies the extensive experience of its senior management and technical staff to benefit all aspects of its operations.
Aneth Field Properties
Resolute’s largest asset, constituting 86% of its net proved reserves, is its ownership of working interests in Greater Aneth Field (“Aneth Field”), a mature, long-lived oil producing field, most of which is located on the Navajo Reservation in southeast Utah. Resolute owns a majority of the working interests in, and is the operator of, three federal production units covering approximately 43,000 gross acres which constitute the Aneth Field Properties. These are the Aneth Unit, the McElmo Creek Unit and the Ratherford Unit in which Resolute owns working interests of 62%, 75% and 59%, respectively. The crude oil produced from the Aneth Field Properties is generally characterized as light, sweet crude oil that is highly desired as a refinery blending feedstock. Resolute believes that significantly more oil can be recovered from its Aneth Field Properties through industry standard secondary and tertiary recovery techniques.
During the twelve months ended December 31, 2011, gross oil production from the Aneth Field Properties averaged 10,230 barrels of oil per day. As of December 31, 2011, Resolute had interests in and operated 391 gross (257 net) producing wells and 330 gross (215 net) active water and CO 2 injection wells.
The primary producing horizon in Aneth Field is the Pennsylvanian-age Desert Creek formation, which is a carbonate algal-mound found at an average depth of approximately 5,525 feet. While there is some reservoir heterogeneity in Aneth Field, development of the reserves generally has been accomplished with well-tested methodologies, including drilling and infilling vertical wells, horizontal drilling, waterflood activities and CO 2 flooding.
Resolute acquired its Aneth Field Properties primarily through two significant acquisitions. In November 2004, it acquired a 53% operating working interest in the Aneth Unit, a 15% non-operating working interest in the McElmo Creek Unit and a 3% non-operating working interest in the Ratherford Unit from Chevron (“Chevron Properties”). In April 2006, it acquired an additional 7.5% working interest in the Aneth Unit, a 60% operating working interest in the McElmo Creek Unit and a 56% operating working interest in the Ratherford Unit from ExxonMobil (“ExxonMobil Properties”).
Resolute acquired its Aneth Field Properties in connection with its strategic alliance with Navajo Nation Oil and Gas Company, Inc. (“NNOG”), an oil and gas company owned by the Navajo Nation. NNOG maintains a minority working interest in each of the Chevron Properties and the ExxonMobil Properties and possesses options to purchase additional minority interests in those properties from Resolute under certain circumstances. Please read “ Resolute’s Business — Relationship with the Navajo Nation .”
Upon completion of the acquisition of the Chevron Properties in 2004 and the ExxonMobil Properties in 2006, Resolute initially focused on a program of field rejuvenation directed at improving field reliability and returning shut in wells to production. This activity had the effect of reversing the long term decline the Aneth Field had been exhibiting prior to the Resolute Acquisition. While production between 2003 and 2004 declined by 13%, production between 2006 and 2007 increased by 5%.
After stabilizing production, Resolute set about identifying strategies to grow reserves and production in Aneth Field. These initiatives focused on expanding a successful CO 2 flood initiated by Mobil in 1985 in the McElmo Creek Unit to the remainder of the field. Other initiatives included re-activating a shut in of the McElmo Creek IIC subzone of the Desert Creek formation, the (“DC IIC”), and infill drilling in previously bypassed sections of the field. The Aneth and McElmo Creek Units exhibit similar geologic characteristics. As a result, Resolute expects its Aneth Unit CO 2 flood to achieve results analogous to those achieved in the McElmo Creek CO 2 flood program, adjusted for operational and timing differences. Resolute estimates that the rate of oil production will increase faster at the Aneth Unit than that experienced at the McElmo Creek Unit because of Resolute’s practice of injecting CO 2 at higher rates at the Aneth Unit than was the case in the McElmo Creek Unit.
The expansion of the CO 2 flood commenced in 2006 with the start of CO 2 flooding in the Aneth Unit. This project was divided into four discrete phases which in total would cover substantially all of the Aneth Unit. As of 2008 Phases 1 through 3 of this project had been completed and CO 2 injection had commenced over the western half of the Aneth Unit. Phase 4, which covers the eastern half of the Unit, was delayed based on economic conditions in 2008 and 2009. Installation of the infrastructure for Phase 4 was commenced in 2010 and CO 2 injection began in the fourth quarter of 2011. Additional work will be required in 2012 to expand the infrastructure and spread CO 2 injection throughout the remainder of the Phase 4 area.
Typically in a tertiary recovery project employing CO 2 injection, twelve to eighteen months elapse between the commencement of injection and a demonstrated production response from the field. After beginning injection in Phases 1 through 3 of the Aneth Unit in late 2007, Resolute began to see response from the wells in this area in late 2008. As of year-end 2011, production from this area had increased 124% from 2007. Of the 86 producing wells in this area, 69 had demonstrated CO 2 response by year end 2011. Resolute anticipates a similar response from injection of CO 2 in the Phase 4 area.
Beginning in early 2010, Resolute began recompleting the DC IIC in the McElmo Creek Unit, with notable increases in production. This subzone was waterflooded by a previous operator. However, due to high water cuts and low oil prices prevalent at the time, the zone was shut in by the early 1980s. Because the CO 2 flood was not started in McElmo Creek Unit until 1985, this zone has never been CO 2 flooded. As part of its work in the field, Resolute has determined that the DC IIC can be reactivated as a water flood with highly economic results given today’s commodity prices. Plans to implement a CO 2 flood in this zone are progressing as reservoir properties collected from the recompletions, such as deliverability, oil cut and reservoir pressure are analyzed. Meanwhile, Resolute has begun the process of repressurizing this zone with water in preparation for CO 2 flooding. This recompletion and CO 2 flood project is expected to continue for several years, with further production increases expected. The project will also require construction and rebuilding of infrastructure to accommodate the incremental injection and production.
The following table sets forth, as of December 31, 2011, Resolute’s estimate of the future capital expenditures, net to its interest, for construction, well work and other costs and for purchases of CO 2 required to implement its CO 2 flood projects in two of the units of its Aneth Field Properties through 2042. The table also sets forth the estimated net proved developed non-producing and proved undeveloped reserves that Resolute anticipates will be produced as a result of these projects, as included in Resolute’s reserve report as of December 31, 2011. Resolute incurred $61.0 million of capital expenditures related to the Aneth Field Properties during 2011.
Wyoming Producing Properties
Resolute’s producing Wyoming Properties, which are operated by the Company, are located in the Powder River Basin and constitute approximately 6% of Resolute’s net proved reserves. Hilight Field, anchoring our Wyoming production and reserves, produces oil and gas from the Muddy sandstone and Mowry shale formations. As of December 31, 2011, the Wyoming Properties consisted of 157 gross (149 net) producing wells, excluding shut-in coalbed methane (“CBM”) wells, and 2 gross (2 net) active water injection wells.
Hilight Field in Campbell County consists of the Jayson Unit, the Grady Unit and the Central Hilight Unit. Resolute has an 82.7% working interest in the Jayson Unit, an 82.5% working interest in the Grady Unit and a 98.5% working interest in Central Hilight Unit. The Jayson, Grady and Central Hilight Units cover an area of almost 50,000 gross acres. Hilight Field was discovered by Inexco Oil Company in 1969, unitized in 1971 and 1972 and underwent waterflood between 1972 and the mid-1990s. As of December 31, 2011, there were 139 gross (132 net) producing wells, and cumulative production through December 31, 2011 from Resolute’s three operated units was 68 MMBbl of oil and 150 Bcf of gas. Average daily gross production for the twelve months ending December 31, 2011 was 243 Bbl of oil and 9,202 Mcf of gas per day. Resolute also has non-unitized production in the Hilight area which consists of 15 gross (14 net) wells. Muddy formation sandstones form the main reservoir in the field at an average depth of approximately 9,100 feet. Resolute also operates production from the Mowry and Niobrara formations. Resolute has prepared a multi-year development plan for the Wyoming Properties based on stimulating the Muddy formation. Resolute has continued this program with seven refracs completed during 2010 and four completed during 2011 and has initiated the Mowry shale exploration program with re-completions of two wells performed in 2010 and seven performed in 2011.
All of Resolute’s CBM production was shut-in as of December 31, 2011. Prior to shut-in, Resolute CBM production came from 260 gross (239 net) producing wells. Average daily gross production for the twelve months ending December 31, 2011, was 1,379 Mcf per day. Although it varies from well to well, Resolute has an average of approximately 91% working interest in its Hilight area CBM properties. No net proved reserves were attributable to the CBM wells as of December 31, 2011. Due to field economics, the Company anticipates plugging and abandoning the CBM properties over a three year period beginning in 2012.
North Dakota Properties
As of December 31, 2011, Resolute had interests in approximately 94,000 gross (33,000 net) acres within the Bakken shale trend of the Williston Basin in North Dakota. The Company’s position is divided between two principal project areas; the New Home project area located in Williams County, comprising approximately 23,000 net acres and the Paris project area located in McKenzie County, comprising approximately 9,000 net acres. The Company also has interests in various smaller project areas, which in total comprise approximately 1,000 net acres, primarily in McKenzie County.
New Home Project. Resolute acquired its interest in the New Home project area in 2010 through a joint venture with GeoResources. In total, the New Home project area includes 70,000 gross acres, in which Resolute and GeoResources each have an average 33% working interest. During 2011, Resolute participated in drilling and completing nine wells and had an additional eight wells waiting on completion at year-end. Based on drilling activity to date, approximately 15% of the acreage is considered developed and 29% is held by production. In 2012, the companies plan to employ two drilling rigs in this area with the objective of drilling and completing 24 to 26 gross (5 to 6 net) wells.
The primary objective of the New Home development plan is the middle member of the Bakken shale formation. A secondary objective is the Three Forks formation which lies below the lower Bakken shale. All of the Company’s producing wells are producing from the Middle Bakken. While Resolute has not tested the Three Forks formation, it is productive in other portions of Williams and McKenzie counties. To date, the Company has a 100% success rate on wells drilled and completed within the project area, with all wells drilled being completed as producers. The wells in this area are drilled to a target depth, at which point the drill bit is steered to result in drilling horizontally through the target formation. A typical well in this area has a horizontal length of 10,000 feet and is completed using hydraulic fracturing with between 24 and 34 frac stages.
During the fourth quarter of 2011, average daily production from the New Home project was approximately 300 Boe per day net to Resolute. Production from New Home is approximately 95% oil. See “ Marketing and Customers” for more information on how production from this area is sold.
In 2012, Resolute and GeoResources are focused on improving the economics of new development in this area primarily through lowering drilling and completion costs. The most recent Authorization for Expenditures (“AFE”) in this area have been less than $8 million per well. Some techniques currently employed to reduce costs include pad drilling where multiple wells are drilled and completed from the same surface location, changes in completion design that seek to optimize the number of fracture stages and the proppant design relative to well performance and through reducing cycle times which reduce the number of days required to drill a well to total depth and directly affects the related rig charges.
Paris Project. Resolute acquired its interest in the Paris project area through a farmout from Marathon Oil Company. The Paris project area covers approximately 19,000 gross acres, and Resolute has approximately a 46% interest in the acreage. Resolute is the operator of the Paris project and earned its ownership by drilling and completing two wells. The first well, the Watson USA 14 32H, was completed in the first quarter of 2011 and is currently producing. The second well, the Forest USA 14 2H, was drilled in the first quarter of 2011, but experienced weather induced delays and mechanical difficulties in completing the well. While the Forest well has produced commercial quantities of oil at times during the completion process, it is currently shut in pending a work over and finalization of the planned completion. We expect that this well will be completed and placed on production in the second quarter of 2012.
Resolute does not currently anticipate drilling any additional wells in the Paris area during 2012. While activities by other operators in close proximity to the Paris area lead us to believe this area will be economic, we do not face pending material lease expirations with the nearest expirations occurring in the third quarter of 2014. The land situation in the Paris area allows us the time to perform additional analysis pending completion of the Forest well while we focus on our New Home project where we face more near term lease expirations.
When drilling does re-commence in the Paris area we plan to utilize many of the same cost containment measures currently being employed in the New Home project to maximize economic returns from development in Paris.
CEO BACKGROUND
Nicholas J. Sutton has been Chairman of the Board of Directors and Chief Executive Officer of the Company since the Company’s formation in July 2009. Mr. Sutton has been the Chief Executive Officer of, and previously served on the board of managers of, Resolute Natural Resources Company, LLC and related companies and of Resolute Holdings since their founding in 2004. Mr. Sutton was a co-founder, Chairman and Chief Executive Officer of HS Resources, Inc., a New York Stock Exchange listed company, from 1978 until the company’s acquisition by Kerr-McGee Corporation in late 2001. From 2002 until the formation of Resolute Holdings in 2004, Mr. Sutton was a director of Kerr-McGee Corporation. Currently, Mr. Sutton is a director of Tidewater, Inc., a publicly traded company that is the owner and operator of the world’s largest fleet of vessels serving the global offshore oil industry. He also is a member of the Society of Petroleum Engineers and of the American Association of Petroleum Geologists. In determining Mr. Sutton’s qualifications to serve on our Board of Directors, the Board of Directors has considered, among other things, his experience and expertise in the oil and gas industry, his track record in growing public oil and gas companies, including managing acquisition programs, as well as his role in the founding of Resolute Holdings and in the Resolute Transaction (as defined below). In addition, Mr. Sutton has degrees in engineering and law, and has attended the Harvard Owner/President Management program, giving him expertise in all of the areas of importance to the Company.
Thomas O. Hicks, Jr. was elected to the Company’s Board of Directors in September 2009. Mr. Hicks has been a member of the Corporate Governance/Nominating Committee since September 25, 2009. Between September 25, 2009 and December 15, 2009, he was also a member of the Compensation Committee. He was a vice president of Hicks Acquisition Company I, Inc. from February 2007 through September 2009 and was its secretary from August 2007 to September 2009. He currently serves as Secretary and Vice President of Hicks Acquisition Company II, Inc. Mr. Hicks has served as a vice president of Hicks Holdings LLC since its inception in 2005. Hicks Holdings LLC is a Dallas-based family holding company for the Hicks family and a private investment firm which owns and manages real estate assets and makes corporate acquisitions. In 2004 and 2005, Mr. Hicks served as Director, Corporate and Suite Sales, for the Texas Rangers Baseball Club. From 2001 to 2003, Mr. Hicks was an analyst at Greenhill & Co. LLC, a New York based merchant banking firm. From May 2010 to August 2010, Mr. Hicks served as Executive Vice President of Texas Rangers Baseball Partners, Rangers Equity Holdings, L.P. and Rangers Equity Holdings GP, LLC. On May 24, 2010, Texas Rangers Baseball Partners filed a voluntary petition for bankruptcy and on May 28, 2010, a group of creditors filed an involuntary bankruptcy petition against Rangers Equity Holdings, L.P. and Rangers Equity Holdings GP, LLC. In determining Mr. Hicks’s qualifications to serve on our Board of Directors, the Board of Directors has considered, among other things, his experience and expertise in sales, banking and management.
Richard L. Covington was elected to the Company’s Board of Directors in September 2009. Mr. Covington has been a member of the Compensation and Corporate Governance/Nominating Committees since September 25, 2009 and is our Lead Independent Director. He is a managing director of the Natural Gas Partners (“NGP”) private equity funds. He has been a member of the board of managers of Resolute Holdings since its founding in 2004. Mr. Covington joined Natural Gas Partners in 1997. Prior to joining NGP, Mr. Covington was a senior shareholder at the law firm of Thompson & Knight, LLP in Dallas, Texas. Mr. Covington serves on the investment committee of NGP Capital Resources Company and as a director of numerous private energy companies. In determining Mr. Covington’s qualifications to serve on our Board of Directors, the Board of Directors has considered, among other things, his experience and expertise in the legal and finance aspects of the oil and gas industry and his role as a key advisor to Predecessor Resolute from the founding of Resolute Holdings to the present.
William H. Cunningham was elected to the Company’s Board of Directors in September 2009. Dr. Cunningham has been a member of the Audit Committee since September 25, 2009, and was member of the Compensation and Corporate Governance/Nominating Committees between September 25, 2009 and December 14, 2009. Dr. Cunningham was a director of Hicks Acquisition Company I, Inc. from October 2007 through March 2010. Since 1979, Dr. Cunningham has served as a professor of marketing at the University of Texas at Austin and he has held the James L. Bayless Chair for Free Enterprise at the University of Texas at Austin since 1985. From 1983 to 1985 he was Dean of the College of Business Administration and Graduate School of Business of the University of Texas at Austin, from 1985 to 1992 he served as the President of the University of Texas at Austin, and from 1992 to 2000 he served as the Chancellor (Chief Executive Officer) of the University of Texas System. Dr. Cunningham currently serves on the Board of Directors of Lincoln National Corporation, a New York Stock Exchange listed holding company for insurance, investment management, broadcasting and sports programming businesses; Southwest Airlines, an airline listed on the New York Stock Exchange; and Lin Television, a New York Stock Exchange listed company that owns a number of television stations. Dr. Cunningham currently serves as a member of the Board of Trustees of John Hancock Mutual Funds. Dr. Cunningham was president and chief executive officer of IBT Technologies, a privately held e-learning company, from December 2000 through December 2001. IBT Technologies filed for bankruptcy in December 2001 and has been liquidated. Dr. Cunningham received a Bachelor of Business Administration degree in 1966, a Master of Business Administration degree in 1967 and a Ph.D. in 1971, each from Michigan State University. In determining Dr. Cunningham’s qualifications to serve on our Board of Directors, the Board of Directors has considered, among other things, his academic experience in corporate governance matters, his service on more than 20 corporate boards, including in many instances as chairman of the audit committee of public companies, and his experience and expertise in marketing and management.
James E. Duffy was elected to the Company’s Board of Directors in September 2009. Mr. Duffy has been a member of the Compensation and Audit Committees since September 25, 2009, and between September 25, 2009 and December 15, 2009, was also a member of the Corporate Governance/Nominating Committee. He is a co-founder and, since 2003, Chairman of StreamWorks Products Group, Inc., a private consumer products development company that manufactures products for the sport fishing, industrial safety, specialty tool and outdoor recreation industries. From 1990 to 2001, he served as Chief Financial Officer and Director of HS Resources, Inc. until its sale to Kerr-McGee Corporation. Prior to that time, he served as Chief Financial Officer and Director of a division of Tidewater, Inc. He was also a general partner in a boutique investment banking business specializing in the oil and gas business, and began his career with Arthur Young & Co in San Francisco. He is a certified public accountant. In determining Mr. Duffy’s qualifications to serve on our Board of Directors, the Board of Directors has considered, among other things, his experience and expertise in oil and gas finance, accounting and banking, as well as his position as chief financial officer of two public oil and gas companies and his service as an audit manager for a major accounting firm with engagement responsibility for public and private entities.
James M. Piccone has been the President and a member of the Board of Directors of the Company since the Company’s formation in July 2009. He was also General Counsel and Secretary of the Company from its formation in July 2009 until July 2010. Mr. Piccone has served as President of the following Company subsidiaries and affiliates: Resolute Natural Resources Company, LLC; WYNR, LLC; BWNR, LLC; RNRC Holdings, Inc.; Resolute Wyoming, Inc.; and Resolute Aneth, LLC (collectively, Resources, WYNR, BWNR, RNRC, RWI and Aneth are referred to as “Predecessor Resolute”), and of Resolute Holdings, LLC, since the formation of these entities beginning in 2004. He also served as General Counsel and Secretary of each of these entities until July 2010 and as a member of the Board of Managers of certain of these entities. From January 2002 until January 2004, Mr. Piccone was Executive Vice President and General Counsel for Aspect Energy, LLC, a private oil and gas company. He also served as a contract attorney for Aspect Energy from October 2001 until January 2002. Mr. Piccone served as Vice President — General Counsel and Secretary of HS Resources, Inc. from May 1995 until the acquisition of HS Resources by Kerr-McGee Corporation in August 2001. Mr. Piccone is admitted to the practice of law in Colorado and is a member of local and national bar associations. He is a member of the American Association of Corporate Counsel. In determining Mr. Piccone’s qualifications to serve on our Board of Directors, the Board of Directors has considered, among other things, his management and legal expertise, his knowledge of the oil and gas industry and the role he played in the success of HS Resources and Resolute Holdings, including his role in the September 25, 2009 business combination with Hicks Acquisition Company I, Inc. (the “Resolute Transaction”).
William J. Quinn was elected to the Company’s Board of Directors in September 2009. Mr. Quinn has been a member of the Compensation Committee since September 25, 2009, and between September 25, 2009 and December 15, 2009, was also a member of the Corporate Governance/Nominating Committee. He is a managing partner of the Natural Gas Partners private equity funds, having served in those or similar capacities since 1998. He has been a member of the board of managers of Resolute Holdings, LLC since its founding in 2004. He currently serves on the investment committee of NGP Capital Resources Company, and is a director of Eagle Rock Energy Partners, L.P., and of its general partner, Eagle Rock Energy G&P, LLC. He also serves as a member of the board of numerous private energy companies. In determining Mr. Quinn’s qualifications to serve on our Board of Directors, the Board of Directors has considered, among other things, his extensive experience and expertise in finance and in the energy industry.
Robert M. Swartz was elected to the Company’s Board of Directors in September 2009. Mr. Swartz has been a member of the Audit Committee since September 25, 2009, and between September 25, 2009 and December 15, 2009, was also a member of the Compensation and Corporate Governance/Nominating Committees. Effective January 1, 2011, Mr. Swartz became Executive Vice President and Chief Operating Officer of Glazer’s Distributors. He was previously Managing Director and Partner of Hicks Equity Partners LLC from 2007 to 2011. He was Chief Executive Officer of Hicks Acquisition Company II, Inc. from September 2010 to December 2010. He was a Senior Vice President of Hicks Acquisition Company I, Inc. from September 2007 until September 2009. From 1999 until 2007, Mr. Swartz served in various positions at Centex Corporation, a New York Stock Exchange home building company, serving as Senior Vice President of Strategic Planning and Mergers and Acquisitions from 1999 to 2000, and serving as Chairman and Chief Executive Officer of Centex HomeTeam Services from 2000 to 2007. Mr. Swartz is on the Board of Directors of Ocular LCD, Inc. Mr. Swartz received a Bachelor’s of Science degree in accounting from the State University of New York in Albany in 1973 and a Master of Business Administration degree in finance from New Hampshire College in 1976. Mr. Swartz is a Certified Public Accountant. In determining Mr. Swartz’s qualifications to serve on our Board of Directors, the Board of Directors has considered, among other things, his experience and expertise in mergers and acquisitions, finance, accounting and management.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview
Resolute is an independent oil and gas company engaged in the acquisition, exploration, development and production of oil, gas and hydrocarbon liquids. Resolute’s strategy is to grow through exploration, exploitation and industry standard enhanced oil recovery projects.
As of December 31, 2011, Resolute’s estimated net proved reserves were approximately 64.8 MMBoe, of which approximately 44% were proved developed producing reserves and approximately 82% were oil. The standardized measure of Resolute’s estimated net proved reserves as of December 31, 2011, was $816 million. See Note 13 to the Consolidated Financial Statements.
Resolute focuses its efforts on increasing reserves and production while controlling costs at a level that is appropriate for long-term operations. Resolute’s future earnings and cash flow from existing operations are dependent on a variety of factors including commodity prices, exploitation and recovery activities and its ability to manage its overall cost structure at a level that allows for profitable operation.
How Resolute Evaluates Its Operations
Resolute’s management uses a variety of financial and operational measurements to analyze its operating performance, including but not limited to, production levels, trends and prices, reserve trends, operating and general and administrative expenses, operating cash flow, and Adjusted EBITDA (defined below).
Production Levels, Trends and Prices. Oil and gas revenue is the product of Resolute’s production multiplied by the price that it receives for that production. Because the price that Resolute receives is highly dependent on many factors outside of its control, except to the extent that it has entered into derivative arrangements that can influence its net price either positively or negatively, production is the primary revenue driver over which it has some influence. Although Resolute cannot greatly alter reservoir performance, it can aggressively implement exploitation activities that can increase production or diminish production declines relative to what would have been the case without intervention. Examples of activities that can positively influence production include minimizing production downtime due to equipment malfunction, well workovers and cleanouts, recompletions of existing wells in new parts of the reservoir, and expanded secondary and tertiary recovery programs.
The price of crude oil has been extremely volatile, and Resolute expects that this volatility will continue. Given the inherent volatility of crude oil prices, Resolute plans its activities and budget based on sales price assumptions that it believes to be reasonable. Resolute uses derivative contracts to provide a measure of stability to its cash flows in an environment of volatile oil and gas prices and currently has such contracts in place through 2014. These instruments limit its exposure to declines in prices, but also limit its benefits if prices increase. Changes in the price of oil or gas will result in the recognition of a non-cash gain or loss recorded in other income or expense due to changes in the future fair value of the derivative contracts. Recognized gains or losses only arise from payments made or received on monthly settlements of derivative contracts or if a derivative contract is terminated prior to its expiration. Resolute typically enters into derivative contracts that cover a significant portion of its estimated future oil and gas production. Resolute currently has such derivative contracts in place through 2014.
Reserve Trends. From inception, Predecessor Resolute grew its reserve base through a focused acquisition strategy, completing three significant acquisitions. These included the acquisition of the majority of its Aneth Field Properties through two significant purchases: the acquisition of the Chevron Properties was completed in November 2004 followed by the acquisition of the ExxonMobil Properties in April 2006. Predecessor Resolute acquired all of its Wyoming Properties through the purchase of Primary Natural Resources, Inc. now known as RWI in July 2008. Subsequent to the Resolute Transaction, Resolute acquired its North Dakota Properties in 2010 and 2011 and its Texas Properties in 2011 and plans to continue to seek opportunities to acquire similar producing properties that have upside potential through low-risk development drilling and exploitation projects. Resolute believes that its knowledge of various domestic (on shore) operating areas, strong management and staff and solid industry relationships will allow it to locate, capitalize on and integrate strategic acquisition opportunities.
At December 31, 2011, Resolute had estimated net proved reserves of approximately 36.5 MMBoe that were classified as proved developed non-producing and proved undeveloped. An estimated 32.0 MMBoe, or 87%, of those reserves are attributable to recoveries associated with expansions, extensions and processing of the tertiary recovery CO 2 floods that are currently in operation on Resolute’s Aneth Field Properties. Resolute believes that these expenditures will result in significant increases in its oil and gas production.
Operating Expenses . Operating expenses are costs associated with the operation of oil and gas properties and are classified as lease operating expenses and production and ad valorem taxes. Direct labor, repair and maintenance, workovers, utilities and contract services comprise the most significant portion of lease operating expenses. Resolute monitors its operating expenses in relation to the amount of production and the number of wells operated. Some of these expenses are relatively independent of the volume of hydrocarbons produced, but may fluctuate depending on the activities performed during a specific period. Other expenses, such as taxes and utility costs, are more directly related to production volumes or reserves. Severance taxes, for example, are charged based on production revenue and therefore are based on the product of the volumes that are sold and the related price received. Ad valorem taxes are generally based on the value of reserves. Because Resolute operates on the Navajo Reservation, it also pays a possessory interest tax, which is effectively an ad valorem tax assessed by the Navajo Nation. Resolute’s largest utility expense is for electricity that is used primarily to power the pumps in producing wells and the compressors behind the injection wells. The more fluid that is moved, the greater the amount of electricity that is consumed. Higher oil prices can lead to higher demand for drilling rigs, workover rigs, operating personnel and field supplies and services, which in turn can increase the costs of those goods and services. Resolute projects 2012 cash lease operating expenses of $60.5 million to $65.0 million.
General and Administrative Expenses . Resolute monitors its general and administrative expenses carefully, attempting to balance the cash effect of incurring general and administrative costs against the benefits of, among other things, hiring and retaining highly qualified staff who can add value to the Company’s asset base. General and administrative expenses include, among other things, salaries and benefits, share-based compensation, general corporate overhead, fees paid to independent auditors, lawyers, petroleum engineers and other professional advisors, costs associated with shareholder reports, investor relations activities, registrar and transfer agent fees, director and officer liability insurance costs and director compensation.
Operating Cash Flow. Operating cash flow is the cash directly derived from Resolute’s oil and gas properties, before considering such things as administrative expenses and interest costs. Operating cash flow on a per unit of production basis is a measure of field efficiency, and can be compared to results obtained by operators of oil and gas properties with characteristics similar to Resolute’s in order to evaluate relative performance. Aggregate operating cash flow is a measure of Resolute’s ability to sustain overhead expenses and costs related to capital structure, including interest expenses.
Adjusted EBITDA. Adjusted EBITDA (a non-GAAP measure) is defined by the Company as consolidated net income adjusted to exclude interest expense, interest income, income taxes, depletion, depreciation and amortization, impairment expense, accretion of asset retirement obligation, change in fair value of derivative instruments, expiration of derivative premiums, non-cash equity-based compensation expense, early settlement of derivative instruments and noncontrolling interest amounts. Adjusted EBITDA is a financial measure that Resolute reports to its lenders and uses as a gauge for compliance with some of the financial covenants under its revolving credit facility.
Factors That Significantly Affect Resolute’s Financial Results
Revenue, cash flow from operations and future growth depend substantially on factors beyond Resolute’s control, such as economic, political and regulatory developments and competition from other sources of energy. Crude oil prices have historically been volatile and may be expected to fluctuate widely in the future. Sustained periods of low prices for crude oil could materially and adversely affect Resolute’s financial position, its results of operations, the quantities of oil and gas that it can economically produce, and its ability to obtain capital.
Like all businesses engaged in the exploration for and production of oil and gas, Resolute faces the challenge of natural production declines. As initial reservoir pressures are depleted, oil and gas production from a given well decreases. Thus, an oil and gas exploration and production company depletes part of its asset base with each unit of oil or gas it produces. Resolute attempts to overcome this natural decline by implementing secondary and tertiary recovery techniques and by acquiring more reserves than it produces. Resolute’s future growth will depend on its ability to enhance production levels from existing reserves and to continue to add reserves in excess of production through exploration, development and acquisition. Resolute will maintain its focus on costs necessary to produce its reserves as well as the costs necessary to add reserves through production enhancement, drilling and acquisitions. Resolute’s ability to make capital expenditures to increase production from existing reserves and to acquire more reserves is dependent on availability of capital resources, and can be limited by many factors, including the ability to obtain capital in a cost-effective manner and to timely obtain permits and regulatory approvals.
Other Income (Expense). All oil and gas derivative instruments are accounted for under mark-to-market accounting rules, which provide for the fair value of the contracts to be reflected as either an asset or a liability on the balance sheet. The change in the fair value during an accounting period is reflected in the income statement for that period. During 2011, the realized and unrealized losses on our oil and gas derivatives totaled $5.3 million. This amount included approximately $20.8 million of realized losses, including $5.0 million of partial terminations of certain derivative contracts, offset by $15.5 million of increases in the unrealized fair value of oil and gas derivatives. During 2010, the realized and unrealized losses on oil and gas derivatives totaled $17.8 million and included approximately $9.6 million of unrealized losses in the fair value of oil and gas derivatives and $8.2 million of realized losses from monthly settlements.
Interest expense was $3.8 million during 2011, as compared to $4.9 million during 2010. The $1.1 million, or 21%, decrease is attributable to lower interest rates, a lower average debt balance and higher interest capitalization during 2011.
Income Tax Benefit (Expense). Income tax expense recognized during 2011 was $17.9 million, or 37.0% of income before income taxes, as compared to income tax expense of $2.4 million, or 27.9% of income before income taxes for Resolute in 2010. The change in the effective rate reflects changes in permanent differences and revisions in 2010 to prior year estimates as a result of final income tax return filings. Income tax expense differs from the amount that would be provided by applying the statutory U.S. federal income tax rate of 35% due to state income taxes and estimated permanent differences. The Company expects income taxes to be between 36% and 39% of income (loss) before income taxes in future years. Resolute carried a $13.7 million current deferred tax asset at December 31, 2011, for which no valuation allowance was recorded as it is more likely than not that the asset will be realized due to projected future taxable income.
Year Ended December 31, 2010, Compared to the year Ended December 31, 2009
Revenue. Revenue from oil and gas activities increased to $173.4 million during 2010, from $127.8 million during 2009. Total production increased 0.6% during 2010 as compared to 2009, from 2,714 MBoe to 2,730 MBoe. The increase in production was largely attributed to an increased response from the Company’s CO 2 flood and recompletion projects in its Aneth Field Properties. In addition to natural production declines, the overall increase in production was offset by limited compression capability at the Western Gas Resources Hilight Plant for the majority of 2010. Full compression capability was restored in September 2010, and management estimates that these constraints resulted in a reduction in production volumes of approximately 29.5 MBoe during the year, as compared to what the field was capable of producing if unconstrained. In addition, the Company voluntarily shutdown a portion of its coalbed methane production in Wyoming during 2009 due to uneconomic product prices for natural gas in that area. This led to a reduction of production volumes in 2010 of approximately 28.9 MBoe. Further, in 2009 the Company deferred its anticipated capital projects due to low product prices and limited financial liquidity. Had these anticipated capital projects been completed, the resulting additional production in 2010 may have partially offset the natural production declines.
In addition to increased production versus 2009, the Company experienced an increase in average sales price, excluding derivatives settlements, from $47.08 per Boe in 2009 to $63.52 per Boe in 2010, as a result of increased commodity pricing.
Operating Expenses. Lease operating expenses increased to $51.6 million during 2010, from $49.9 million during 2009. The $1.7 million, or 3.4%, increase was primarily attributable to a $1.0 million increase in equipment maintenance and supplies, $0.9 million increase in utilities and fuel and a $0.4 million increase in labor costs. The overall increase was offset by decreases in workover and compression and gathering expenses.
Production and ad valorem taxes increased to $24.2 million during 2010 from $18.8 million during 2009. The $5.4 million, or 28.7% increase was mainly due to the 35.7% increase in revenue. The increase in production and ad valorem taxes was offset by a decrease in the ad valorem tax rate from 14.7% of total revenue in 2009 to 13.9% of total revenue in 2010.
Depletion, depreciation, amortization and accretion expenses increased to $47.0 million during 2010, as compared to $33.5 million during 2009. The $13.5 million, or 40.3%, increase is mainly due to an increase in the per Boe depletion, depreciation and amortization rate from $12.33 per Boe in 2009 to $17.22 per Boe in 2010, due to increased capital spending versus 2009 and the increased depletable base that resulted from the acquisition accounting on the date of the Resolute Transaction.
Pursuant to full cost accounting rules, Resolute performs a ceiling test each quarter on its proved oil and gas assets. As a result of this limitation on capitalized costs, Predecessor Resolute included a provision for an impairment of oil and gas property costs of $13.3 million during the 267 day period ended September 24, 2009. No provision for impairment was recorded in 2010.
General and administrative expenses decreased to $19.4 million during 2010, as compared to $31.9 million during 2009. The $12.5 million, or 39.2%, decrease in the absolute level of general and administrative expenses principally resulted from a decrease of $19.1 million in acquisition and transaction costs incurred in 2009 in connection with the Resolute Transaction, the like of which were not incurred during 2010. Outside of these costs, the Company incurred a $0.8 million increase in corporate overhead, a $0.8 million increase in professional services and consulting fees, a $4.2 million increase in personnel costs due to additional employees versus 2009 and accrual of the Company’s Short Term Incentive Plan and an increase of $2.2 million in stock based compensation awarded under the Company’s 2009 Performance Incentive Plan.
Other Income (Expense). During 2010, the realized and unrealized losses on of oil and gas derivatives totaled $17.8 million. This amount included approximately $8.2 million of realized losses on oil and gas derivatives and $9.6 million of decreases in the unrealized fair value of oil and gas derivatives. During 2009, the realized and unrealized losses on oil and gas derivatives totaled $73.0 million and included approximately $71.8 million of unrealized losses in the fair value of oil and gas derivatives and $1.2 million of realized losses from monthly settlements.
Interest expense was $4.9 million during 2010, as compared to $20.0 million during 2009. The $15.1 million, or 75.5%, decrease is attributable to lower interest rates and a lower average debt balance during 2010 as the Company utilized funds received in the Resolute Transaction in 2009 to pay off a significant amount of debt on the Acquisition Date.
Income Tax Benefit (Expense). Income tax expense recognized during 2010 was $2.4 million, or 27.9% of income before income taxes, as compared to an income tax benefit of $24.9 million, or 22.3% of loss before income taxes, for Resolute in 2009. The change in the effective rate reflects the differing tax jurisdictions in which Resolute operates following the Resolute Transaction, permanent differences relating to transaction costs in 2009 and the differing entities subject to federal and state income tax prior to the Resolute Transaction. Income tax expense differs from the amount that would be provided by applying the statutory U.S. federal income tax rate of 35% due to state income taxes, estimated permanent differences and revisions to prior year estimates as a result of final income tax return filings. Resolute carried a $12.0 million current deferred tax asset at December 31, 2010, for which no valuation allowance was recorded as it is more likely than not that the asset will be realized due to projected future taxable income. The Company expects income tax benefit (expense) to more closely reflect the U.S. federal income tax rate of 35% in future years.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview
Resolute is a publicly traded, independent oil and gas company engaged in the exploitation, development, exploration and acquisition of oil and gas properties. Our primary operational focus is on increasing reserves and production from our properties while improving efficiency and optimizing operating costs. We plan to expand our reserve base through an organic growth strategy focused on the expansion of tertiary oil recovery in Aneth Field, the exploitation and development of oil-prone acreage, particularly in our Texas and North Dakota Properties, and through carefully targeted exploration activities in our Wyoming Properties. We also expect to engage in opportunistic acquisitions in our core geographic areas that would allow us to take advantage of our operational expertise.
As of December 31, 2011, Resolute’s estimated net proved reserves were approximately 64.8 MMBoe, of which approximately 44% were proved developed producing reserves, 82% were oil, and 91% were oil and natural gas liquids. The standardized measure of Resolute’s estimated net proved reserves as of December 31, 2011, was $816 million.
Resolute focuses its efforts on increasing reserves and production while controlling costs at a level that is appropriate for long-term operations. Resolute’s future earnings and cash flow from existing operations are dependent on a variety of factors including commodity prices, exploitation and recovery activities and its ability to manage its overall cost structure at a level that allows for profitable operation.
Resolute’s management uses a variety of financial and operational measurements to analyze its operating performance. These measurements include: (i) production levels, trends and prices, (ii) reserve and production volumes and trends, (iii) operating expenses and general and administrative expenses, (iv) operating cash flow and (v) Adjusted EBITDA. The analysis of these measurements should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in Resolute’s Annual Report on Form 10-K for the year ended December 31, 2011.
Aneth Field Properties
Resolute’s largest asset, constituting 86% of its net proved reserves as of year-end 2011, is its ownership of working interests in Greater Aneth Field, a mature, long-lived oil producing field, most of which is located on the Navajo Reservation in southeast Utah. Resolute owns a majority of the working interests in, and is the operator of, three federal production units which constitute the Aneth Field Properties. These are the Aneth Unit, the McElmo Creek Unit and the Ratherford Unit in which Resolute owned working interests of 62%, 75% and 59%, respectively, at March 31, 2012. The crude oil produced from the Aneth Field Properties is generally characterized as light, sweet crude oil that is highly desired as a refinery blending feedstock. Resolute believes that significantly more oil can be recovered from its Aneth Field Properties through industry standard secondary and tertiary recovery techniques.
Wyoming Properties
Resolute’s producing Wyoming Properties, which are operated by the Company, are located in the Powder River Basin and constitute approximately 6% of Resolute’s net proved reserves as of year-end 2011. Hilight Field, anchoring our Wyoming production and reserves, produces oil and gas from the Muddy sandstone and Mowry shale formations.
Resolute has interests in two exploratory areas in Wyoming. The Big Horn Basin has unconventional oil objectives in the Cretaceous Mowry shale and conventional oil objectives in the Permian Phosphoria formation. We are currently testing a horizontal well in the Big Horn Basin targeting the Mowry oil shale formation. In addition to exploration activities performed by Resolute, two other operators have drilled a total of four additional wells targeting the Mowry shale. In the Powder River Basin, levels of industry activity have increased significantly with various companies pursuing exploration programs targeting objectives including the Turner, Niobrara and Mowry formations. Some of this activity is on acreage directly adjacent to acreage controlled by Resolute. Resolute is currently analyzing a speculative 3D seismic survey covering Hilight Field and adjacent areas that was completed in 2011. This 3D seismic survey should help to delineate oil drilling prospects in the Mowry, and also in the Turner and Niobrara formations.
North Dakota Properties
Resolute has interests in within the Bakken shale trend of the Williston Basin in North Dakota (the “North Dakota Properties”). The Company’s position is divided between two principal project areas; the New Home project area located in Williams County and the Paris project area located in McKenzie County. During the first quarter of 2012, we placed 9 gross (2.2 net) wells on production and had 4 gross (1.1 net) wells waiting for completion operations.
Texas Properties
Resolute has interests in the Permian Basin of Texas (the “Texas Properties”). The Company’s position is divided between two principal project areas. The Wolfbone project area consists of approximately 8,000 net acres located in the Delaware Basin portion of the Permian Basin in Reeves County, and the Wolfberry project area located in the Midland Basin portion of the Permian Basin in Howard and Martin counties. During the first quarter of 2012, we drilled and completed 2 gross (1 net) wells and had an additional 2 gross (1 net) wells waiting on completion operations.
Factors That Significantly Affect Resolute’s Financial Results
Revenue, cash flow from operations and future growth depend substantially on factors beyond Resolute’s control, such as economic, political and regulatory developments and competition from other sources of energy. Crude oil prices have historically been volatile and may fluctuate widely in the future. Sustained periods of low prices for crude oil could materially and adversely affect Resolute’s financial position, its results of operations, the quantities of oil and gas that it can economically produce, and its ability to obtain capital.
Like all businesses engaged in the exploration for and production of oil and gas, Resolute faces the challenge of natural production declines. As initial reservoir pressures are depleted, oil and gas production from a given well decreases. Thus, an oil and gas exploration and production company depletes part of its asset base with each unit of oil or gas it produces. Resolute attempts to overcome this natural decline by implementing secondary and tertiary recovery techniques and by developing and acquiring more reserves than it produces. Resolute’s future growth will depend on its ability to enhance production levels from existing reserves and to continue to add reserves in excess of production through exploration, development and acquisition. Resolute will maintain its focus on costs necessary to produce its reserves as well as the costs necessary to add reserves through production enhancement, drilling and acquisitions. Resolute’s ability to make capital expenditures to increase production from existing reserves and to acquire more reserves is dependent on availability of capital resources, and can be limited by many factors, including the ability to obtain capital in a cost-effective manner and on economic terms and to timely obtain permits and regulatory approvals.
Operating Expenses. Lease operating expenses include direct labor, contract services, field office rent, production and ad valorem taxes, vehicle expenses, supervision, transportation, minor maintenance, tools and supplies, workover expenses, utilities and other customary charges. Resolute assesses lease operating expenses in part by monitoring the expenses in relation to production volumes and the number of wells operated.
Lease operating expenses increased to $17.2 million during 2012, from $14.4 million during 2011. The $2.8 million, or 19%, increase was attributable to higher service and supply costs and rates resulting in increases in equipment and maintenance costs, contract and company labor, utilities and fuel and increased workover expense related to well repairs in the Aneth Field Properties, offset by decreases in compression and gathering costs.
Production and ad valorem taxes increased by 31% to $10.2 million in 2012, versus $7.8 million in 2011, mainly due to the increase in commodity pricing and production over 2011 combined with higher ad valorem tax estimates due to increases in the assessed value of reserves in 2012. Production and ad valorem taxes were 16.1% of total revenue in 2012 versus 14.4% of total revenue in 2011.
Depletion, depreciation, amortization and accretion expenses increased to $17.1 million during 2012, as compared to $13.0 million during 2011. The $4.1 million, or 32%, increase is principally due to an increase in the depletion, depreciation and amortization rate from $18.33 per Boe in 2011 to $22.37 per Boe in 2012 as a result of increased finding costs on new drilling and completion activities.
General and administrative expenses include the costs of employees and executive officers, related benefits, share-based compensation, office leases, professional fees, general corporate overhead and other costs not directly associated with field operations. Resolute monitors its general and administrative expenses carefully, attempting to balance the cash effect of incurring general and administrative costs against the related benefits with a focus on hiring and retaining highly qualified staff who can add value to the Company’s asset base.
General and administrative expenses for Resolute increased to $5.2 million during 2012, as compared to $4.4 million during 2011. The $0.8 million, or 20%, increase in general and administrative expenses mainly resulted from $0.7 million of increased salaries and wages due to additional hiring to meet the demand of increasing operations across our four primary focus areas.
Other Income (Expense). All of our oil and gas derivative instruments are accounted for under mark-to-market accounting rules, which provide for the fair value of the contracts to be reflected as either an asset or a liability on the balance sheet. The change in the fair value during an accounting period is reflected in the income statement for that period. During 2012, the loss on oil and gas derivatives was $13.8 million, consisting of $5.3 million of unrealized losses and $8.5 million of realized losses. During 2011, the loss on oil and gas derivatives was $40.0 million, consisting of $34.6 million of unrealized losses and $5.4 million of realized losses on derivative settlements.
Interest expense in 2012 increased to $1.2 million from the $1.1 million recorded in 2011 as a result of higher debt balances during 2012 compared to 2011.
Income Tax Benefit (Expense). Income tax benefit recognized during 2012 was $0.4 million, or 37.3% of the loss before income taxes, as compared to an income tax benefit of $9.7 million, or 36.7% of the loss before income taxes for Resolute in 2011.
Resolute plans to reinvest a sufficient amount of its cash flow in its development operations in order to maintain its production over the long term, and plans to use external financing sources as well as cash flow from operations and cash reserves to increase its production.
Net cash used in investing activities was $47.5 million in 2012 compared to $20.2 million in 2011. The primary investing activity in 2012 was cash used for capital expenditures of $44.8 million. Capital expenditures were comprised of $9.5 million in compression and facility and drilling projects in Aneth Field, $4.2 million in CO 2 acquisition, $10.4 million in drilling activities and infrastructure projects in the Permian Basin of West Texas, $17.1 million in drilling and completion activities in the Bakken trend of North Dakota, and $5.3 million in recompletion and drilling activities in the Company’s Wyoming properties and $0.5 million in other capital projects. A portion of these capital costs are accrued and not paid at period end. The 2011 capital expenditures were comprised of $12.4 million in compression and facility related projects, $3.5 million in CO 2 acquisition, $5.0 million in drilling and completion activities in the Bakken trend of North Dakota and $0.6 million in recompletion activities in the Company’s Wyoming properties.
Net cash provided by financing activities was $18.0 million in 2012 compared to cash used by financing activities of $3.3 million in 2011. The primary financing activity in 2012 was net borrowings of $18.0 million under the Credit Facility. Primary financing activities in 2011 were $45.9 million in net payments under the Credit Facility and $42.6 million in proceeds from warrants exercised. The Company is unable to predict the amount or timing of future warrant exercises.
If cash flow from operating activities does not meet its needs, Resolute may reduce its expected level of capital expenditures and/or fund a portion of its capital expenditures using borrowings under its Credit Facility, issuances of debt and equity securities or from other sources, such as asset sales. The Company has in place an effective universal shelf registration statement pursuant to which an aggregate amount of $500 million of any such equity or debt securities could be issued. There can be no assurance that needed capital will be available on acceptable terms or at all. Additionally, in April of 2012, the Company completed an offering of $250 million in aggregate principal amount of Senior Notes due in 2020, the proceeds of which will be used to repay outstanding borrowings under the Credit Facility and for general corporate purposes, including capital expenditures. Resolute’s ability to raise funds through the incurrence of additional indebtedness could be limited by the covenants in its Credit Facility and in the indenture governing the Senior Notes. If Resolute is unable to obtain funds when needed or on acceptable terms, it may not be able to complete acquisitions that could be favorable to it or finance the capital expenditures necessary to maintain production or proved reserves.
Resolute plans to continue its practice of hedging a significant portion of its production through the use of various derivative transactions. Resolute’s existing derivative transactions do not qualify as cash flow hedges, and the Company anticipates that future transactions will receive similar accounting treatment. Derivative arrangements are generally settled within five days of the end of the month. As is typical in the oil and gas industry, however, Resolute does not generally receive the proceeds from the sale of its crude oil production until the 20th day of the month following the month of production. As a result, when commodity prices increase above the fixed price in the derivative contacts, Resolute will be required to pay the derivative counterparty the difference between the fixed price in the derivative contract and the market price before receiving the proceeds from the sale of the hedged production. If this occurs, Resolute may use Credit Facility borrowings to fund its operations.
Revolving Credit Facility
Resolute’s credit facility is with a syndicate of banks led by Wells Fargo Bank, National Association (the “Credit Facility”) with Resolute as the borrower. The Credit Facility specifies a maximum borrowing base as determined by the lenders. The determination of the borrowing base takes into consideration the estimated value of Resolute’s oil and gas properties in accordance with the lenders’ customary practices for oil and gas loans.
At Resolute’s option, the outstanding balance under the Credit Facility accrues interest at either (a) the London Interbank Offered Rate, plus a margin which varies from 1.75% to 2.75% or (b) the Alternative Base Rate defined as the greater of (i) the Administrative Agent’s Prime Rate, (ii) the Federal Funds Effective Rate plus 0.5%, or (iii) an adjusted London Interbank Offered Rate plus 1%, plus a margin which ranges from 0.75% to 1.75%. Each such margin is based on the level of utilization under the borrowing base. During November 2011, the borrowing base was increased to $330.0 million. As of March 31, 2012, the weighted average interest rate on the outstanding balance under the Credit Facility was 2.53%.
The borrowing base is redetermined semi-annually, and the amount available for borrowing could be increased or decreased as a result of such redeterminations. Under certain circumstances, either Resolute or the lenders may request an interim redetermination. As of March 31, 2012, outstanding borrowings were $188.0 million and unused availability under the borrowing base was $138.9 million. The borrowing base availability had been reduced by $3.1 million in conjunction with letters of credit issued to vendors at March 31, 2012. To the extent that the borrowing base, as adjusted from time to time, exceeds the outstanding balance, no repayments of principal are required prior to maturity. The Credit Facility is guaranteed by all of Resolute’s subsidiaries and is collateralized by substantially all of the proved oil and gas assets of Aneth and Resolute Wyoming, Inc., which are wholly-owned subsidiaries of the Company.
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Fund Letters
