Approach Resources Inc. – Unconventional E&P Files for Chapter 11 Citing Commodity Price Declines; Lines Up $16.5mn in New Money DIP Financing and Will Continue Exploring Strategic Options

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November 18, 2019 − Approach Resources Inc. and six affiliated Debtors (NASDAQ Global Select: AREX, “Approach” or the “Debtors”) filed for Chapter 11 protection with the U.S. Bankruptcy Court in the Southern District of Texas, lead case number 19-36444. The Debtors, who engage in the exploration, development, production and acquisition of unconventional oil and gas reserves in the Midland Basin of the greater Permian Basin in West Texas, are represented by David M. Bennett of Thompson & Knight LLP. Further board-authorized engagements include (i) Perella Weinberg Partners LP as investment banker, (ii) Alvarez & Marsal North America, LLC as financial advisor, (iii) KPMG US LLP as tax advisor and (iv) Epiq Corporate  Restructuring, LLC as claims agent. 

The Debtors’ lead petition notes between 200 and 1,000 creditors; estimated assets between $100.0mn and $500.0mn; and estimated liabilities between $100.0mn and $500.0mn. The Debtors' 2018 10-K lists assets of almost $1.1bn, although this is almost entirely comprised of oil and gas properties and valued using the "successful efforts method of accounting," and liabilities of $494.5mn, comprised principally of (i) the Debtors' Senior Secured Facility due 2020 (the "Senior Secured Facility," $300.5mn), (ii) the Debtors' 7% Senior Notes due 2021 (the "Senior Notes," $84.5mn) and (iii) deferred income tax obligations ($77.8mn).

Documents filed with the Court list the Debtors’ three largest unsecured creditors as (i) JPMorgan Chase Bank, N.A. ($undetermined deficiency claim in respect of Senior Secured Facility), (ii) Wilmington Trust, N.A. ($84.6mn deficiency claim for the Senior Notes) and (iii) USA Compression Partners ($493k trade debt).

In a press release announcing the filing, the Debtors advised that they had commenced the Chapter 11 cases “to explore strategic alternatives, including, without limitation, the restructuring of its balance sheet or the sale of its business as a going concern…"

DIP Financing

The Debtors also announced that they have received a commitment from their pre-petition lenders (with JPMorgan Chase Bank, N.A. as administrative agent ) for $16.5mn in new money, debtor-in-possession (“DIP”) financing; funding that, together with access to cash collateral, the Debtors believe will see them through the bankruptcy process and allow them to "timely pay all employees, vendors and suppliers for services and products."  The DIP financing will also include a roll-up of  $24.75mn of obligations under the Debtors' pre-petition credit agreement. 

Pre-Petition Capital Structure

  • Senior Secured Credit Facility – The Debtors are party to a $325.0mn, May 2014 credit agreement (the “Prepetition Credit Agreement”), with JPMorgan Chase Bank, N.A., as an Issuing Bank and as Administrative Agent (the “Prepetition Agent”) and other lenders thereto. As of the Petition date, approximately $322.0mn is outstanding under this facility.
  • 7.00% Senior Notes – Debtor Approach is party to a senior indenture dated June 11, 2013 (Wilmington Trust, National Association, as trustee), further to which Approach issued $250.0mn aggregate principal amount of the Senior Notes in a public offering. The Senior Notes are fully and unconditionally guaranteed on a senior unsecured basis by each of Approach’s subsidiaries. Subsequent exchange transactions have reduced the amount of outstanding principal on the Senior Notes such that, as of the Petition date, approximately $85.2mn in principal amount remains outstanding. The Debtors estimate Wilks Brothers, LLC and its affiliates (collectively “Wilks”) holds approximately $62.3mn of those outstanding Senior Notes. 
  • Common Equity – As of the Petition Date, there were 93,630,390 shares of Common Stock issued and outstanding. The Common Stock currently trades on the OTC Pink marketplace. Previously, the Common Stock traded on the Nasdaq Global Select Market. Based on the most recent Schedule 13D/A filing of Wilks, as of the Petition Date, Wilks owns approximately 48% of the outstanding Common Stock, and senior management of the Company owns approximately 1% of the outstanding Common Stock.

Events Leading to the Chapter 11 Filing

In a declaration in support of the Chapter 11 filing (the “Krylov Declaration”), Sergei Krylov, the Debtors' Chief Executive Officer, detailed the events leading to the Debtors’ Chapter 11 filings. The Debtors' "tale of woe" is now abundantly familiar: Lower commodity prices have resulted in lower revenues and lower levels of exploration that inevitably follows, the two feeding off of each other in a downward cycle and eventually resulting in breaches under existing credit agreements and an inability to make scheduled interest payments (much less principal). Perhaps the most striking comment in this particular iteration of the E&P narrative is the Debtors' frank admission that "prices for oil, gas and NGLs will remain volatile, and below previous highs, for the foreseeable future."

The Krylov Declaration states: "Primarily, the Debtors’ business has been impacted, along with many producers in the United States oil and gas industry, by the prolonged and continuing period of commodity price decline and subsequent volatility, which began in November 2014 and is continuing through the Petition Date. These macroeconomic factors, combined with the Company’s pre-existing debt levels and debt service costs, have resulted in decreased drilling activity and decreasing production, which in turn led to higher leverage metrics and the Company’s breach of certain financial covenants contained in its revolving credit facility. 

This track record of volatility appears to indicate that prices for oil, gas and NGLs will remain volatile, and below previous highs, for the foreseeable future. The magnitude of these price declines, as well as the slow pace and volatility of recovery, materially and adversely impacted the results of the Debtors’ operations and led to substantial reductions in the Debtors’ drilling program. 

Each year since 2016, the Debtors operated a significantly reduced drilling schedule in an attempt to more closely align capital expenditures with cash flows. This reduced drilling activity has led to a decline in production, as Approach has not drilled and completed enough wells to fully offset natural production decline. The decrease in the price of oil, natural gas and NGLs, along with the natural decline in production and limited new drilling activity, resulted in a significant reduction in the Debtors’ revenue and EBITDAX, which declined approximately 56% and 69%, respectively, from the twelve months ended December 31, 2014 to the twelve months ended December 31, 2018. 

Measured as of March 31, 2019 (and continuing through the Petition Date), Approach was not in compliance with the consolidated interest coverage ratio and consolidated total leverage ratio financial covenants under the Prepetition Credit Agreement, which represents an event of default under the Prepetition Credit Agreement.

Because of this default, the entire outstanding balance under the Prepetition Credit Agreement was classified as a current liability on the Company’s balance sheet as of June 30, 2019. 

On May 9, 2019, the Debtors entered into a Limited Forbearance Agreement (the ‘Forbearance Agreement’) with certain lenders named therein (the ‘Consenting Lenders’) and JPMorgan Chase Bank, N.A., as an Issuing Bank and as Administrative Agent, with respect to the Prepetition Credit Agreement. The Forbearance Agreement was amended 9 times to extend the termination date, but expired on October 28, 2019. 

On September 16, 2019, and September 30, 2019, to preserve liquidity, Approach did not make its scheduled interest payments under the Prepetition Credit Agreement. As of the Petition Date, the Debtors lacked sufficient liquidity to satisfy their ongoing payment obligations under their debt documents. Moreover, in the absence of access to capital, the Debtors will soon lack sufficient liquidity to fund ordinary course operations, to maintain the value of their assets and to pay ongoing costs related to their restructuring efforts."

About the Debtors

The Debtors, a Delaware corporation headquartered in Fort Worth, Texas, are an independent exploration and production company focused on the acquisition and development of U.S. onshore oil and natural gas resources. Approach Oil & Gas Inc., a Delaware corporation (“AOG”), and Approach Operating, LLC (“Approach Operating”), Approach Delaware, LLC (“Approach Delaware”), Approach Services, LLC (“Approach Services”) and Approach Midstream Holdings LLC (“Approach Midstream”), each a Delaware limited liability company, are wholly-owned subsidiaries of Approach. Approach Resources I, LP (“Approach LP”) is a Texas limited partnership with Approach Operating holding a 1% general partnership interest and Approach Delaware holding a 99% limited partnership interest. A detailed corporate organizational chart is attached as Exhibit A. 

The Debtors engage in the exploration, development, production and acquisition of unconventional oil and gas reserves in the Midland Basin of the greater Permian Basin in West Texas, where the Debtors leased approximately 113,000 net acres as of the Petition Date. Approach is a holding company with no independent assets or operations. All of the Debtors’ oil and gas leases are held by AOG and Approach LP. All of the Debtors’ employees are employed by Approach Operating, and the Debtors’ assets are operated by Approach Operating. Approach Operating manages substantially all of the Debtors’ receipts and disbursements. Approach Midstream, Approach Delaware and Approach Services currently perform no material services, and hold no material assets.

Corporate Structure Chart

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