UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

SCHEDULE 14A

Proxy Statement Pursuant to Section 14(a) of the
Securities Exchange Act of 1934 (Amendment No.      )

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Approach Resources Inc.

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NOTICE OF ANNUAL MEETING OF STOCKHOLDERS

 

To our stockholders:

 

The 2011 annual meeting of stockholders of Approach Resources Inc., a Delaware corporation, will be held at the offices of Approach Resources Inc., located at One Ridgmar Centre, 6500 West Freeway, Suite 800 in Fort Worth, Texas, on Wednesday, June 1, 2011, at 10:00 a.m. Central Time, for the following purposes:

 

 

You may vote if you were a stockholder of record at the close of business on April 13, 2011. To ensure that your vote is properly recorded, please vote as soon as possible, even if you plan to attend the annual meeting. You may still vote in person if you attend the annual meeting. For further details about voting, please see “General Matters” beginning on page 1 of this proxy statement.

 

If your shares are held in “street name” in a stock brokerage account or by a bank or other nominee, you must provide your broker with instructions on how to vote your shares in order for your shares to be voted on important matters presented at the annual meeting. If you do not instruct your broker on how to vote in the election of directors and on compensation matters, your shares will not be voted on these matters.

 

This notice and proxy statement are first being sent to stockholders on or about April 21, 2011. Our 2010 annual report to stockholders is being sent with this notice and proxy statement.

 

BY ORDER OF THE BOARD OF DIRECTORS,

 

 

J. Ross Craft, P.E.

President and Chief Executive Officer

 

April 21, 2011

Fort Worth, Texas

 

TABLE OF CONTENTS

 

APPROACH RESOURCES INC.

 

PROXY STATEMENT

 

Annual Meeting of Stockholders

June 1, 2011

 

These proxy materials are being furnished to you in connection with the solicitation of proxies by the Board of Directors of Approach Resources Inc. for use at the 2011 annual meeting of stockholders and any adjournments or postponements of the meeting. We refer to our Board of Directors as the “Board” and to Approach Resources Inc. as “Approach,” the “Company,” “we,” “us” or “our.” The annual meeting will be held at the offices of the Company, One Ridgmar Centre, 6500 West Freeway, Suite 800 in Fort Worth, Texas, on Wednesday, June 1, 2011, at 10:00 a.m. Central Time.

 

The items to be considered are summarized in the notice of annual meeting of stockholders and more fully described in this proxy statement. The notice of annual meeting, this proxy statement, the enclosed proxy card and our 2010 annual report to stockholders are first being mailed on or about April 21, 2011, to all record holders of our common stock as of April 13, 2011. Shares of our common stock represented by proxies will be voted as described below or as specified by each stockholder.

 

Important Notice Regarding the Availability of Proxy Materials
for the Annual Meeting of Stockholders to be held on June 1, 2011

 

The notice of annual meeting, this proxy statement and our 2010 annual report to stockholders are available at www.approachresources.com. On this site, you will be able to access these materials and any amendments or supplements to these materials that are required to be furnished to stockholders. Information contained on or connected to our website is not incorporated by reference into this proxy statement and should not be considered a part of this proxy statement or any other filing that we make with the Securities and Exchange Commission (the “SEC”).

 

Record date.  The record date for the annual meeting is April 13, 2011. On the record date, there were 28,460,473 shares of our common stock outstanding and there were no outstanding shares of any other class of stock.

 

Quorum.  In order for us to hold our annual meeting, holders of a majority of our outstanding shares of common stock as of April 13, 2011, must be present in person or by proxy at the meeting. Proxy cards or voting instruction forms that reflect abstentions and broker non-votes will be counted as shares present to determine whether a quorum exists to hold the 2011 annual meeting.

 

Voting Your Proxy.  Our stockholders are entitled to one vote for each share of common stock that is owned on the record date, April 13, 2011, on all matters considered at the annual meeting. You may vote your shares either in person or by proxy. To vote by proxy, you may vote by telephone by using the toll-free number listed on the proxy card, by the Internet at the website for Internet voting listed on the proxy card or you may mark, date, sign and mail the enclosed proxy card in the prepaid envelope. If you plan to vote in person at the annual meeting, please bring proof of identification. Even if you currently plan to attend the annual meeting, we recommend that you also submit your proxy as described above so that your vote will be counted if you later decide not to attend the annual meeting.

 

Shares Held of Record.  If your shares are held in your name and you vote by granting a proxy, the proxy holders will vote the shares in accordance with your instructions. If you submit a proxy without giving specific voting instructions, the proxy holders will vote those shares as recommended by our Board.

Shares Held in Street Name.  If your shares are held in “street name” by your broker, bank or other nominee, you will receive a voting instruction form with this proxy statement. Like shares held of record, you may vote your shares held in street name in person at the annual meeting if you have obtained a legal proxy from the holder of record for your shares or you may sign and date the enclosed voting instruction form and return it in the enclosed, postage-paid envelope. If your shares are held in street name in a brokerage account or by a bank or other nominee, you must provide your broker with instructions on how to vote your shares in order for your shares to be voted on Proposals 1, 2 and 3. If you do not instruct your broker on how to vote these proposals, your shares will not be voted on these matters.

 

Revoking Your Proxy.  Even after you have returned your proxy card, you may revoke your proxy at any time before it is exercised by (i) submitting a written a notice of revocation to our Corporate Secretary by mail to Approach Resources Inc., One Ridgmar Centre, 6500 West Freeway, Suite 800, Fort Worth, Texas 76116 or by facsimile at (817) 989-9001, (ii) mailing in a new proxy card with a later date or (iii) attending the annual meeting and voting in person, which suspends the powers of the proxy holder.

 

Vote Required.  For Proposal 1, the election of three directors, you may vote “FOR ALL NOMINEES,” “WITHHOLD AUTHORITY FOR ALL NOMINEES” or “FOR ALL EXCEPT.” A plurality of the votes of the shares present in person or represented by proxy at the meeting and entitled to vote on the election of directors is required for the election of directors. This means that the three director nominees receiving the highest number of affirmative votes of the shares present in person or represented by proxy at the annual meeting and entitled to vote on the election of directors will be elected to our Board. Broker non-votes and votes marked “WITHHOLD AUTHORITY FOR ALL NOMINEES” will have no legal effect on the outcome of the election of directors. With respect to votes marked “FOR ALL EXCEPT,” votes for director nominees that are withheld will have no legal effect on the outcome of the election of directors, while votes for all other director nominees will count toward a plurality.

 

For each of the Proposals 2, 4 and 5, you may vote “FOR,” “AGAINST” or “ABSTAIN.” For Proposal 3, you may vote to hold an advisory vote on the frequency of future advisory votes on our executive compensation every “1 YEAR,” “2 YEARS” or “3 YEARS,” or you may “ABSTAIN.”

 

The affirmative vote of a majority of the shares present in person or represented by proxy and entitled to vote is required to approve Proposals 2, 4 and 5. As such, abstentions will have the effect of a vote against the matters to be voted on in Proposals 2, 4 and 5. Brokers will not have discretionary authority to vote on Proposals 2 and 4, and broker non-votes will have no effect on the outcome of such votes. Brokers will have discretionary authority to vote on Proposal 5. With respect to Proposal 3, while approval of matters presented to the Company’s stockholders generally requires the affirmative vote of a majority of the shares present in person or represented by proxy and entitled to vote, because this proposal is advisory and non-binding and there are four options from which a stockholder may choose to vote, the option receiving the greatest number of votes will be considered the frequency recommended by the Company’s stockholders. Abstentions and broker non-votes will, therefore, have no legal effect on the outcome of the matter to be voted on in Proposal 3.

 

If you have any questions about this proxy statement or the annual meeting, please contact our Corporate Secretary at Approach Resources Inc., One Ridgmar Centre, 6500 West Freeway, Suite 800, Fort Worth, Texas 76116, or by telephone at (817) 989-9000.

 

Under our certificate of incorporation, the members of our Board are divided into three classes with staggered, three-year terms. The terms of three Class I directors expire at the 2011 annual meeting.

The Board has nominated Alan D. Bell for election as a director and Sheldon B. Lubar and Christopher J. Whyte for re-election as directors. Upon election, Mr. Bell, Mr. Lubar and Mr. Whyte will serve for terms expiring at the 2014 annual meeting of stockholders or, in each case, until their successors are elected and qualified.

 

Each of the nominees has agreed to serve if elected. If any of them becomes unavailable to serve as a director, the Board may designate a substitute nominee. In that case, the persons named as proxies will vote for the substitute nominee designated by the Board. The Board does not presently expect that any of the nominees will become unavailable for election.

 

In making these nominations, the Compensation and Nominating Committee (“Compensation Committee”) reviewed the background of the nominees and recommended nomination to the full Board consistent with the Compensation Committee’s guidelines for identifying and evaluating nominees for directors. Please see “Corporate Governance — Identifying and Evaluating Nominees for Directors” for more information on the Compensation Committee’s guidelines for identifying and nominating director nominees. In addition, information on each nominee is set forth below.

 

The Board believes that each nominee and director has valuable individual skills and experiences that, taken together, provide us with the knowledge, judgment and strategic vision necessary to provide effective oversight of the Company. The biographies below reflect the particular experience, qualifications, attributes and skills that led the Board to conclude that each nominee and director should serve on the Board, including:

 

 

The Board believes that these skills and experiences qualify the nominees and directors to serve on the Board of the Company.

The principal occupation and other information about our directors are set forth below. All of our directors are members of the National Association of Corporate Directors.

 

 

Alan D. Bell was appointed to our Board in August 2010 and is Chairman of our Audit Committee. Mr. Bell’s prior experience includes 33 years in various capacities at Ernst & Young LLP from 1973 until his retirement in 2006, when he was Director of Ernst & Young’s Energy Practice in the Southwest United States. Before joining Ernst & Young, Mr. Bell was a production engineer with Chevron Oil Company in the Gulf of Mexico. In 2009, Mr. Bell served as the Chief Restructuring Officer of Energy Partners Ltd., a New Orleans-based exploration and development company that emerged from Chapter 11 in September 2009. Mr. Bell currently serves on the Board of Directors of Dune Energy Inc., an independent energy company based in Houston, where he is non-executive Chairman of the Board of Directors. During the past five years, Mr. Bell has also been a director of Toreador Resources Corporation, an independent energy company with interests in developed and undeveloped oil properties in France. Mr. Bell earned a degree in Petroleum Engineering from the Colorado School of Mines and an M.B.A. from Tulane University. He is a current member of the American Institute of Certified Public Accountants, the Texas Society of Certified Public Accountants and is a licensed Certified Public Accountant in Texas. Mr. Bell is also a member of the Institute of Certified Management Accountants, Association of Certified Fraud Examiners and the Society of Petroleum Engineers. Mr. Bell is also an Eagle Scout.

 

James H. Brandi joined us as a director in June 2007 and is Chairman of our Compensation Committee and a member of our Audit Committee. Mr. Brandi has been a Managing Director in investment banking at BNP Paribas, a global bank and financial services company, since May 2010, when BNP Paribas acquired Hill Street Capital. From November 2005 to May 2010, Mr. Brandi was a partner at Hill Street Capital, a financial advisory and private investment firm. From 2000 until November 2005, Mr. Brandi was a Managing Director at UBS Securities, LLC, where he was the Deputy Global Head of the Energy and Power Groups. Before 2000, Mr. Brandi was a Managing Director at Dillon, Read & Co. Inc. and later its successor firm, UBS Warburg, concentrating on transactions in the energy and consumer goods areas. Mr. Brandi is a director of OGE Energy Corp., an energy and energy services provider that delivers electricity in Oklahoma and Arkansas and gathers, processes and transports natural gas in the North Central United States through its subsidiary, Enogex LLC. During the past five years, Mr. Brandi also has been a director of Energy East Corp., a utility holding company, and Armstrong Land, LLC, a coal holding company. Mr. Brandi is a trustee of The Kenyon Review and a former trustee of Kenyon College. Mr. Brandi holds a B.A. in History from Yale University and an M.B.A. from Harvard Business School and attended Columbia Law School as a Harlan Fiske Stone Scholar.

 

J. Ross Craft has been our President and Chief Executive Officer and a member of our Board since our inception in September 2002. Before Approach, Mr. Craft co-founded Athanor Resources Inc., an international exploration and production company with operations in the United States and Tunisia, in 1998 and was its Executive Vice President from 1998 until its merger with Nuevo Energy Company in September 2002. From 1988 to 1997, Mr. Craft served in various positions with American Cometra Inc., an independent exploration and production company with operations in the United States, including as Vice President — Operations from 1995 to 1997. American Cometra was sold in two parts, to Range Resources in 1995 and Pioneer Natural Resources in 1997. Mr. Craft has over 30 years of experience in the oil and gas industry. Mr. Craft holds a B.S. in Petroleum Engineering from Texas A&M University and is a registered Professional Engineer licensed in Texas. Mr. Craft is a member of the Society of Petroleum Engineers, the Texas Oil & Gas Association, the Permian Basin Petroleum

Association and the Independent Petroleum Association of America. Mr. Craft has served on the Board of the Fort Worth Chapter of the Society of Petroleum Engineers and on the Board of the Fort Worth Petroleum Engineers Club, where his last position was President. Mr. Craft is also an Eagle Scout. Mr. Craft is the brother-in-law of J. Curtis Henderson, our Executive Vice President and General Counsel.

 

James C. Crain joined us as a director in June 2007 and is a member of our Audit Committee and our Compensation Committee. Mr. Crain has been in the energy industry for over 30 years, both as an attorney and as an executive officer. Since 1984, Mr. Crain has been an officer of Marsh Operating Company, an investment management company focusing on energy investing, including his current position as President, which he has held since 1989. Mr. Crain has served as general partner of Valmora Partners, L.P., a private investment partnership that invests in the oil and gas sector, among others, since 1997. Before joining Marsh in 1984, Mr. Crain was a partner in the law firm of Jenkens & Gilchrist, where he headed the firm’s energy section. Mr. Crain is a director of Crosstex Energy, Inc., a midstream natural gas company, and GeoMet, Inc., a natural gas exploration and production company. During the past five years, Mr. Crain has also been a director of Crosstex Energy GP, LLC, the general partner of a midstream natural gas company, and Crusader Energy Group Inc., an oil and gas exploration and production company. Mr. Crain holds a B.B.A., M.P.A. and J.D. from the University of Texas at Austin.

 

Bryan H. Lawrence has been a member of our Board since 2002 and is the Chairman of our Board. Mr. Lawrence is a founder and Senior Manager of Yorktown Partners LLC, the manager of the Yorktown group of investment partnerships, which make investments in companies in the energy industry. The Yorktown group of investment partnerships was formerly affiliated with the investment firm of Dillon, Read & Co. Inc., where Mr. Lawrence had been employed since 1966, serving as a Managing Director until the merger of Dillon Read with SBC Warburg in 1997. Mr. Lawrence is a director of Crosstex Energy, Inc. and Crosstex Energy GP, LLC, midstream natural gas companies, Hallador Energy Company, an independent company engaged in the production of coal and the exploration and production of oil and gas, the general partner of Star Gas Partners, L.P., a home heating oil distributor and services provider, Winstar Resources Ltd. and Compass Petroleum Ltd., Canadian oil and gas companies, and certain non-public companies in the energy industry in which the Yorktown group of investment partnerships holds equity interests. During the past five years, Mr. Lawrence has also been a director of TransMontaigne Inc., a refined petroleum products company. Mr. Lawrence is a graduate of Hamilton College and holds an M.B.A. from Columbia University.

 

Sheldon B. Lubar joined us as a director in June 2007 and is a member of our Compensation Committee. Mr. Lubar has been Chairman of the Board of Lubar & Co. Incorporated, a private investment and venture capital firm he founded, since 1977. He was Chairman of the Board of Christiana Companies, Inc., a logistics and manufacturing company, from 1987 until its merger with Weatherford International in 1995. Mr. Lubar is a director of Crosstex Energy, Inc. and Crosstex Energy GP, LLC, midstream natural gas companies, Hallador Energy Company, an independent company engaged in the production of coal and the exploration and production of oil and gas, and the general partner of Star Gas Partners, L.P., a home heating oil distributor and services provider. During the past five years, Mr. Lubar has also been a director of Weatherford International, Inc., a global provider of oilfield products and services, and Grant Prideco, a provider of drill pipe and drill bits. Mr. Lubar previously held governmental appointments under three United States Presidents, including Commissioner of the White House Conference on Small Business from 1979 to 1980 under President Carter, Assistant Secretary, Housing Production and Mortgage Credit, Department of Housing and Urban Development, Commissioner of the Federal Housing Administration and Director of the Federal National Mortgage Association from 1973 to 1974 under Presidents Nixon and Ford. Mr. Lubar is a past president of the Board of Regents of the University of Wisconsin System. Mr. Lubar holds a B.B.A., J.D. and an honorary Doctor of Humanities degree from the University of Wisconsin — Madison, was awarded an honorary Doctor of Commercial Science degree from the University of Wisconsin — Milwaukee, and an Honorary Doctors degree from the Medical College of Wisconsin.

 

Christopher J. Whyte joined our Board in June 2007 and is a member of our Audit Committee. Mr. Whyte has been President, Chief Executive Officer and a director of PetroSantander Inc., which owns and operates oil and gas producing properties in the United States, Colombia and Brazil, since 1995. Mr. Whyte is a director of Winstar Resources Ltd. and Compass Petroleum Ltd., public Canadian oil and gas companies.

Mr. Whyte holds a B.A. from the University of Pittsburgh. Mr. Whyte has over 25 years of experience in various operating, executive and finance positions, including as a Chief Executive and Chief Financial Officer, in the E&P and energy businesses.

 

The affirmative vote of a plurality of the votes of the shares present in person or represented by proxy at the annual meeting and entitled to vote is required for the election of directors. A properly-executed proxy marked “WITHHOLD AUTHORITY FOR ALL NOMINEES” or “FOR ALL EXCEPT” with respect to the election of one or more directors will not be voted with respect to the director or directors indicated, although it will be counted for purposes of determining whether a quorum is present.

 

The Board recommends a vote “FOR” the election of each of the nominees.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted in July 2010, requires that we provide our stockholders with the opportunity to vote to approve, on a non-binding, advisory basis, the compensation of our named executives officers as disclosed in this proxy statement in accordance with the compensation disclosure rules of the SEC.

 

As described in detail below in this proxy statement under “Compensation Discussion and Analysis,” we seek to (i) pay our named executive officers for performance, (ii) closely align the interests of our named executive officers with the interests of our stockholders and (iii) attract, retain and motivate top talent. Below is a summary of how we have structured our executive compensation program to achieve these goals:

 

The vote on this resolution is not intended to address any specific element of compensation; rather, the vote relates to the overall compensation of our named executive officers as described in this proxy statement in accordance with the compensation disclosure rules of the SEC. The vote is advisory, which means that the vote is not binding on the Company, our Board or the Compensation Committee. If there are significant votes against our named executive officer compensation as disclosed in this proxy statement, the Compensation Committee will evaluate whether any actions are necessary to address the concerns of stockholders.

 

The affirmative vote of a majority of the shares present in person or represented by proxy and entitled to vote is required to approve this Proposal 2.

 

The text of the resolution to be voted on is as follows:

 

“RESOLVED, that the Company’s stockholders approve, on an advisory basis, the compensation of the named executive officers as disclosed in the Company’s proxy statement for the 2011 Annual Meeting of Stockholders pursuant to the compensation disclosure rules of the Securities and Exchange Commission, including the Compensation Discussion and Analysis, the 2010 Summary Compensation Table and other related tables and disclosure.”

 

The Board recommends a vote “FOR” the approval of the compensation of our named executive officers as disclosed in this proxy statement.

 

The Dodd-Frank Act also provides that stockholders must be given the opportunity to vote, on a non-binding, advisory basis, for their preference on how frequently we should seek future advisory votes on the compensation of our named executive officers as disclosed in accordance with the compensation disclosure rules of the SEC. By voting on this Proposal 3, stockholders may indicate whether they prefer that we conduct future advisory votes on executive compensation every one, two or three years. Stockholders also may, if they wish, abstain from casting a vote on this proposal.

 

After careful consideration, our Board of Directors has determined that an advisory vote on executive compensation that occurs every year is the most appropriate alternative for the Company and, therefore, our Board recommends that you vote for an annual advisory vote on executive compensation. Although the Company’s compensation policies and practices are designed to incentivize our named executive officers to build long-term stockholder value, the Board recognizes that executive compensation disclosures are made annually. Therefore, providing for an annual advisory vote on executive compensation may provide the Company with more direct and immediate feedback on our annual compensation disclosure.

 

This vote is advisory and not binding on the Company or our Board. However, the Board and the Compensation Committee will take into account the outcome of the vote in determining the frequency of future advisory votes on executive compensation. The Board may decide that it is in the best interests of our stockholders and the Company to hold an advisory vote on executive compensation more or less frequently than the frequency receiving the most votes cast by our stockholders.

 

Because this Proposal 3 seeks the input of our stockholders and provides our stockholders with the option to vote to hold an advisory vote on executive compensation once every one, two or three years (or to abstain from voting), the option receiving the greatest number of votes will be considered the frequency recommended by the Company’s stockholders. Although our Board recommends holding this vote every year, you have the

option to specify one of four choices for this proposal on the proxy card: “1 YEAR,” “2 YEARS,” “3 YEARS” or “ABSTAIN.” You are not voting to approve or disapprove of the Board’s recommendation.

 

The text of the resolution to be voted on is as follows:

 

“RESOLVED, that the option of every one, two or three years that receives the highest number of votes properly cast for this resolution will be determined to be the preferred frequency recommended by the stockholders of the Company with which the Company is to hold a non-binding, advisory vote to approve the compensation of the Company’s named executive officers in accordance with the compensation disclosure rules of the Securities and Exchange Commission.”

 

The Board recommends that you vote to conduct a non-binding, advisory vote on executive compensation every “1 YEAR.”

 

Our Board originally adopted the Approach Resources Inc. 2007 Stock Incentive Plan (the “2007 Plan”) on June 26, 2007, and our stockholders originally approved the 2007 Plan on that same date. At this annual meeting, stockholders will be asked to reapprove the material terms of the 2007 Plan so that awards granted under the 2007 Plan that are intended to qualify as “performance-based compensation” within the meaning of Section 162(m) of the Internal Revenue Code (the “Code”) will be fully deductible by us and our subsidiaries.

 

The use of stock-based awards under the 2007 Plan continues to be a key element of our compensation program. Of the 2,822,689 shares currently authorized for issuance under the 2007 Plan, a total of 1,612,281 shares have been issued as of March 31, 2011, after the lapse of restrictions on grants of restricted stock or upon the exercise of stock options. As of March 31, 2011, under the 2007 Plan, a total of 313,566 shares remained subject to outstanding stock options and 898,696 shares remained subject to awards of restricted stock still subject to forfeiture. The 2007 Plan is a broad-based plan under which we grant awards to our employees, officers, directors and consultants. We continue to believe that our long-term interests are best served by aligning the interests of our outside directors and key employees with the interests of our stockholders. While the Board and Compensation Committee recognize the potential dilutive effect of compensatory stock awards, they also recognize the significant motivational and performance benefits that can be achieved from making such awards.

 

Reapproval of the material terms of the 2007 Plan will permit us to use stock-based compensation to align stockholder and employee interests in a manner that qualifies certain designated awards for exemption from the deduction limitations of Section 162(m) of the Code. Under Section 162(m), the federal income tax deductibility of compensation paid to our Chief Executive Officer and three other most highly compensated officers (other than our Chief Executive Officer and Chief Financial Officer) (“Covered Employees”) determined pursuant to the executive compensation disclosure rules under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) may be limited to the extent such compensation exceeds $1,000,000 in any taxable year. However, we may deduct compensation paid to our Covered Employees in excess of that amount if it qualifies as “performance-based compensation” as defined in Section 162(m). In addition to certain other requirements, in order for awards under the 2007 Plan to constitute “performance-based compensation,” the material terms of the 2007 Plan must be disclosed to and reapproved by our stockholders no later than the first meeting of our stockholders occurring after the close of the third calendar year following the calendar year in which our initial public offering occurred and, subsequently, every five years. Based on transition relief provided to newly public companies under the Section 162(m) regulations, we were not previously subject to the deduction limitations of Section 162(m).

 

Under the Section 162(m) regulations, the material terms of the 2007 Plan are (i) the maximum amount of compensation that may be paid to a participant under the 2007 Plan in any fiscal year, (ii) the employees eligible to receive compensation under the 2007 Plan and (iii) the business criteria on which the performance goals are based. We intend that certain awards under the 2007 Plan qualify for exemption from the deduction limitations of Section 162(m). Accordingly, we are asking our stockholders to reapprove the material terms of the 2007 Plan for Section 162(m) purposes so that awards under the 2007 Plan will be fully deductible by us. The material terms of the 2007 Plan are disclosed below as follows: (i) the maximum amount of compensation that may be paid to a participant is described in the section entitled “Summary of the 2007 Plan — Maximum Amount of Compensation that May be Paid to a Participant,” (ii) the eligible employees are described in the section entitled “Summary of the 2007 Plan — Persons Who May Participate” and (iii) the business criteria are described in the section entitled “Summary of the 2007 Plan — Awards under the 2007 Plan — Performance Awards.”

 

Assuming the presence of a quorum, the affirmative vote of a majority of the shares present, in person or by proxy, at the annual meeting is necessary for reapproval of the material terms of the 2007 Plan for Section 162(m) purposes.

 

Failure of our stockholders to approve this Proposal will not affect the rights of existing award holders under the 2007 Plan or under any previously granted awards under the 2007 Plan. However, if this proposal is not approved, the deductibility of awards granted to Covered Employees after the annual meeting will potentially be limited. In that event, we will be required to re-evaluate our executive compensation structure.

 

The following summary of the 2007 Plan does not purport to be a complete description of all provisions of the 2007 Plan and should be read in conjunction with, and is qualified in its entirety by reference to, the complete text of (i) the 2007 Plan, which was filed as Exhibit 10.6 to our Registration Statement on Form S-1 on July 12, 2007, and (ii) the First Amendment to the 2007 Plan, which was filed as Exhibit 10.1 to our Current Report on Form 8-K on December 31, 2008. The 2007 Plan gives the Compensation Committee the ability to award stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards, unrestricted stock awards and other incentive awards, with vesting and other award provisions that provide effective incentives to our employees and outside directors and alignment of stockholder, management and outside director interests. Unless earlier terminated by action of our Board, the 2007 Plan will terminate on June 26, 2017. Awards granted before the termination date of the 2007 Plan will continue to be effective in accordance with their terms and conditions.

 

Persons Who May Participate.  Awards may be made under the 2007 Plan to our employees, outside directors and consultants, including any employee who is an officer, and to any other service provider who, in the opinion of the Compensation Committee, is in a position to make a significant contribution to our success. Only individuals who are our employees or who are employees of one of our corporate subsidiaries are eligible to receive incentive stock options. The Compensation Committee determines in its discretion which eligible persons will receive awards under the 2007 Plan. As of April 13, 2011, approximately 58 employees, five outside directors and one consultant were eligible to participate in the 2007 Plan.

 

Shares Subject to the 2007 Plan.  The total aggregate number of shares of our common stock that may be subject to awards under the 2007 Plan is equal to 10% of our outstanding shares of common stock (which is adjusted at the beginning of each year to remain at 10% of the outstanding shares of our common stock), plus all shares of common stock that remain available for the grant of awards under our 2003 Stock Option Plan (“Prior Plan”), plus shares of common stock subject to outstanding awards under the Prior Plan that later cease to be subject to those awards for any reason other than those awards having been exercised. Although the maximum number of shares of common stock available for grant of awards under the 2007 Plan adjusts on the first day of each year to 10% of our outstanding shares of common stock, we exclude shares of common stock subject to previously-granted awards under the 2007 Plan from our calculation of shares available for

grant. The maximum number of shares of common stock available for grant of awards under the 2007 Plan is also subject to adjustment for corporate events such as recapitalizations, stock splits, stock dividends and other corporate events. See “Awards Under the 2007 Plan — Corporate Events,” below.

 

Our common stock issued or to be issued under the 2007 Plan consists of authorized but unissued shares. If an award granted under the 2007 Plan expires, is forfeited or becomes unexercisable for any reason without having been exercised in full, the undelivered shares of common stock that were subject to the award become available for future awards under the 2007 Plan.

 

Maximum Amount of Compensation that May be Paid to a Participant.  The maximum shares of common stock that may be subject to incentive stock options granted under the 2007 Plan is 1,100,000. The maximum number of shares of common stock that may be subject to all awards granted to any one participant in each fiscal year is 330,000 shares. The maximum number of shares of common stock that may be subject to nonqualified stock options and stock appreciation rights granted to any one participant during a fiscal year is 330,000 shares. The amount that may be paid in cash pursuant to performance awards granted to a Covered Employee that are intended to qualify as “performance-based compensation” under Section 162(m) of the Code is $5,000,000 for each fiscal year during the applicable performance period.

 

Administration.  The 2007 Plan provides for administration by the Board or the Compensation Committee, or another committee of the Board designated by the Board. Subject to the terms of the 2007 Plan, the Board or the Compensation Committee has broad authority to, among other things, select participants to receive awards, determine the types of awards and terms and conditions of awards and interpret provisions of the 2007 Plan. Currently, the 2007 Plan is administered by the Compensation Committee. Under NASDAQ rules, members of the Compensation Committee are required to satisfy the NASDAQ’s standards for independence, subject to certain narrow exceptions. The Compensation Committee may delegate various functions to subcommittees or certain officers.

 

Stock Options.  The 2007 Plan permits the granting of options to purchase shares of common stock intended to qualify as incentive stock options under the Code and stock options that do not qualify as incentive stock options (i.e., nonqualified stock options). The exercise price of each stock option may not be less than 100% of the fair market value of the common stock on the date of grant. In the case of certain 10% stockholders who receive incentive stock options, the exercise price may not be less than 110% of the fair market value of the common stock on the date of grant. An exception to these requirements is made for options that we grant in substitution for options held by employees of companies that we acquire. In such a case, the exercise price is adjusted to preserve the economic value of the employee’s stock option from his or her former employer.

 

The term of each stock option is fixed at the time of grant and may not exceed 10 years from the date of grant. The Compensation Committee determines when each option may be exercised and the period of time, if any, after retirement, death, disability or other termination of employment during which options may exercised. Options may be exercisable in installments. The exercisability of options may be accelerated by the Compensation Committee. In general, a participant may pay the exercise price of an option in cash or in cash equivalents, by tendering shares of common stock having an aggregate fair market value at the time of exercise equal to the total exercise price, by surrendering a sufficient portion of the shares with respect to which the option is exercised having an aggregate fair market value at the time of exercise equal to the total exercise price, by a sale through a broker-dealer or in a combination of these forms, as permitted by the Compensation Committee. The 2007 Plan prohibits the repricing of stock options without stockholder approval.

 

Stock Appreciation Rights.  A stock appreciation right provides the right to receive a number of shares or, in the discretion of the Compensation Committee, an amount in cash or a combination of shares and cash, based on the increase in the fair market value of the shares underlying the rights during a specified period of time. The Compensation Committee may grant stock appreciation rights subject to such terms and conditions and exercisable at such times as determined by the Compensation Committee and specified in the applicable award agreement. The price at which stock appreciation rights may be exercised will not be less than 100% of

the fair market value of our common stock on the date of grant, unless the award is granted in substitution of an award held by an employee of a company we acquire. The term of a stock appreciation right will not exceed 10 years. Stock appreciation rights may not be repriced without stockholder approval.

 

Restricted Stock.  A restricted stock award is an award of shares that is subject to one or more restrictions, including, without limitation, a restriction that constitutes a “substantial risk of forfeiture” within the meaning of Section 83 of the Code and prohibitions regarding the transferability of the shares, for a period to be determined by the Compensation Committee. The Compensation Committee has the discretion to determine the terms of any restricted stock award including the number of shares subject to the award, the price (if any) paid for shares subject to the award and the minimum period over which a restricted stock award may be vested. Unless otherwise determined by the Compensation Committee, participants holding shares subject to restricted stock awards may exercise full voting rights with respect to the shares during the restriction period and will be entitled to receive all dividend and other distributions with respect to the shares.

 

Restricted Stock Units.  A restricted stock unit is an award of units denominated in shares and payable in shares or cash, which is subject to such performance and/or other conditions as are specified by the Compensation Committee. The Compensation Committee has the discretion to determine the terms of any restricted stock unit award, including the number of shares subject to such award and the minimum period over which the award may vest and be settled. Holders of restricted stock units will be entitled to receive dividend equivalents only to the extent provided by the Compensation Committee.

 

Performance Awards.  The 2007 Plan provides for the grant of performance awards, ultimately payable in common stock or cash (or a combination thereof), as determined by the Compensation Committee. Performance awards are conditioned upon the level of achievement of one or more stated performance goals over a specified performance period that is not shorter than one year. The applicable award agreement will specify the amount, or the formula for determining the amount, that may be earned under the performance award, the performance criteria and level of achievement versus the performance criteria that will determine the amount payable under the performance award, the performance period over which performance is measured, and such other terms and conditions as the Compensation Committee may determine. Performance awards to Covered Employees or to individuals who are likely to be Covered Employees may be designed to qualify as “performance-based compensation” under Section 162(m) of the Code to the extent the Compensation Committee so designates. Notwithstanding satisfaction of any applicable performance goals, the number of shares issued under or the amount paid under an award may, to the extent specified in the award agreement, be reduced by the Compensation Committee on the basis of such further considerations as the Compensation Committee in its sole discretion shall determine.

 

Performance goals set by the Compensation Committee may relate to one or more of the following objective performance criteria (on an absolute basis or relative to the performance of other business entities) that the Compensation Committee determines is appropriate: (i) earnings or earnings per share (whether on a pre-tax, after-tax, operational or other basis), (ii) return on equity, (iii) return on assets or net assets, (iv) return on capital or invested capital and other related financial measures, (v) cash flow or EBITDA or EBITDAX, (vi) revenues, (vii) income or operating income, (viii) expenses or costs or expense levels or cost levels (absolute or per unit), (ix) one or more operating ratios, (x) stock price, (xi) total stockholder return, (xii) operating profit, (xiii) profit margin, (xiv) capital expenditures, (xv) net borrowing, debt leverage levels, credit quality or debt ratings, (xvi) the accomplishment of mergers, acquisitions, dispositions, public offerings or similar extraordinary business transactions, (xvii) net asset value per share, (xviii) economic value added, (xix) individual business objectives, (xx) growth in production, (xxi) growth in reserves, (xxii) reserve replacement ratio and/or (xxiii) finding and development costs per unit. The performance goals based on these performance measures may be made relative to the performance of other business entities.

 

Other Awards.  In addition to the award types described above, the 2007 Plan permits the granting of the following types of awards:

 

 

 

Transferability.  Unless otherwise provided by the Compensation Committee, awards under the 2007 Plan are generally only transferable (i) by the recipient’s last will and testament and by the applicable laws of descent and distribution, (ii) pursuant to a domestic relations order or (iii) to immediate family members or trusts or partnerships solely for the benefit of the participant’s immediate family members. Incentive stock options are transferable only as provided in clause (i) above.

 

Tax Withholding.  A participant must satisfy any applicable federal, state, local or foreign tax withholding obligations that arise due to an award made under the 2007 Plan, and the Compensation Committee will not be required to issue any shares or make any payment until the participant satisfies those obligations in a manner satisfactory to us. The Compensation Committee may permit tax withholding obligations to be satisfied by having the Company withhold a portion of the shares that would otherwise be issued to the participant under an award or by allowing the participant to surrender previously acquired shares.

 

Amendment and Termination.  Our Board may amend, suspend or terminate the 2007 Plan at any time and for any reason. Amendments to the 2007 Plan will be submitted for stockholder approval if an amendment increases the maximum number of shares available under the 2007 Plan (except as otherwise allowable under the 2007 Plan), changes the designation or class of persons eligible to receive awards under the 2007 Plan or if required by applicable law or by applicable stock exchange listing requirements. Amendments to limit the scope of the 2007 Plan do not require stockholder approval. No amendment to the 2007 Plan or awards may adversely affect in any material way any outstanding award without the consent of the holder of such award.

 

Corporate Events.  We may make appropriate adjustments in outstanding awards and the number of shares available for issuance under the 2007 Plan, including the individual limitations on awards, to reflect recapitalizations, reclassifications, stock splits, reverse stock splits, stock dividends and other similar events. Unless provided otherwise in an applicable award agreement, in the event of a “change in control” (as defined in the 2007 Plan), the vesting of all awards will be accelerated and any performance criteria will be deemed to be achieved to the maximum extent possible. If there is a change in control and we are not the surviving corporation (or if we survive only as a subsidiary of another corporation), unless the Compensation Committee determines otherwise, awards will be replaced with similar awards of the surviving corporation (or parent of the surviving corporation). The Compensation Committee may require the surrender to us by selected participants of some or all of the outstanding awards held by such participants, at which time we will cancel those awards and cause to be paid to each affected participant a certain amount of cash per share, as specified in the 2007 Plan.

 

The following discussion is for general information only and is intended to summarize briefly the U.S. federal tax consequences to participants arising from participation in the 2007 Plan. This description is based on current law, which is subject to change (possibly retroactively). The tax treatment of participants in the 2007 Plan may vary depending on the particular situation and therefore may be subject to special rules not discussed below. No attempt has been made to discuss any potential foreign, state or local tax consequences.

 

Incentive Options; Nonqualified Options; Stock Appreciation Rights.  Participants will not realize taxable income upon the grant of a nonqualified stock option or a stock appreciation right. Upon the exercise of a nonqualified stock option or a stock appreciation right, a participant will recognize ordinary compensation income (subject to withholding) in an amount equal to the excess of (i) the amount of cash and the fair market value of the common stock received, over (ii) the exercise price (if any) paid. A participant will generally have a tax basis in any shares of common stock received pursuant to the exercise of a stock appreciation right, or pursuant to the cash exercise of a nonqualified stock option, that equals the fair market value of such shares on the date of exercise. Subject to the discussion under “Federal Income Tax Consequences — Tax Code Limitations on Deductibility” below, we or one of our subsidiaries (as applicable) will be entitled to a

deduction for federal income tax purposes that corresponds as to timing and amount with the compensation income recognized by a participant under the rules described above.

 

Participants eligible to receive an incentive stock option will not recognize taxable income on the grant of an incentive stock option. Upon the exercise of an incentive stock option, a participant will not recognize taxable income, although the excess of the fair market value of the shares of common stock received upon exercise of the incentive stock option (“ISO Stock”) over the exercise price will increase the alternative minimum taxable income of the participant, which may cause such participant to incur alternative minimum tax. The payment of any alternative minimum tax attributable to the exercise of an incentive stock option would be allowed as a credit against the participant’s regular tax liability in a later year to the extent the participant’s regular tax liability is in excess of the alternative minimum tax for that year.

 

Upon the disposition of ISO Stock that has been held for the requisite holding period (generally, at least two years from the date of grant and one year from the date of exercise of the incentive stock option), a participant will generally recognize capital gain (or loss) equal to the excess (or shortfall) of the amount received in the disposition over the exercise price paid by the participant for the ISO Stock. However, if a participant disposes of ISO Stock that has not been held for the requisite holding period (a “Disqualifying Disposition”), the participant will recognize ordinary compensation income in the year of the Disqualifying Disposition in an amount equal to the amount by which the fair market value of the ISO Stock at the time of exercise of the incentive stock option (or, if less, the amount realized in the case of an arm’s-length disposition to an unrelated party) exceeds the exercise price paid by the participant for such ISO Stock. A participant would also recognize capital gain to the extent the amount realized in the Disqualifying Disposition exceeds the fair market value of the ISO Stock on the exercise date. If the exercise price paid for the ISO Stock exceeds the amount realized (in the case of an arm’s-length disposition to an unrelated party), such excess would ordinarily constitute a capital loss.

 

Generally, we will not be entitled to any federal income tax deduction upon the grant or exercise of an incentive stock option, unless a participant makes a Disqualifying Disposition of the ISO Stock. If a participant makes a Disqualifying Disposition, we will then, subject to the discussion below under “Federal Income Tax Consequences — Tax Code Limitations on Deductibility,” be entitled to a tax deduction that corresponds as to timing and amount with the compensation income recognized by a participant under the rules described in the preceding paragraph.

 

Under current rulings, if a participant transfers previously held shares of common stock (other than ISO Stock that has not been held for the requisite holding period) in satisfaction of part or all of the exercise price of a nonqualified stock option or incentive stock option, no additional gain will be recognized on the transfer of such previously held shares in satisfaction of the nonqualified stock option or incentive stock option exercise price (although a participant would still recognize ordinary compensation income upon exercise of a nonqualified stock option in the manner described above). Moreover, that number of shares of common stock received upon exercise that equals the number of shares of previously held common stock surrendered in satisfaction of the nonqualified stock option or incentive stock option exercise price will have a tax basis that equals, and a capital gains holding period that includes, the tax basis and capital gains holding period of the previously held shares of common stock surrendered in satisfaction of the nonqualified stock option or incentive stock option exercise price. Any additional shares of common stock received upon exercise will have a tax basis that equals the amount of cash (if any) paid by the participant, plus the amount of compensation income recognized by the participant under the rules described above. If a reload option is issued in connection with a participant’s transfer of previously held common stock in full or partial satisfaction of the exercise price of an nonqualified stock option or incentive stock option, the tax consequences of the reload option will be as provided above for a nonqualified stock option or incentive stock option, depending on whether the reload option itself is a nonqualified stock option or incentive stock option.

 

The 2007 Plan allows the Compensation Committee to permit the transfer of awards in limited circumstances. See “Summary of the 2007 Plan — Transferability.” For income and gift tax purposes, certain transfers of nonqualified stock options and stock appreciation rights generally should be treated as completed gifts, subject to gift taxation.

The Internal Revenue Service (“IRS”) has not provided formal guidance on the income tax consequences of a transfer of nonqualified stock options (other than in the context of divorce) or stock appreciation rights. However, the IRS has informally indicated that after a transfer of stock options (other than in the context of divorce pursuant to a domestic relations order), the transferor will recognize income, which will be subject to withholding, and FICA/FUTA taxes will be collectible at the time the transferee exercises the stock options.

 

In addition, if a participant transfers a vested nonqualified stock option to another person and retains no interest in or power over it, the transfer is treated as a completed gift. The amount of the transferor’s gift (or generation-skipping transfer, if the gift is to a grandchild or later generation) equals the value of the nonqualified stock option at the time of the gift. The value of the nonqualified stock option may be affected by several factors, including the difference between the exercise price and the fair market value of the stock, the potential for future appreciation or depreciation of the stock, the time period of the nonqualified stock option and the illiquidity of the nonqualified stock option. The transferor will be subject to a federal gift tax, which will be limited by (i) the annual exclusion of $13,000 (for 2011) per donee, (ii) the transferor’s lifetime unified credit or (iii) the marital or charitable deduction rules. The gifted nonqualified stock option will not be included in the participant’s gross estate for purposes of the federal estate tax or the generation-skipping transfer tax.

 

This favorable tax treatment for vested nonqualified stock options has not been extended to unvested nonqualified stock options. Whether such consequences apply to unvested nonqualified stock options is uncertain, and the gift tax implications of such a transfer are a risk the transferor will bear upon such a disposition. The IRS has not specifically addressed the tax consequences of a transfer of stock appreciation rights.

 

Restricted Stock Awards; Restricted Stock Units; Cash Awards.  A participant will recognize ordinary compensation income upon receipt of cash pursuant to a cash award or, if earlier, at the time the cash is otherwise made available for the participant to draw upon. A participant will not have taxable income at the time of grant of a stock award in the form of restricted stock units denominated in common stock, but rather, will generally recognize ordinary compensation income at the time he receives cash or common stock in settlement of the restricted stock units in an amount equal to the cash or the fair market value of the common stock received. In general, a participant will recognize ordinary compensation income as a result of the receipt of common stock pursuant to a restricted stock award in an amount equal to the fair market value of the common stock when such stock is received; provided that, if the stock is not transferable and is subject to a substantial risk of forfeiture when received, a participant will recognize ordinary compensation income in an amount equal to the fair market value of the common stock (i) when the common stock first becomes transferable or is no longer subject to a substantial risk of forfeiture, in cases where a participant does not make an valid election under section 83(b) of the Code, or (ii) when the common stock is received, in cases where a participant makes a valid election under section 83(b) of the Code.

 

A participant will be subject to withholding for federal, and generally for state and local, income taxes at the time he recognizes income under the rules described above for common stock or cash received. Dividends that are received by a participant before the common stock is taxed to the participant under the rules described in the preceding paragraph are taxed as additional compensation, not as dividend income. The tax basis in the common stock received by a participant will equal the amount recognized by him as compensation income under the rules described in the preceding paragraph, and the participant’s capital gains holding period in those shares will commence on the later of the date the shares are received or the restrictions lapse.

 

Subject to the discussion immediately below, we or one of our subsidiaries (as applicable) will be entitled to a deduction for federal income tax purposes that corresponds as to timing and amount with the compensation income recognized by a participant under the rules described above.

 

Tax Code Limitations on Deductibility.  In order for the amounts described above to be deductible, such amounts must constitute reasonable compensation for services rendered or to be rendered and must be ordinary and necessary business expenses.

Our ability (or the ability of one of our subsidiaries, as applicable) to obtain a deduction for future payments under the 2007 Plan could also be limited by the golden parachute payment rules of Section 280G of the Code, which prevent the deductibility of certain excess parachute payments made in connection with a change in control of an employer-corporation.

 

Finally, our ability (or the ability of one of our subsidiaries, as applicable) to obtain a deduction for amounts paid under the 2007 Plan could be limited by Section 162(m) of the Code, which limits the deductibility, for federal income tax purposes, of compensation paid to “covered employees” of a publicly traded corporation to $1,000,000 for any such officer during any taxable year of the corporation. However, an exception applies to this limitation in the case of certain “performance-based compensation.” In order to exempt “performance-based compensation” from the $1,000,000 deductibility limitation, the grant or vesting of the award relating to the compensation must be based on the satisfaction of one or more performance goals as selected by the Compensation Committee. Performance-based awards intended to comply with Section 162(m) may not be granted in a given period if such awards relate to shares of common stock that exceed a specified limitation or, alternatively, the performance-based awards may not result in compensation, for a participant, in a given period that exceeds a specified limitation. If the material terms of the 2007 Plan are reapproved at the annual meeting, a participant who receives an award or awards intended to satisfy the “performance-based compensation” exception to the $1,000,000 deductibility limitation may not receive performance-based awards relating to more than 330,000 shares of common stock or, with respect to awards not related to shares of common stock, $5,000,000, in any given fiscal year. Although the 2007 Plan has been drafted to satisfy the requirements for the “performance-based compensation” exception, we may determine that it is in our best interests not to satisfy the requirements for the exception. See “Summary of the 2007 Plan — Awards under the 2007 Plan — Performance Awards.”

 

Requirements Regarding Deferred Compensation.  Certain of the benefits under the 2007 Plan may constitute “deferred compensation” within the meaning of Section 409A of the Code. Failure to comply with the requirements of Section 409A regarding the timing of payment distributions could result in the affected participants being required to recognize ordinary income for federal tax purposes earlier than expected, and being subject to substantial penalties.

 

The awards, if any, that will be made to eligible persons under the 2007 Plan are subject to the discretion of the Compensation Committee and, therefore, we cannot currently determine the benefits or number of shares subject to awards that may be granted in the future to our executive officers, employees and directors under the 2007 Plan. Therefore, a New Plan Benefits Table is not provided.

 

We made annual equity awards under the 2007 Plan in 2010 to the named executive officers, outside directors and to other eligible employees. The 2010 grants to the named executive officers are reflected in the “Grants of Plan-Based Awards for Year Ended December 31, 2010” table on page 42 of this proxy statement. The 2010 grants to outside directors are reflected in the Director Compensation Table on page 50 of this proxy statement. On April 13, 2011, the closing price of our common stock was $27.73 per share.

The following table sets forth, for the named executive officers and certain other groups, all shares underlying outstanding stock options awarded before December 31, 2010, under the 2007 Plan and the Prior Plan. No associate of any of the directors, named executive officers or nominees set forth below holds or has held options to purchase our common stock.

 

 

 

 

The reapproval of the material terms of the 2007 Plan to comply with the “performance-based compensation” exception of Section 162(m) of the Code requires the affirmative vote of the holders of a majority of the shares of common stock present in person or by proxy and entitled to vote on the matter.

 

The Board believes that the reapproval of the material terms of the 2007 Plan for purposes of Section 162(m) is essential to our continued success. For the reasons stated above, the stockholders are being asked to approve this proposal.

 

The Board recommends a vote “FOR” the reapproval of the material terms of the 2007 Plan to comply with Section 162(m) of the Code.

 

The Audit Committee of the Board has appointed Hein & Associates LLP (“Hein”) as the independent registered public accounting firm to audit our consolidated financial statements as of and for the fiscal year ending December 31, 2011, and our internal controls over financial reporting as of December 31, 2011. Hein has served as our independent registered public accounting firm since 2005 and has provided us certain audit-related services during that time. Hein also provided us certain tax services through 2008. Representatives of Hein are expected to be present at the annual meeting to respond to appropriate questions from stockholders and will be given the opportunity to make a statement if they desire to do so.

The submission of this matter for approval by stockholders is not legally required; however, the Board and Audit Committee believe that such submission is consistent with best practices in corporate governance and is an opportunity for stockholders to provide direct feedback to the Board and Audit Committee on an important issue of corporate governance. If the appointment is not ratified, the Audit Committee will consider whether it should select another independent registered public accounting firm.

 

The affirmative vote of a majority of the shares of our common stock present in person or by proxy and entitled to vote on the matter is required for the ratification of the appointment of Hein & Associates LLP as our independent registered public accounting firm for fiscal year 2011.

 

The Board recommends a vote “FOR” the ratification of the appointment of Hein & Associates LLP as our independent registered public accounting firm for the fiscal year 2011.

 

As of the date of this proxy statement, our Board has seven directors and two committees, the Audit Committee and the Compensation and Nominating Committee. Our Board is classified into three classes of directors, each serving staggered, three-year terms. As a result, stockholders will elect a portion of our Board each year. The current terms of Class I, Class II and Class III directors expire at the annual meeting of stockholders in 2011, 2012 and 2013, respectively. Our bylaws provide that the Board will consist of at least three but not more than nine directors, and the exact number of directors that make up the Board will be fixed from time to time by resolution of the Board. No decrease in the number of directors may shorten the term of any incumbent director.

 

During 2010, our Board held 10 meetings. The independent directors met two times in executive session during 2010. Each director attended at least 75% of the meetings of the Board.

 

Our Board currently separates the roles of Chairman of the Board and Chief Executive Officer (“CEO”). The Board believes that the functions of the Chairman of the Board are distinct from those of the CEO. The Board believes that, although these functions may be fulfilled by a single individual, separation of the positions currently serves to enhance the Board’s oversight of, and independence from, management. Our Board does not have a written policy regarding the separation of the positions of Chairman and CEO, and may modify this structure in the future to best address circumstances as appropriate.

 

Assessing and managing risk is the responsibility of the management of the Company. However, the Board has an active role, as a whole, and also at the committee level, in overseeing management of the Company’s risks. The Board regularly reviews information regarding the Company’s credit, liquidity and operations, as well as the risks associated with each.

 

Under its charter, the Audit Committee reviews and discusses with management the Company’s major financial risk exposures and the steps management has taken to monitor and control such exposures, including the Company’s risk assessment and risk management policies. In addition, the Audit Committee oversees risks related to the Company’s financial statements, the financial reporting process, accounting, tax and legal matters as well as liquidity risks and guidelines, policies and procedures for monitoring and mitigating risks.

The Audit Committee meets regularly in executive session without the Company’s independent registered public accounting firm and without management. Members of the Audit Committee routinely attend meetings of the Company’s Disclosure Committee, which meets before the Company files quarterly and annual financial reports with the SEC. In addition, the Audit Committee reviews and discusses with management and the Company’s independent registered public accounting firm any major issues as to the adequacy of the Company’s internal controls, any special steps adopted in light of material control deficiencies and the adequacy of disclosures about changes in internal control over financial reporting. The Audit Committee also meets with our internal controls, Sarbanes-Oxley compliance and enterprise risk management consultants, and, if applicable, reviews related-party transactions for potential conflicts of interest. Specifically relating to enterprise risk management during 2010-2011, the Company performed an enterprise risk assessment to identify key risks and assess procedures for managing, monitoring and mitigating risks. The Audit Committee met with management and the Company’s enterprise risk management consultant regarding this process.

 

The Compensation and Nominating Committee manages risks associated with executive compensation and the independence of the Board, and meets regularly in executive session without management. While each committee is responsible for evaluating certain risks and overseeing the management of such risks, the entire Board is regularly informed through committee reports about such risks.

 

Committee membership during the last fiscal year, number of meetings and the function of each of the committees are described below. Each of the committees operates under a written charter adopted and approved by our Board. Each of the committee charters is available under the Corporate Governance section of our website at www.approachresources.com and is available in printed form upon request by any stockholder.

 

 

 

 

Each committee member attended at least 75% of the meetings of each committee on which such member served.

 

We have an Audit Committee established in accordance with Section 10A-3 of the Exchange Act. Our Audit Committee is composed of Alan D. Bell, Chairman, James H. Brandi, James C. Crain and Christopher J. Whyte. Our Board has determined that all members of the Audit Committee satisfy the independence criteria applicable to Audit Committee members under NASDAQ and SEC rules and regulations. Additionally, the Board has determined that each member of the Audit Committee has accounting and related financial management expertise under NASDAQ rules. The Board has determined that Alan D. Bell, James C. Crain and Christopher J. Whyte are each “audit committee financial experts” as described in Item 407(d)(5) of Regulation S-K.

The Audit Committee oversees the annual audit and recommends to our Board the independent public accountants who audit our financial statements. The Audit Committee also approves any other services provided by public accounting firms. The Audit Committee assists our Board in fulfilling the Board’s oversight responsibility to the stockholders, the investment community and others relating to the integrity of our financial statements, our compliance with legal and regulatory requirements and the independent registered public accounting firm’s qualifications and independence. The Audit Committee oversees our system of disclosure controls and procedures and system of internal controls regarding financial, accounting, legal compliance and ethics that management and our Board have established. In doing so, it is the responsibility of the Audit Committee to maintain free and open communication between the Audit Committee, our independent registered public accounting firm and our management. For ease of reference in this proxy statement we may refer to the independent registered public accounting firm as our “accounting firm.”

 

Principal responsibilities of the Audit Committee under its charter include the following:

 

 

The Compensation and Nominating Committee (“Compensation Committee”) oversees our executive and director compensation and the Board nominees for election by stockholders. Our Compensation Committee is composed of James H. Brandi, Chairman, James C. Crain and Sheldon B. Lubar. Our Board has determined that all members of the Compensation Committee satisfy the independence criteria applicable to compensation committee members under applicable SEC and NASDAQ rules and regulations.

 

Principal responsibilities of the Compensation Committee under its charter include the following:

 

 

 

We are committed to sound corporate governance principles. Following such principles is essential to running our business efficiently and maintaining our integrity in the marketplace. Our corporate governance documents are available under the Corporate Governance section of our website at www.approachresources.com, and are available in print upon request by any stockholder to our Corporate Secretary, Approach Resources Inc., One Ridgmar Centre, 6500 West Freeway, Suite 800, Fort Worth, Texas 76116. The information on our website is not part of this proxy statement.

 

We have adopted a Code of Conduct that applies to all of our directors, officers and employees. The Code of Conduct is available under the Corporate Governance section of our website at www.approachresources.com. Any change to or waiver from our Code of Conduct may be made only by the Board or, in the case of any change in or waiver for any of our officers, by our independent directors. All changes and waivers will be disclosed as required by applicable SEC and NASDAQ rules and regulations.

 

The Board has determined that Mr. Brandi, Mr. Bell, Mr. Crain, Mr. Lubar and Mr. Whyte are independent within the meaning of applicable SEC and NASDAQ rules and regulations. Furthermore, the Board has determined that each of the current members of both the Audit Committee and the Compensation Committee is independent within the meaning of applicable SEC and NASDAQ rules and regulations.

 

In determining the independence of Board and committee members under applicable SEC and NASDAQ rules and regulations, the Board specifically considered Mr. Brandi’s position as a Managing Director of BNP Paribas (“Paribas”). Mr. Brandi became a Managing Director of Paribas in May 2010, after the acquisition by Paribas of Hill Street Capital, a financial advisory and private investment firm where Mr. Brandi was formerly a partner. In an unrelated transaction, Paribas became a party to our Credit Agreement in May 2010, after acquiring Fortis Capital Corp., a former member of our bank group. As a member of our bank group and party to our Credit Agreement, Paribas has committed to loan us 23.33% of our total borrowing base of $150 million and indirectly receives a proportionate share of the interest and fees that we pay to the bank group for maintaining our revolving credit facility. Mr. Brandi has no direct or indirect material interest in this transaction. After reviewing all of the relevant facts and circumstances of Mr. Brandi’s employment by Paribas and Paribas’s relationship with the Company, the Board determined Mr. Brandi to be independent under applicable SEC and NASDAQ rules and regulations regarding independence. The Board also determined that

Mr. Brandi would continue to qualify as an “outside director” under Section 162(m) of the Code and applicable regulations.

 

The policy of the Compensation Committee is to consider properly submitted nominations for candidates for membership on the Board. The Compensation Committee and Board seek individuals who are of high ethical character and who share our values.

 

The Compensation Committee and the Board also seek individuals with a diversity of professional experiences, including chief executive officers and other operating executives, investment and finance professionals, attorneys and individuals with experience or advanced degrees in public accounting. Other criteria that the committee will use to evaluate director nominees are:

 

 

The Compensation Committee has no specific policy on diversity. However, the committee does not discriminate on the basis of race, gender, age or cultural background in identifying and nominating nominees for director. For purposes of consideration of diversity, the Compensation Committee and the Board include members with differences of viewpoint, professional experience, education, skills and other individual qualities and attributes.

 

The Compensation Committee may consider suggestions from many sources regarding possible candidates for nomination to the Board, including suggestions from management, directors and stockholders. For the deadlines for stockholder suggestions to the Compensation Committee of individuals to be considered for nomination as candidates to be elected at the 2011 annual meeting of stockholders, see “Submission of Stockholder Proposals and Other Deadlines for the 2011 Annual Meeting of Stockholders.” Any such suggestion should be sent to the Compensation Committee, c/o our Corporate Secretary, Approach Resources Inc., One Ridgmar Centre, 6500 West Freeway, Suite 800, Fort Worth, Texas 76116, together with the same information as that described in our bylaws for stockholder nominations made by the Board or management. The information should also include the name and address of the stockholder recommending the individual, the number of shares owned beneficially and of record by the stockholder, the suggested individual’s name and address, a description of all arrangements or understandings (if any) between the stockholder and the individual being suggested for the committee’s consideration, the information about the individual being suggested that would be required to be included in a proxy statement filed with the SEC and an indication of the individual’s willingness to be named as a nominee and to serve as a director if nominated by the committee and the Board. Possible candidates who have been suggested by stockholders are evaluated by the committee in the same manner as are other possible candidates. The committee has not retained a third-party search firm to identify candidates at this time but may do so in the future in its discretion.

 

Mr. Bell is our only nominee for director who is not a previously-elected director standing for re-election. Mr. Bell was introduced to the Company through the Company’s independent accounting firm. The Compensation and Nominating Committee evaluated Mr. Bell’s qualification to serve on the Company’s Board pursuant to its director nomination guidelines. In August 2010, Mr. Bell was recommended by the independent directors of our Compensation and Nominating Committee, and subsequently was unanimously appointed by the Board, to serve as a director of the Company.

 

Stockholders may send written communications to the Board, c/o our Corporate Secretary, Approach Resources Inc., One Ridgmar Centre, 6500 West Freeway, Suite 800, Fort Worth, Texas 76116. These communications will be compiled by the Corporate Secretary and promptly forwarded to the Board.

 

Our Board expects directors to attend the annual meetings of our stockholders. We have formalized this expectation in a written policy that has been approved by the Compensation Committee and the Board. All directors attended the last annual meeting of stockholders either in person or by telephone.

 

Section 16(a) of the Exchange Act requires our directors, officers and persons who beneficially own more than 10% of our common stock to file initial reports of ownership on Form 3 and reports of changes of ownership on Forms 4 and 5 with the SEC. These officers, directors and 10% beneficial owners are also required to furnish us with copies of all Section 16(a) forms that they file. Specific due dates for these reports have been established by regulation, and we are required to report in this proxy statement any failure to file by these dates in 2010.

 

We are aware that a Form 4 was not timely filed on behalf of each of James H. Brandi, James C. Crain, Sheldon B. Lubar and Christopher J. Whyte for grants of restricted shares that they elected to receive as of April 1, 2010, as part of their respective annual director compensation. A Form 4 for each of these directors was filed on April 30, 2010. Based solely on our review of reports and written representations that we have received during the year ended December 31, 2010, we believe that all other required reports were timely filed.

 

The following table sets forth, as of April 13, 2011, beneficial ownership of our common stock by our directors, the executive officers named in the Summary Compensation Table in this proxy statement, all directors and executive officers as a group and all persons who were known to us to be the beneficial owners of more than 5% of our outstanding shares:

 

 

 

 

 

The number of shares beneficially owned also includes 4,154 restricted shares issued to William S. Buckler, III, in connection with his employment as Vice President — Engineering on April 5, 2011.

 

 

 

The following table sets forth the names, ages and positions of our executive officers.

 

 

J. Ross Craft has been our President and Chief Executive Officer and a member of our Board since our inception in September 2002. For Mr. Craft’s biographical information, please see “Proposal One — Election of Directors — Directors.”

 

Steven P. Smart joined us as Treasurer at our inception in September 2002. Mr. Smart was named Vice President — Finance in August 2005, and promoted to Executive Vice President and Chief Financial Officer in June 2007. From 2000 to 2002, Mr. Smart was Controller and Treasurer of Prize Energy Corp., a public exploration and production company. From 1998 to 2000, Mr. Smart was a Senior Manager in the Energy Industry group at Arthur Andersen LLP. Prior to 1998, Mr. Smart served in senior executive financial positions with several public and private oil and gas companies, including Magnum Hunter Resources Inc. and Saxon Oil Co. Mr. Smart began his career in public accounting with Deloitte & Touche (formerly Touche Ross). Mr. Smart has over 30 years of experience with both public and private companies in the oil and gas industry. Mr. Smart holds a B.B.A. in Accounting from Angelo State University and is a licensed Certified Public Accountant in the State of Texas.

 

J. Curtis Henderson joined us in February 2007 as Executive Vice President, General Counsel and Secretary. From 2005 to 2007, Mr. Henderson served as President and Chief Executive Officer of Coterie Capital Partners, Ltd., a private equity partnership in Dallas, Texas. From 1996 to 2005, Mr. Henderson served as General Counsel of Nucentrix Broadband Networks, Inc., a public, broadband wireless telecommunications company based in Dallas. While he was at Nucentrix, Mr. Henderson oversaw its sale to an affiliate of Nextel Communications Inc. under Section 363 of the United States Bankruptcy Code in 2004. Mr. Henderson began his career as a lawyer in the corporate and securities section of Locke Lord Bissell & Liddell (formerly Locke Purnell Rain Harrell). Mr. Henderson has over 23 years of experience in public and private securities, mergers and acquisitions, corporate finance and regulatory affairs. Mr. Henderson holds a B.A. in Political Science from Austin College and a J.D. from Washington and Lee University School of Law, where he served as Articles Editor of the Washington and Lee Law Review. Mr. Henderson is the brother-in-law of J. Ross Craft, our CEO and President.

 

Qingming Yang joined us in July 2009 as Vice President — Exploration. In November 2010, Dr. Yang was named Executive Vice President — Business Development and Geosciences. Dr. Yang has over 25 years of domestic and international exploration, technical and operating experience in the oil and gas industry. Before joining Approach, Dr. Yang was employed by Pioneer Natural Resources for 12 years in a variety of positions, including Exploration Manager for Worldwide Exploration and Business Development, Geosciences Advisor and Technical Lead for Pioneer’s Eagle Ford Shale team. Dr. Yang is a member of American Association of Petroleum Geologists (AAPG) and served as an Associate Editor for the AAPG Bulletin from 2003-2009. In addition, Dr. Yang was Chairman of Dallas Geological Society International Committee in 2002. Dr. Yang earned his B.S. in Petroleum Geology from Chengdu University of Technology in the People’s

Republic of China, his M.A. in Geology from George Washington University and his Ph.D. in Structural Geology from the University of Texas at Dallas.

 

Ralph P. Manoushagian joined us in February 2004 as Land Manager. Mr. Manoushagian was named Senior Vice President — Land in June 2007 and Executive Vice President — Land in June 2008. In 2003, Mr. Manoushagian worked as an independent landman. From 2001 to 2003, Mr. Manoushagian was the President of Hudco Fuels, a privately-owned fuel distributorship. Mr. Manoushagian has been an active landman and oil and gas operator for over 30 years. Mr. Manoushagian holds a B.B.A. in Finance from the University of North Texas and has been a Certified Professional Landman since 1988. Mr. Manoushagian is a director of the First Financial Bank of Southlake, Texas. He previously served as a director and Vice President of the Texas Independent Producers and Royalty Owners and as a director of the Texas Alliance of Energy Producers.

 

William S. Buckler, III joined us in April 2011 as Vice President — Engineering. Mr. Buckler has over 26 years of operating and engineering experience in the oil and gas industry. Before joining Approach, Mr. Buckler was employed by Chief Oil & Gas LLC as Senior Vice President — Operations and Engineering from 2008 to 2011. While at Chief, Mr. Buckler managed the engineering, operations and procurement departments for Chief’s Barnett Shale and Marcellus Shale operations. From 2003 to 2008, Mr. Buckler was employed by Quicksilver Resources Inc. as Vice President — U.S. Operations. Prior to Quicksilver, Mr. Buckler served as Fort Worth Basin Operations and Engineering Supervisor for Mitchell Energy from 1997 to 2003. Mr. Buckler holds a B.S. in Petroleum Engineering from Texas A&M University and is a registered Professional Engineer licensed in Texas. Mr. Buckler is a member of the Society of Petroleum Engineers and of the Board of Directors of the Fort Worth Petroleum Club.

 

The following compensation discussion and analysis contains statements regarding future Company performance goals and measures. These goals and measures are disclosed in the limited context of the Company’s incentive compensation program and are not statements of management’s expectations or estimates of results or other guidance. The Company specifically cautions investors not to apply these statements to other contexts. Throughout this proxy statement, the individuals who serve as our CEO and Chief Financial Officer (“CFO”) as well as the other three most highly compensated individuals included in the Summary Compensation Table in this proxy statement, are referred to as our “named executive officers” or “executive officers.”

 

The following discussion and analysis is intended to assist you in understanding our compensation program. It is intended to cover all the elements of compensation paid to our named executive officers and the reasoning used by the Compensation Committee in structuring our executive compensation program, which is designed primarily to incentivize our named executive officers to build long-term stockholder value.

 

We believe our success depends on the continued contributions of our named executive officers. Our executive compensation programs are designed with the philosophy of attracting, motivating and retaining experienced and qualified executive officers and directors with compensation that is competitive with comparable public companies and that recognizes both overall business and individual performance. Our policies are also intended to support the achievement of our strategic objectives by aligning the interests of our executive officers with those of our stockholders through operational and financial performance goals and equity-based compensation.

 

The three principal elements of our current executive compensation programs are annual base salary, annual incentive bonuses and long-term equity incentives in the form of stock-based awards under our 2007 Plan. Base salary is annual salary that pays for skill and experience and is required for market competitiveness. Annual incentive bonuses are annual, cash performance awards for achievement of then-current business goals. Long-term equity incentives are stock-based awards that provide a competitive, long-

term incentive to employees and named executive officers in direct alignment with stockholder interests. We also have employment agreements with our executive officers that contain employment terms, severance and change in control provisions. We believe these agreements are important to retain qualified executives in a competitive market for executive talent.

 

We seek to pay our executive officers for performance, closely align the interests of our executive officers with the interests of our stockholders and attract, retain and motivate top executive talent. Below is a summary of our key performance results, achievements and compensation decisions in 2010. In reporting our financial and operating results, natural gas is converted at a rate of six thousand cubic feet (“Mcf”) of natural gas to one barrel of oil equivalent (“BOE”), natural gas liquids (“NGLs”) are converted at a rate of one barrel of NGLs to one BOE and oil and NGLs are converted at a rate of one barrel to six Mcf of gas equivalent (“Mcfe”). Amounts in $ per Boe are converted to amounts in $ per Mcfe at a rate of six to one ($0.06 per Boe equals $0.01 per Mcfe).

 

Our Performance in 2010.  We achieved strong operational and financial results and stockholder returns during 2010. Our executive officers were instrumental in helping us achieve these results. Key 2010 financial and operational results and stockholder returns that were instrumental in our compensation decisions are included below. Comparisons are to the prior year 2009.

 

 

F&D cost and EBITDAX are non-GAAP financial measures. Reconciliation to our audited financial statements and other information on non-GAAP financial measures used in this proxy statement can be found following our annual report on Form 10-K that is being sent with this proxy statement. In addition, we describe how we calculate EBITDAX, F&D costs and drill-bit F&D costs from our audited financial statements and related notes on pages 33, 36 and 33, respectively, of this proxy statement.

 

Three-Year Stockholder Returns.  Our compensation policies are designed to focus our executive officers on the creation of long-term growth in stockholder value. The following graph compares the cumulative return on a $100 investment in our common stock from December 31, 2007, through December 31, 2010, to that of the cumulative, average return on a $100 investment in the Standard & Poor’s 500 (“S&P 500”) index, the Dow Jones U.S. Exploration & Production Total Stock Market (“E&P”) index and a group of our peer companies for the same period. We discuss our peer group below under “— Use of Peer Group Comparisons.” In addition to the peer group discussed below under “— Use of Peer Group Comparisons,” and for purposes of comparing stockholder returns in the graph below, we also include the following peers based on their emphasis

on oil and NGL production: Berry Petroleum Company, Concho Resources Inc., Kodiak Oil & Gas Corp., Northern Oil & Gas, Inc., Oasis Petroleum Inc., Petroleum Development Corporation and Sandridge Energy, Inc. In calculating the cumulative return, reinvestment of dividends, if any, is assumed. This graph is not “soliciting material,” is not deemed filed with the SEC and is not to be incorporated by reference in any of our filings under the Securities Act of 1933 as amended (the “Securities Act”) or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing. This historic stock performance is not indicative of future stock performance.

 

 

Annual Base Salaries.  Since we became a public company in 2007, we have attempted to provide our executive officers with annual base salaries that are competitive with industry peers, particularly in the Dallas — Fort Worth, Texas area, and that are at levels that we believe will allow us to retain our executive officers, with the goal of growing stockholder value. After challenging economic and industry conditions in 2008 and 2009, we did not materially increase salaries for the majority of our executive officers in 2009 and 2010. Annual base salaries for our named executive officers in 2010 ranged from $187,000 for Mr. Manoushagian to $312,500 for Mr. Craft. After strong operating and financial results and stockholder returns in 2010, we increased the range of annual base salaries for our executive officers to $200,000 for Mr. Manoushagian to $400,000 for Mr. Craft for 2011. More detailed information is provided below under “— Elements of the Company’s Executive Officer Compensation Program — Annual Base Salary.”

 

Performance-Based Annual Cash Incentive Plan.  Since 2008, we have provided our executive officers with annual cash incentive bonus opportunities under which we make payments based on the Company’s achievement of annual financial and operating measures that we believe are essential measurements of Company performance and cost control, and on each executive officer’s individual performance. For 2010, Company performance measures of production, reserves and EBITDAX per share growth, lease operating/general and administrative expense and drill-bit F&D costs represented 75% of each executive officer’s total bonus opportunity. Individual performance represented 25% of total bonus opportunity. Threshold and maximum bonus targets ranged from 35% — 75% of annual salary for Mr. Manoushagian and Dr. Yang to 50% — 150% of annual salary for Mr. Craft. Final incentive awards for 2010 ranged from $56,100 for Mr. Manoushagian to $187,500 for Mr. Craft. Consistent with our past practice, we have provided our executive officers with a cash incentive bonus opportunity based on substantially the same performance measures and target levels for 2011. More detailed information is provided below under “— Elements of the Company’s Executive Officer Compensation Program — Performance-Based Annual Incentive Awards.”

 

Long-Term Equity Incentives.  In 2010, we changed the long-term equity incentive component of our compensation program to further link our executives’ pay to performance and align their interests with those

of our stockholders. In 2010, we granted our executive officers performance-based, long-term incentive restricted stock (“LTI”) awards, totaling 400,000 shares of restricted stock, or 1.8% of our weighted average shares of common stock outstanding in 2010. The LTI awards must first be earned based on the Company’s achievement of annual performance measures that we believe are strongly correlated to building stockholder value. The awards are then subject to multi-year, time-based vesting to encourage retention of our key executive officers. The applicable annual performance measures are reserves growth, F&D cost and debt-to-EBITDAX ratio in the performance year of 2010. If all performance measures are met, then the earned LTI awards will vest ratably over four years following the performance year 2010. LTI awards in 2010 ranged from 60,000 shares each for Mr. Manoushagian and Dr. Yang, to 120,000 shares for Mr. Craft. Because of Dr. Yang’s role in undertaking our study of the Wolffork oil shale under our Permian Basin acreage and beginning a pilot drilling program, as well as our goal of retaining Dr. Yang in a competitive market for executive and technical talent, we also granted Dr. Yang an additional award of 35,000 shares of time-vesting, restricted stock in 2010. After strong operating and financial results and stockholder returns in 2010, in 2011 we granted our executive officers LTI awards totaling 204,000 shares of restricted stock, or 0.9% of our weighted average shares of common stock outstanding in 2010, tied to substantially the same performance measures and vesting dates as the 2010 LTI awards. More detailed information is provided below under “— Elements of the Company’s Executive Officer Compensation Program — Long-Term Incentive Stock Compensation.”

 

As discussed above, the primary objectives of our executive compensation programs are as follows:

 

 

To accomplish these objectives, we intend to provide a competitive total compensation package. Base salaries and total compensation are intended to be competitive with our industry peers, considering individual performance and experience, to ensure that each executive officer is appropriately compensated.

 

Role of the Compensation Committee

 

Our Compensation Committee is responsible for the approval, evaluation and oversight of all of our executive officer, director and stock incentive compensation plans, policies and programs. The Compensation Committee also reviews annual base salaries and bonuses for non-executive employees. For ease of reference in this Compensation Discussion and Analysis section of the proxy statement, we may sometimes refer to this committee simply as our Compensation Committee or the committee. The members of our Compensation Committee are James H. Brandi (Chairman), James C. Crain and Sheldon B. Lubar, each of whom is an independent director under applicable SEC and NASDAQ rules and regulations. The committee held six meetings in 2010. In addition, committee members speak frequently with each other concerning compensation matters outside of regularly-scheduled meetings. As Chairman of the committee, Mr. Brandi regularly reports to the full Board regarding compensation matters.

 

The committee meets outside the presence of all of our named executive officers to consider the appropriate compensation for our CEO. The committee analyzes the performance of our CEO and determines his base salary, individual performance portions of our annual incentive program and any grant of LTI or other equity-based awards. For all other executive officers, the committee meets outside the presence of all executive officers, except our CEO. Our CEO annually reviews the performance of each executive officer with the committee and makes recommendations to the committee on the appropriate base salary, payments to be

made under any individual performance portion of our annual incentive program and any grant of LTI or other equity-based awards. Our CEO has no role in determining his own compensation.

 

Based in part on these recommendations from our CEO for non-CEO executive officers, and the other considerations discussed in this Compensation Discussion and Analysis, the committee recommends to the Board the annual compensation package of each of our named executive officers, including our CEO. Input or suggestions applicable to group or individual compensation from other executive officers may be solicited by the committee.

 

The function of the Compensation Committee is more fully described in its charter, which is available under the Corporate Governance section of our website at www.approachresources.com. The information on our website is not part of this proxy statement. The committee’s duties and purpose also are discussed under “Board of Directors, Board Meetings and Committees — Compensation and Nominating Committee” in this proxy statement.

 

Use of Oil and Gas E&P Compensation Survey

 

In considering executive compensation matters for 2010 and 2011, the Compensation Committee consulted the Oil and Gas E&P 2009 and 2010 Compensation Surveys, respectively, prepared by Effective Compensation, Inc. (“ECI”). The 2009 ECI survey contains compensation information from 119 public and private E&P companies in the United States from 2008 and 2009. The 2010 ECI survey contains compensation information from 121 public and private E&P companies in the United States from 2009 and 2010. The 2009 and 2010 ECI surveys provide specific data on an aggregated basis within subcategories based on whether companies are public or private, revenues, exploration and production budget and geographic location, among others. In addition to the individual experience and performance of our executive officers, the committee considered compensation information in the 2009 and 2010 ECI surveys from public, independent oil and gas companies and public and private oil and gas companies that are headquartered in Texas, in making decisions regarding 2010 and 2011 compensation for our named executive officers. The committee considers ECI survey data relevant to, but not determinative of, the committee’s consideration of overall executive compensation matters.

 

Use of Peer Group Comparisons

 

For 2010 executive compensation matters, the Committee also considered compensation data from the following peer group of companies:

 

 

The Compensation Committee reviews the peer group annually. For 2010, the committee added peer group data provided by management from Carrizo Oil & Gas, NGAS Resources, Rex Energy and Rosetta Resources. These companies were added to the 2010 peer group for consideration by the committee based on the companies’ positions in the upstream E&P sector of the oil and gas business, reserve base, year-end reserves, capital budgets and market capitalizations. For 2010, the committee did not consider compensation data from previous peers Parallel Petroleum Corporation and TXCO Resources, Inc., as Parallel terminated its public filings and was sold in 2009, and TXCO filed for relief under Chapter 11 of the U.S. Bankruptcy Code in 2009 and agreed to sell a substantial portion of its assets in 2010. The committee considers peer group data relevant to, but not determinative of, the committee’s consideration of overall executive compensation matters.

 

Role of Compensation Consultant

 

In February 2009, the Compensation Committee retained Longnecker & Associates (“L&A”) as an independent compensation consultant to review the Company’s executive and director compensation programs

and the Company’s compensation peer group. In January 2010, at management’s request, L&A provided the committee with supplemental information on the then-current E&P compensation market and employment agreement trends. The committee considered the information provided by L&A relevant, but not determinative, in the committee’s evaluation and oversight of the compensation programs.

 

Annual Base Salary

 

We provide our named executive officers with an annual base salary to compensate them for their services during the year. Although we have no written policies or guidelines for setting the base salaries of our executive officers within a specified range of the compensation levels of our industry peers, our executive officer salaries are intended to be competitive with our industry peers. Our Compensation Committee recognizes that a substantial amount of competition exists in the oil and gas industry for attracting and retaining qualified management teams, particularly in the Dallas — Fort Worth, Texas area. Our philosophy is to set our executive officers’ base salaries at levels that we believe will enable us to retain them, with the goal of growing stockholder value going forward.

 

We review salary ranges and individual salaries for our executive officers annually. We establish the base salary for each executive officer based on consideration of pay levels of our industry peers and business requirements for certain skills, individual experience and contributions, the roles and responsibilities of the executive and other factors. We believe competitive base salaries are necessary to attract and retain an executive management team with the appropriate abilities and experience required to lead us.

 

2010 Annual Base Salaries

 

For 2010, the committee did not establish benchmarks. Rather, the committee reviewed comparable base salary levels and incentive bonus targets from both the ECI 2009 survey and peer company data to determine the relative competitiveness of the Company’s compensation structure. As there was no material change in the annual base salaries from January 2008 through December 2009, effective January 1, 2010, the committee approved a 3% increase in annual base salaries for the named executive officers for 2010, except for Mr. Manoushagian, who received an increase of 10%, and Dr. Yang, whose salary was held flat. Mr. Manoushagian’s increase in annual base salary for 2010 was based on individual performance and the CEO’s recommendation and committee’s decision to make his salary more competitive with annual salaries of industry peers based on the 2009 ECI survey. Dr. Yang’s 2010 annual base salary was unchanged, as his salary had been recently set in July 2009 when he was initially hired. The Committee believed that a 3% increase in annual base salary for Mr. Craft, Mr. Smart and Mr. Henderson was appropriate as such an increase was slightly more than the cumulative rate of inflation of 2.3% from January 2008 through December 2009, based on the U.S. Department of Labor’s Bureau of Labor Statistics Consumer Price Index. Annual base salaries for 2010 are set forth below:

 

 

2011 Annual Base Salaries

 

For 2011 annual salaries, the committee considered peer data from the 2010 ECI survey and determined that an overall increase in the base salaries of our named executive officers was appropriate to achieve the committee’s objective of retaining top executive talent in a competitive industry and geographic region. The

committee also considered past salary adjustments for the executive officers since 2008, stockholder returns in 2010, the Company’s 2010 financial and operational results noted above in “Our Performance in 2010,” the contributions of individual executive officers to those results and the recommendations of the CEO for non-CEO named executive officers. The committee determined that the salaries of Mr. Craft and Dr. Yang required the largest percentage increases to move their salary levels to more competitive industry levels and as a result of their specific contributions to the Company’s 2010 operating results.

 

Accordingly, the committee recommended, and the Board approved, increases in 2011 annual base salaries for the Company’s named executive officers as follows effective January 1, 2011:

 

 

Performance-Based Annual Incentive Awards

 

A core component of our executive compensation philosophy is that pay should be linked directly to performance and that a significant portion of total annual compensation should be placed at risk. In 2008, we began providing the opportunity for our executive officers to earn an annual, performance-based, cash incentive award. We plan to continue to provide this opportunity to attract and retain an appropriate caliber of talent for these positions and to motivate executives to achieve our annual business goals. We review annual incentive awards for our named executive officers annually in the first 90 days of our fiscal year to determine award payments for the most recently completed fiscal year, and to establish award opportunities for the then-current fiscal year.

 

2010 Annual Incentive Plan Overview

 

Consistent with our philosophy of linking pay directly to performance, our Compensation Committee adopted, and our Board ratified, a performance-based incentive award program for 2010 pursuant to which cash performance awards were made under our 2007 Plan. We refer to these cash performance awards as annual incentive awards.

 

The Compensation Committee developed performance categories, relative weighting among the performance categories and targets to be used for the 2010 annual incentive plan, and reviewed them with our CEO, CFO and General Counsel, except for incentive targets for our CEO, which the committee determines independent from the CEO and other executive officers. The committee adopted the applicable metrics in January 2010. The 2010 annual incentive awards were expressed as a percentage of an executive officer’s annual base salary and were paid to the executive officer upon the achievement of certain performance targets, plus an amount that, in the committee’s discretion, was awarded to named executive officers based on individual performance, including overall duties, responsibilities and expertise.

 

The committee established a minimum, or “threshold,” and maximum, or “excellent,” performance target for each performance category. The Company is required to reach the threshold target in a performance category before a participant receives any credit for such category in the calculation of his annual incentive award. If the Company exceeds the threshold level for a performance category, the amount of the annual incentive award attributable to that category is capped at the excellent level. If actual results fall between the threshold and excellent performance levels, the percentile performance used to determine the payout percentage is proportionally adjusted in accordance with a predetermined formula that measures performance on a linear, pro-rata basis between the threshold and excellent levels.

The committee cannot increase payout amounts under performance categories that depend on the achievement of specific targets, as payments related to performance categories that are tied to the achievement of specific targets are capped once the highest target level is achieved. The committee can, in its reasonable discretion, reduce the payout amounts for these performance categories after taking into account special or unusual factors that may have contributed to the achievement of target performance measures such as acquisitions, commodity prices or other factors considered appropriate by the committee.

 

In addition to the performance categories tied to specific company targets, the committee approved an individual performance category for 2010 that allows the committee, in its discretion, to allocate a portion of an officer’s annual incentive award based on the officer’s individual performance, including overall duties, responsibilities and expertise.

 

2010 Annual Incentive Plan Targets and Performance Categories

 

For 2010, the committee approved, after consultation with our CEO, a 2010 annual incentive plan with annual incentive targets (expressed as a percentage of an executive’s annual salary) for each of our named executive officers except for our CEO, for whom the committee determined incentive targets without consultation with the CEO. As in 2009, the committee attempted to ensure that the payouts provided meaningful incentive to each of our executive officers. For 2010, the annual incentive targets for our named executive officers are as set forth in the following table. These incentive targets assume that the “threshold” or “excellent” targets, as applicable, are met for each of the six performance categories discussed below:

 

 

The six performance categories for the 2010 annual incentive plan are shown in the table below, together with the target levels of achievement, weight given to each category and actual results achieved in 2010 in each category. Five of the performance categories are Company-wide performance measures and the sixth performance category, individual performance, is personal to each executive officer and is determined in the committee’s discretion.

 

 

 

 

Seventy-five percent of the amount of potential 2010 annual incentive bonuses continued to be determined by objective, Company performance results. However, growth and cost performance targets are based on forecasts that are subject to ongoing change depending on external factors such as commodity prices

and oilfield service costs. Therefore, the committee believes it was appropriate to also include a discretionary, individual performance measure representing 25% of the executive officers’ bonus opportunity. Each of the five Company-wide performance measures is described in greater detail below.

 

Production and reserve volume growth are essential measurements of our performance. Production and reserves used in the calculation of these criteria are based on results we report in our annual report on Form 10-K.

 

We define EBITDAX per share as net (loss) income plus (i) exploration expense, (ii) impairment of unproved properties, (iii) depletion, depreciation and amortization expense, (iv) share-based compensation expense, (v) impairment of investment, (vi) unrealized (gain) loss on derivatives, (vii) interest expense and (viii) income taxes, divided by the weighted average number of shares of common stock outstanding for the applicable year, each as set forth in the audited financial statements of our annual report on Form 10-K. The committee has determined that EBITDAX per share is appropriate because it is widely accepted by the investment community as a financial indicator of a company’s ability to internally fund development and exploration activities and it reflects a company’s ability to adapt to the impact of changing commodity prices as well as oilfield service costs.

 

LOE and G&A per Mcfe is the sum of our annual lease operating expense (“LOE”), plus general and administrative expense (“G&A”), divided by our annual production as measured in Mcfe. LOE and G&A are two financial measures under GAAP from our audited financial statements. Our committee believes that, in addition to performance measures for growth, it is critical to incentivize management to control costs.

 

Drill-bit F&D costs are calculated by dividing the sum of annual exploration and development costs by the total of reserve extensions and discoveries for the applicable year end, each as set forth in the notes to the audited financial statements of our annual report on Form 10-K. The committee believes this measure is important to evaluate how efficiently we can add proved reserves through our own drilling program.

 

The committee believes that these performance categories and targets, taken together, are objective indicators of our overall performance.

 

The individual performance category is discretionary and allows the committee to recognize performance that is more difficult to quantify, such as successful supervision of significant company projects, cost reductions, demonstrated departmental leadership and other contributions to our Company. The committee is in regular contact with our CEO, is knowledgeable about Company operations and believes that it is in a position to accurately and fairly judge individual performance, with the specific recommendations of the CEO for the named executive officers other than the CEO, after year end.

 

2010 Annual Incentive Plan Awards

 

For 2010, the actual annual incentive award amount paid to each executive officer was based upon the Company’s performance in the five, Company-wide performance categories and the individual performance of each executive officer. As set forth above in the “2010 Actual Results” column of the table entitled “2010 Performance Targets,” the Company achieved the excellent target of the reserve volume growth performance category. No other threshold or excellent targets of Company performance categories were met and, as a result, no payments were made with respect to such categories. For individual performance, the committee determined to award the excellent targets of 18.75% to 37.5% of annual base salaries to the executive officers. In making this determination, the committee considered each of the named executive officer’s overall duties, responsibilities, expertise and individual contributions to the Company’s achievements in 2010 discussed on page 26 of this proxy statement.

 

After reviewing the above considerations, the Company’s 2010 results, performance of the CEO and the CEO’s recommendations on the performance of the other executive officers, the committee awarded the 2010 award percentages as set forth in the table below. The 2010 award percentage is the sum of the percentage performance results calculated for each performance category plus individual performance. The 2010 award

payments are also included in the Summary Compensation Table below under the “Non-Equity Incentive Plan Compensation” column for 2010.

 

 

 

 

2011 Annual Incentive Plan

 

For 2011, the Compensation Committee has established an annual incentive plan with annual incentive targets and performance measures that are substantially similar to the 2010 annual incentive plan. Threshold and excellent annual incentive targets (as a percentage of annual base salary) for 2011 are 50% and 150%, respectively, for Mr. Craft, and 50% and 100%, respectively, for each of our other named executive officers. As in the 2010 annual incentive plan, the committee established a minimum, or “threshold,” and maximum, or “excellent,” performance target for each performance category. The Company is required to reach the threshold target in a performance category before a participant receives any credit for such category in the calculation of his annual incentive award. If the Company exceeds the threshold level for a performance category, the amount of the annual incentive award attributable to that category is capped at the excellent level. If actual results fall between the threshold and excellent performance levels, the percentile performance used to determine the payout percentage is proportionally adjusted in accordance with a predetermined formula that measures performance on a linear, pro-rata basis between the threshold and excellent levels.

 

For 2011, the distinction between Executive Vice Presidents I and II and Vice Presidents was eliminated for our named executive officers in setting threshold and excellent levels for performance. In making this decision, the committee considered the promotion of Dr. Yang from Vice President to Executive Vice President — Business Development and Geosciences, the individual contributions of Dr. Yang and Mr. Manoushagian to Company achievements in 2010 discussed at page 26 of this proxy statement and issues of internal pay equity.

 

The six performance categories and relative weighting among the categories for 2011 are substantially the same as 2010, with adjustments for then-current business projections and our current reporting in BOE rather than Mcfe due to the increasing percentage of oil and NGLs in our production and reserve base. Compared to the 2010 incentive plan, the committee adjusted the 2011 plan performance measures by:

 

 

These adjustments reflect the Company’s focus on balancing cost control with growing oil and NGLs reserves and production during a time of escalating service costs and competition in the Permian Basin. The

six performance categories selected for the 2011 annual incentive plan are shown in the table below, together with the target levels of achievement and weight given to each category.

 

 

 

 

The committee’s general policy is to determine any payout amounts for annual incentive awards before March 15 of the following year based upon our performance against the performance measures established by the committee and the committee’s determinations with respect to the individual performance component of the awards, subject to the committee’s discretion to reduce the payout amounts after taking into account special or unusual factors that may have contributed to the achievement of target performance measures such as acquisitions, commodity prices or other factors considered appropriate by the committee.

 

Long-Term Incentive Stock Compensation

 

We use LTI equity grants to attract, retain and motivate our executive officers as part of our total compensation package. Stock incentive awards are granted under our 2007 Plan. The 2007 Plan allows for the grant of restricted stock, stock options, stock appreciation rights, restricted stock units, stock awards and other incentive awards. The primary purpose of the 2007 Plan is to attract and retain highly qualified officers, directors, key employees and other persons, and to motivate these persons to improve our business results by providing an opportunity to acquire or increase a direct, proprietary interest in our operations and future success. We expense stock awards under FASB ASC Topic 718, formerly Statement of Financial Accounting Standards No. 123(R), Share-Based Payments.

 

Since our IPO in 2007, the committee has generally used restricted stock that vests over three to four years to align the compensation of our executive officers with an increase in long-term stockholder value. We believe awards of restricted stock can effectively balance our objective of focusing the recipient of the award on delivering long-term value to our stockholders with our objective of providing value to the recipient with the equity awards. Restricted stock awards offer recipients the opportunity to receive shares of our common stock that are subject to a risk of forfeiture and other restrictions until certain specified service or performance requirements are satisfied. In this regard, we believe that restricted stock serves both to reward and retain the recipients. Restricted stock awards also allow the Company to budget for charges to earnings under FASB ASC Topic 718 with greater certainty than other types of awards such as stock options. Recipients of restricted stock awards are entitled to receive and retain all cash dividends that may be paid with respect to the shares. The committee does not make, nor has the committee in the past made, incentive stock grants in coordination with the release of material, non-public information. Instead, the committee will grant equity awards at the time or times dictated by our normal compensation process as that process is developed by the committee.

2010 LTI Performance-Based Stock Awards

 

In February 2010, in keeping with its philosophy of linking pay to performance, the committee began meeting to consider an annual, performance-based, time-vesting LTI stock award program. The committee met several times through July 2010 to discuss appropriate performance measures and vesting requirements for these awards.

 

In determining whether, and in what amounts, to grant a 2010 award, the committee considered stock ownership and award data from the 2010 ECI survey, committee members’ own experience and knowledge of executive compensation matters at other public E&P companies (including such experience and knowledge with respect to grant date fair value of stock awards as a multiple of base salary), the potential dilutive effect of stock awards, the charge to Company earnings under FASB ASC Topic 718, internal pay equity among our executives and the then-current economic and market environment. The committee also considered existing stock ownership of our executive officers and the importance of retention and alignment of objectives with stockholders’ interests as goals of any effective long-term incentive stock award grant. The committee also reviewed the number of shares available for grant under the 2007 Plan and the Company’s prior annual “burn rate,” or percentage of weighted average shares outstanding granted under the Plan in each of the Plan’s prior years. At the time of the 2010 grant in August 2010, there were approximately 1,135,842 shares available for grant under the 2007 Plan, or 54.2% of the total shares available for grant under the 2007 Plan, and the Company’s average three-year annual burn rate was 2.23%. The committee also considered the individual performance of the CEO and the recommendations of the CEO regarding the individual performance of the executive officers other than the CEO. In determining the amounts of the 2010 LTI awards, the committee did not establish benchmarks. Rather, the committee took into consideration all of the above factors to determine the appropriate levels of LTI stock awards.

 

In determining performance and vesting measures appropriate for the award, the committee considered a number of potential measures and vesting schedules, including the proportion of any award that should be tied to performance compared to time vesting. In determining performance measures, the committee sought to achieve a balance of measures that would encourage growth, cost control and financial stability.

 

After considering all of the factors discussed above, the committee decided on a total 2010 LTI stock award of 400,000 shares of restricted stock to our executive officers, subject to the following performance measures and time vesting restrictions.

 

First trigger:  Satisfaction of the following performance measures during the applicable performance period (fiscal year 2010):

 

 

Second trigger:  If all of the performance measures in the first trigger are met during the performance period (fiscal year 2010), then 1/3 of each individual’s restricted shares will ratably vest on December 31, 2012, 2013, and 2014, provided the executive officer is employed by the Company on the applicable vesting dates.

 

Performance measures defined.  Proved reserves are estimated proved reserves as determined by the Company’s independent reserve engineering firm. F&D costs are calculated by dividing the sum of property acquisition, exploration and development costs by extensions, discoveries, acquisitions and revisions (excluding price revisions), each as set forth in the notes to the audited financial statements of our annual report on Form 10-K. The committee determined to exclude price revisions from F&D cost to mitigate the risk of volatile commodity price swings, which are outside the executives’ control. Long-term debt is calculated under GAAP and included in the Company’s balance sheet. EBITDAX is described on page 33 of this proxy statement. The committee may also include other non-recurring items that the committee in its sole discretion deems appropriate to be added back to GAAP net income.

The LTI stock awards will vest in full upon a Change in Control, Disability (each as defined in the 2007 Plan) or death of the executive, and all performance criteria and other conditions will be deemed to be achieved to the maximum extent.

 

The Committee believes that the performance metrics and target values for the 2010 LTI stock awards strongly correlate with our long-term business objectives and, specifically, with increasing stockholder value. If one of the performance measures is not satisfied, the entire award is forfeited and the award shares are returned to the 2007 Plan. The committee also decided that the award should be subject to a time-based vesting period longer than three years, which the committee previously had adopted as a practice for time vesting for prior restricted share grants under the 2007 Plan, to strengthen the retention component of the 2010 award.

 

The table below summarizes the number of restricted shares subject to LTI stock awards made to each of our named executive officers for 2010. The aggregate grant date fair value of the awards under FASB ASC Topic 718 is set forth in the Summary Compensation Table on page 41 of this proxy statement under the column “Stock Awards.”

 

 

The table below summarizes the performance measures required to be achieved for the 2010 LTI award and actual 2010 results.

 

 

Based on these results, all of the performance measures applicable to the 2010 awards were satisfied and the awards are eligible for time-based vesting based on the schedule described above under “— 2010 LTI Performance-Based Stock Awards.”

 

2011 LTI Stock Program

 

For 2011, the committee recommended, and the Board approved in March 2011, an LTI stock award with a combination of performance measures and time vesting restrictions substantially similar to the 2010 LTI award. In determining the number of shares to be awarded, the committee considered all of the factors described above under “— 2010 LTI Performance-Based Stock Awards” for the 2010 awards. At the time of the 2011 grant in March 2011, there were approximately 1,412,911 shares available for grant under the 2007 Plan, or 50.1% of the total shares available for grant under the 2007 Plan, and the Company’s three-year average annual burn rate was 1.51%. The committee also gave significant weight to the individual contributions of each of the executive officers to strong total stockholder returns in 2010 in making its decisions on 2011 LTI awards.

 

After considering all of the factors noted above, the committee decided on a total 2011 LTI stock award of 204,000 shares of restricted stock to our named executive officers, subject to the performance measures and time vesting restrictions set forth below. The primary reason for the decrease in the number of shares from the 2010 LTI award was the increase in value of the Company’s common stock and, therefore, the increase in value of the 2011 award and charge to earnings under FASB ASC Topic 718, compared to 2010.

First trigger:  Satisfaction of the following performance measures during the applicable performance period (fiscal year 2011):

 

 

Second trigger:  If all of the performance measures in the first trigger are met during the performance period (fiscal year 2011), then 1/3 of each individual’s restricted shares will ratably vest on December 31, 2012, 2013, and 2014, provided the executive officer is employed by the Company on the applicable vesting dates.

 

The table below summarizes the number of restricted shares subject to LTI stock awards made to each of our named executive officers for 2011:

 

 

Other Named Executive Officer Grants — 2010

 

In May 2010, our Compensation Committee authorized the grant of a restricted stock award under the 2007 Plan covering 35,000 shares of restricted stock to Dr. Yang. This stock award reflects (i) the importance of Dr. Yang’s role in helping lead our study of the Wolffork oil shale under our Permian Basin acreage, (ii) beginning a pilot Wolffork drilling program, (iii) our goal of retaining Dr. Yang in a competitive market for executive and technical talent and (iv) our goal of a more internally-balanced level of equity ownership among our executive officers. This additional restricted stock award to Dr. Yang is subject to time-based vesting conditions and will vest in three equal annual installments beginning on the first anniversary of the date of grant of the award, as long as Dr. Yang remains employed by the Company through the applicable vesting dates.

 

Stock Ownership Guidelines

 

The committee has not established minimum stock ownership requirements for our named executive officers or directors. However, the committee believes that meaningful stock ownership by our officers and directors is critical in aligning management’s interests with the interests of our stockholders. For 2010, the Board changed the $85,000 annual retainer under our director compensation plan from cash, stock or a combination of both, to $50,000 in mandatory common stock and $35,000 in cash, common stock or a combination of both. The committee will continue to consider whether minimum stock ownership requirements may be necessary to achieve our goal of aligning management’s interests with those of our stockholders.

 

In general, prior compensation, such as gains from prior stock options or stock awards, is not taken into account in setting other elements of compensation, such as base pay or annual incentive bonuses. However, the committee will generally consider prior stock purchases by, and prior stock and stock option awards to, our named executive officers when considering additional stock award grants. For new executive officers, we expect to take into account their prior base salary, annual cash incentives, the value of any equity compensation or other benefits that the new officer would forfeit to accept employment with us, as well as the contributions expected to be made by the new officer, our business needs and the role of the officer with us.

Employment Agreements

 

In January 2011, the Company entered into amended and restated employment agreements with Mr. Craft and Mr. Smart and new employment agreements with Mr. Henderson, Dr. Yang and Mr. Manoushagian. The agreements provide for potential severance payments upon the termination of the officers’ employment in certain situations. The agreements were designed so that the officers would all have employment agreements with the same employment term and similar severance and change in control provisions.

 

After the initial term of the agreements through January 1, 2013, the agreements are automatically renewed for additional one year terms unless either party elects not to renew an agreement or an agreement is otherwise terminated in accordance with its terms. The agreements provide for annual base salaries beginning in 2011 as described on page 31 of this proxy statement, subject to annual review and adjustment by the Board; provided, that for Mr. Craft, once established at an increased amount, his base salary will not be reduced below that increased amount during the term.

 

The severance and change in control provisions contained in the employment agreements are described in greater detail below under “— Potential Payments Upon a Termination or Change in Control.” The Company believes that these severance and change in control arrangements mitigate some of the risk that exists for executives working in a publicly-owned company. The amended and restated agreements for Mr. Craft and Mr. Smart, as well as the new agreements for Mr. Henderson, Mr. Yang and Mr. Manoushagian, are intended to retain qualified executives in a competitive market for executive talent. The committee believes that the severance and change in control arrangements in these agreements provide important protection to the Company’s executive officers, are consistent with the practices of peer companies and are appropriate for the retention of executive talent.

 

Benefits and Perquisites

 

Named executive officers receive the same health and welfare benefits, including medical, prescription drug, dental and vision, that are offered to all employees. The same contribution amounts and plan design provisions apply to all employees. The named executive officers also participate in the same qualified 401(k) plan as other employees. Under the plan, the Company currently matches 100% of an employee’s elective deferrals up to 3% of annual base salary, plus an additional 50% of elective deferrals on the next 2% of annual base salary. All matching contributions are subject to applicable federal limitations under the Internal Revenue Code and U.S. Treasury regulations. These benefits are part of our overall pay program and are designed to encourage continuity in employment and executive leadership and to remain competitive in the market for talent and experience in the E&P business. In addition to the above benefits, we provide Mr. Craft with a long-term disability plan, for which we pay a monthly premium of approximately $355 per month, and reimbursement of club membership dues and expenses. Please see the Summary Compensation Table for all compensation received by our named executive officers.

 

Deductibility of Executive Compensation

 

Section 162(m) of the Code, as clarified by the Internal Revenue Service and applicable regulations, generally disallows a federal income tax deduction to public companies for compensation in excess of $1,000,000 paid for any fiscal year to each of the company’s Covered Employees as of the end of any fiscal year. However, the regulations currently exempt qualified, performance-based compensation from the $1,000,000 deduction limit if certain requirements are met.

 

Newly-public companies are not subject to the deduction limitations of Section 162(m) of the Code until the first meeting of stockholders occurring after the close of the third calendar year following the calendar year in which the company’s initial public offering occurred. Therefore, the Company will become subject to the limitations and requirements of Section 162(m) as of the 2011 annual meeting.

 

Our policy is to have compensation programs that recognize and reward performance that increases stockholder value, and, to the extent consistent with this policy, to seek to maintain the favorable tax treatment of that compensation. We believe, however, that under some circumstances, such as to attract or retain key

executives or to recognize outstanding performance, it is in the Company’s and our stockholders’ best interests to provide compensation to selected executives even if it is not deductible.

 

We designed our performance-based, cash incentive award program for executive officers for 2010 and 2011 so that incentive compensation based on our company-wide performance measures will be exempt from the Section 162(m) $1,000,000 deduction limitation as qualified performance-based compensation. Incentive compensation based on individual performance will not be exempt from the $1,000,000 deduction limitation as qualified performance-based compensation. Therefore, if the $1,000,000 deduction limitation is exceeded, the tax deductibility of incentive compensation based on individual performance will be limited.

 

The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with our management. Based on this review and discussion, the Compensation Committee recommended to the Board that the Compensation Discussion and Analysis be included in this proxy statement and incorporated by reference in the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2010.

 

Respectfully submitted by the Compensation Committee of the Board,

 

James H. Brandi, Chairman

James C. Crain

Sheldon B. Lubar

 

The Compensation Committee believes that an appropriate part of total compensation is fixed for our executive officers, while another, equally appropriate portion is variable and linked to performance. Although the majority of the compensation provided to the named executive officers is performance-based, we believe our compensation programs do not encourage excessive and unnecessary risk taking by our executive officers (or other employees) because these programs are designed to encourage our officers and other employees to remain focused on both our near- and long-term operational and financial goals.

 

While annual cash incentive awards play an appropriate role in our executive compensation program, the committee believes that awards should be determined based on Company performance on a wide variety of measures, including both growth and cost control measures, which the committee believes mitigates excessive risk-taking that could produce unsustainable gains in one area of performance at the expense of our overall long-term interests. In addition, the committee sets performance goals that it believes are reasonable in light of our past performance, then-current business projections and market conditions. A portion of the variable compensation we provide is composed of performance-based, time-vesting LTI awards, which can retain value even in a depressed market, so executives are less likely to take unreasonable risks. Similar to our annual cash incentive awards, the committee believes that the LTI awards should be subject to measures of both growth and debt control, to build stockholder value while preserving a sustainable capital structure.

 

None of our executive officers serves as a member of the board or compensation committee of any entity that has one or more of its executive officers serving as a member of our Board or Compensation Committee.

 

As explained in our Compensation Discussion and Analysis, set forth below is the compensation awarded to, earned by or paid to our named executive officers for services rendered for 2008, 2009 and 2010 in all capacities, consisting of base salaries, cash bonuses, long-term equity incentives and other compensation.

 

 

 

 

The table below sets forth the range of potential annual cash incentive awards for 2010 performance as a dollar amount for each of the named executive officers under the Company’s 2010 annual incentive plan. The table also sets forth the number of shares and grant date fair value of restricted stock awarded during 2010 to the Company’s named executive officers under the 2007 Plan.

 

 

 

 

The following table summarizes the number of securities underlying outstanding equity plan awards for each named executive officer as of December 31, 2010.

 

 

 

 

 

 

 

 

The following table reflects option awards actually exercised and/or stock awards that vested for each of our named executive officers during 2010:

 

 

 

 

We do not have any plan that provides for payments or other benefits at, following or in connection with retirement, other than our 401(k) plan.

 

We do not have any plan that provides for the deferral of compensation on a basis that is not tax qualified.

 

Employment Agreements

 

We entered into employment agreements with each of our named executive officers in January 2011. Mr. Craft’s and Mr. Smart’s employment agreements restated and replaced existing employment agreements originally entered into on January 1, 2003, and previously amended on December 31, 2008. These agreements, and the employment agreement with Mr. Henderson, are included as exhibits to a Form 8-K dated January 1, 2011, and filed with the SEC on January 6, 2011. We entered into employment agreements with each of Dr. Yang and Mr. Manoushagian on January 24, 2011. These agreements are included as exhibits to a Form 8-K dated January 24, 2011, and filed with the SEC on January 28, 2011.

 

The employment agreements provide for potential severance payments upon the termination of the officers’ employment in certain situations, including in connection with a change in control, without “cause” by the Company or for “good reason” by the executive officer, upon proper notice of nonrenewal by either party and upon the death or permanent disability of the executive officer. Other than the prior employment agreements with Mr. Craft and Mr. Smart and our stock-based incentive awards, there were no arrangements with other named executive officers providing severance or change in control benefits during 2010. In order to provide our stockholders with an understanding of the severance and change in control arrangements currently in effect, the discussion below is of the benefits payable under the 2011 employment agreements, assuming such arrangements were in place as of December 31, 2010. Additional information regarding the employment agreements is included above under “Compensation Discussion and Analysis — Elements of the Company’s Executive Officer Compensation Program — Employment Agreements.”

 

Under the terms of the employment agreements, in the event of an executive’s death or if he becomes “permanently disabled,” as defined in the agreements, the agreements will terminate and we will pay the executive or his estate a lump sum severance payment equal to (i) 100% of the executive’s then-current annual

base salary, and (ii) 100% of the average of any bonuses received by the executive in the two years immediately before the separation from service.

 

If the agreements are terminated by the Company without “cause,” as defined in the agreements, by the executive for “good reason,” as defined in the agreements, or by the Company’s proper notice of nonrenewal of the agreement, the Company will pay each named executive officer a lump sum severance payment equal to (i) 150% of the greater of the executive officer’s then-current base salary or the executive officer’s base salary at any time within two years immediately before the separation from service (200% in the case of Mr. Craft) and (ii) 100% of the bonus that the named executive officer would have received based on achievement of applicable performance goals in the year of termination (prorated for any partial year of service in the case of the named executive officers other than Mr. Craft and in the case of the Company’s prior notice of nonrenewal for any of the named executive officers). The Company will also reimburse the named executive officers for certain premiums paid under the Consolidated Omnibus Reconciliation Act of 1985 (“COBRA”), for up to 18 months (24 months in the case of Mr. Craft and, for all named executive officers, 12 months if the executive terminates his employment for good reason), depending on the executive’s eligibility for continuation of coverage under COBRA.

 

If Mr. Craft is employed by the Company at the time of a “change in control,” as defined in the agreements, Mr. Craft’s agreement will terminate, regardless of whether Mr. Craft experiences a separation from service, and Mr. Craft will receive payments equal to (i) 200% of the greater of Mr. Craft’s then-current base salary and Mr. Craft’s base salary at any time within the two years before the change in control, and (ii) 200% of the average of any bonuses received by Mr. Craft in the two years before the change in control. We will also reimburse Mr. Craft for certain premiums paid under COBRA for up to 24 months following his separation from service, depending on Mr. Craft’s eligibility for continuation of coverage under COBRA.

 

If one of the other named executive officers is employed by us at the time of a change in control and his agreement is terminated without cause or by the executive for good reason within one year of the change in control, the executive will receive severance payments equal to (i) 150% of the greater of the executive’s then-current base salary and his base salary at any time within the two years immediately before the change in control, and (ii) 100% of the average of bonuses received by the executive in the two years before the change in control. We will also reimburse the executive for certain premiums paid under COBRA for a period of up to 18 months, depending on the executive’s eligibility for continuation of coverage under COBRA.

 

If a named executive officer is terminated by the Company without cause or if he terminates his employment for good reason, in either case, within 120 days before the occurrence of a change in control, then the named executive officer will be entitled to receive, in addition to the benefits described above for termination without cause or for good reason, a lump sum equal to the excess, if any, of the change in control benefits he would have received if he had been employed on the date of the change in control over the severance benefits he actually received in connection with his termination of employment.

 

All payments and benefits due under the employment agreements are conditioned upon the execution and non-revocation by the executive officer of a release for the Company’s benefit. Under the agreements, the executive officers have also agreed to certain confidentiality, non-competition and non-solicitation covenants with respect to the Company. The confidentiality covenants apply during the term of the agreement and for a one year period following the executive officer’s termination of employment. The non-competition and non-solicitation covenants apply during the term of the agreement and for one year following the executive officer’s termination of employment (for six months following termination of employment (i) in the case of Mr. Craft, in the event of his termination from employment for good reason or in connection with a change in control, or (ii) in the case of the other named executive officers, if the executive officer is terminated without cause or for good reason within one year following a change in control). Violation of these restrictive covenants entitles us to complete relief, including restitution. Further, in the event of a breach of the restrictive covenants during the executive officer’s employment with us, the executive could be terminated for cause (provided the breach constituted a material violation of the employment agreement). The employment agreements do not prohibit the waiver of a breach of these covenants.

If amounts payable to an executive officer under his employment agreement (together with any other amounts that are payable by us as a result of a change in ownership or control) (collectively, the “Payments”) exceed the amount allowed under Section 280G of the Code for such executive (thereby subjecting the executive to an excise tax), then the Payments due to the executive officer under the employment agreement will either (i) be reduced (but not below zero) so that the aggregate present value of the Payments fall within the amount allowed by Section 280G, or (ii) be paid in full, whichever produces the better, net, after-tax result for the executive officer (taking into account any applicable excise or income taxes).

 

Employment Agreement Terms.  For purposes of the employment agreements, the following terms have been given the meanings set forth below:

 

“Change in control” is generally defined as (i) any consolidation or merger of the Company in which the Company is not the continuing or surviving corporation or under which shares of the Company’s common stock would be converted into cash, securities or other property, other than a merger of the Company in which the holders of the Company’s common stock immediately before the merger have the same proportionate ownership of common stock of the surviving corporation immediately after the merger, (ii) any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all or substantially all, of the assets of the Company and the its subsidiaries to any other person or entity (other than an affiliate of the Company), (iii) the stockholders of the Company approve any plan or proposal for liquidation or dissolution of the Company, (iv) any person or entity (other than Yorktown Energy Partners V, L.P., or any of its affiliated funds), including a “group” as contemplated by Section 13(d)(3) of the Exchange Act, acquires or gains ownership or control (including, without limitation, power to vote) of more than 50% of the outstanding shares of the Company’s voting stock (based upon voting power) or (v) as a result of or in connection with a contested election of directors, the persons who were directors of the Company before such election shall cease to constitute a majority of the Board. A change in control does not include a public offering of the Company’s common stock or a transaction with its sole purpose to change the state of the Company’s incorporation or to create a holding company that will be owned in substantially the same proportions by the persons who held the Company’s securities immediately before such transaction.

 

“Cause” is generally defined as (i) the willful and continued failure by the executive substantially to perform his duties, responsibilities or authorities (other than any such failure resulting from the executive becoming permanently disabled), (ii) the willful engaging by the executive in misconduct that is materially injurious to the Company, (iii) any misconduct by the executive in the course and scope of the executive’s employment, including but not limited to dishonesty, disloyalty, disorderly conduct, insubordination, harassment of other employees or third parties, abuse of alcohol or controlled substances or other violations of the Company’s personnel policies, rules or Code of Conduct, (iv) any material violation by the executive of his employment agreement or (v) any violation by the executive of any fiduciary duty owed by the executive to the Company or its affiliates. For these purposes, no act, or failure to act, on the executive’s part shall be considered “willful” unless done, or omitted to be done, by him not in good faith and without reasonable belief that his action or omission was in the best interest of the Company.

 

“Good reason” is generally defined as, without the executive’s consent, (i) a material diminution in the executive’s annual base salary, duties, responsibilities or authorities, (ii) a requirement that the executive report to an officer or employee other than the Board (or, in the case of executive officers other than Mr. Craft, to an officer or employee other than the president or the Board), (iii) a material relocation of the executive’s primary work location more than 25 miles away from the Company’s corporate headquarters for the Mr. Craft, and 50 miles for the other named executive officers or (iv) any other material breach by the Company of its obligations under the employment agreement.

 

An executive will be deemed to have become “permanently disabled” when (i) he receives disability benefits under either Social Security or the Company’s long-term disability plan, if any, (ii) the Board, upon the written report of a qualified physician designated by the Board or its insurers, shall have determined (after a complete physical examination of the executive at any time after he has been absent from the Company for a total period of 180 or more calendar days in any 12-month period) that the executive has become physically and/or mentally incapable of performing his essential job functions with or without reasonable accommodation

as required by law or (iii) he is otherwise unable for a continuous period of 120 calendar days to perform his essential job functions with or without reasonable accommodation as required by law due to injury, illness or other incapacity (90 days in the case of executive officers other than Mr. Craft).

 

Potential Severance Benefits.  The following table summarizes the potential severance payments payable to our executive officers under their employment agreements. The table is only intended to summarize various terms of the employment agreements and is qualified in its entirety by reference to the full text of the actual agreements, copies of which are on file with the SEC as discussed above.

 

 

 

 

Stock Incentive Plan

 

In addition to potential severance payments under the executive employment agreements discussed above, certain restricted stock awards granted under the 2007 Plan provide for the accelerated vesting of such awards in the event of a change in control or certain termination events. Specifically, the 2007 Plan provides that restricted shares will vest in full upon the occurrence of a change in control. In addition, the stock award agreements for restricted shares granted to executive officers after August 1, 2010, provide that restricted shares will vest in full upon termination of employment by reason of death or disability. The definitions for change in control in the 2007 Plan and applicable restricted stock award agreements are the same as in the employment agreements and are discussed above under “— Employment Agreement Terms.” The definition of disability in the restricted stock award agreements is the same as in the 2007 Plan: (i) the executive is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental

impairment that can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, or (ii) the executive is, by reason of any medically determinable physical or mental impairment that can be expected to result in death or can be expected to last for a continuous period of not less than 12 months, receiving income replacement benefits for a period of not less than three months under an accident or health plan covering employees of the Company or an affiliate.

 

Quantification of Payments

 

The table below summarizes the dollar amounts of potential payments to each named executive officer assuming that one of the events described in the table below occurs and assuming that the employment agreements with all the named executive officers were in effect on December 31, 2010. The table assumes that each specified event occurred on December 31, 2010, when the closing price of the Company’s common stock was $23.10. The values below are our best estimate of the severance payments and benefits the executives would receive upon a termination of employment or a change in control as of December 31, 2010, and we believe the amounts below have been calculated using reasonable assumptions. All amounts are before taxes, which would reduce amounts ultimately due to our named executive officers. Any actual payments that may be made pursuant to the agreements described above are dependent on various factors, which may or may not exist at the time a change in control actually occurs and/or the named executive officer is actually terminated. Therefore, such amounts and disclosures should be considered “forward looking statements.”

 

 

 

 

Our directors received an annual retainer of $50,000 in common stock for services rendered in 2010 under our director compensation plan. Our directors also received an annual retainer of $35,000 in cash, stock or a combination of both at the election of the director and payable in four equal installments on the first trading day of each quarter. In addition, the Chairmen of the Audit and Compensation Committees received $15,000 and $5,000, respectively, in cash, stock or a combination of both, also at the election of the Chairman and payable in four equal installments on the first trading day of each quarter. Further, directors and committee members received cash meeting fees of $1,000 for each Board meeting attended, $1,000 for each Audit Committee meeting attended and $500 for each Compensation Committee meeting attended.

 

Additionally, each director is reimbursed for travel and miscellaneous expenses to attend meetings and activities of the Board or its committees, and travel and miscellaneous expenses related to such director’s participation in general education and programs for directors.

 

The following table sets forth a summary of the compensation we paid to our directors in 2010. The calculation of the amounts elected to be received in common stock was calculated in accordance with FASB ASC Topic 718 and based on the NASDAQ closing price of our common stock on the date of grant. Mr. Craft,

who is a full-time employee, and Mr. Lawrence, who is affiliated with Yorktown Energy Partners, do not receive compensation for serving as directors.