ITEM 1A.
RISK FACTORS
You should carefully consider the following risk factors as well as the other information contained or incorporated by reference in this report, as these important factors, among others, could cause our actual results to differ from our expected or historical results. It is not possible to predict or identify all such factors. Consequently, you should not consider any such list to be a complete statement of all of our potential risks or uncertainties.
A substantial or extended decline in oil and natural gas prices may adversely affect our business, financial condition, cash flow, liquidity or results of operations and our ability to meet our capital expenditure obligations and financial commitments and to implement our business strategy.
Our business is heavily dependent upon the prices of, and demand for, oil and natural gas. Historically, the prices for oil and natural gas have been volatile and are likely to remain volatile in the future. The prices
we receive for our oil and natural gas production and the level of such production will be subject to wide fluctuations and depend on numerous factors beyond our control, including the following:
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the domestic and foreign supply of oil and natural gas;
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weather conditions;
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the price and quantity of imports of crude oil and natural gas;
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political conditions and events in other oil-producing and natural gas-producing countries, including embargoes, hostilities in the Middle East and other sustained military campaigns, and acts of terrorism or sabotage;
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the actions of the Organization of Petroleum Exporting Countries, or OPEC;
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domestic government regulation, legislation and policies;
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the level of global oil and natural gas inventories;
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technological advances affecting energy consumption;
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the price and availability of alternative fuels; and
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overall economic conditions.
If the decline in the price of crude oil or natural gas that first started in 2008 continues again during 2010, the lower prices will adversely affect:
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our revenues, profitability and cash flow from operations;
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the value of our proved oil and natural gas reserves;
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the economic viability of certain of our drilling prospects;
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our borrowing capacity; and
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our ability to obtain additional capital.
In the future we may enter into hedging arrangements in order to reduce our exposure to price risks. Such arrangements would limit our ability to benefit from increases in oil and natural gas prices.
The current recession could have a material adverse impact on our financial position, results of operations and cash flows.
The oil and gas industry is cyclical and tends to reflect general economic conditions. The United States and other countries are in a recession which could last through 2010 and beyond, and the capital markets are experiencing significant volatility. The recession has had an adverse impact on demand and pricing for crude oil and natural gas. A continuation of the recession could have a further negative impact on oil and natural gas prices. Our operating cash flows and profitability will be significantly affected by declining oil and natural gas prices. Further declines in oil and natural gas prices may also impact the value of our oil and gas reserves, which could result in future impairment charges to reduce the carrying value of our oil and gas properties and our marketable securities. Our future access to capital could be limited due to tightening credit markets and volatile capital markets. If our access to capital is limited, development of our assets may be delayed or limited, and we may not be able to execute our growth strategy.
Our future production and revenues depend on our ability to replace our reserves.
Our future production and revenues depend upon our ability to find, develop or acquire additional oil and natural gas reserves that are economically recoverable. Our proved reserves will generally decline as reserves are depleted, except to the extent that we conduct successful exploration or development activities or acquire properties containing proved reserves, or both. To increase reserves and production, we must continue our acquisition and drilling activities. We cannot assure you, however, that our acquisition and drilling activities will result in significant additional reserves or that we will have continuing success drilling productive wells at low finding and development costs. Furthermore, while our revenues may
increase if prevailing oil and natural gas prices increase significantly, our finding costs for additional reserves could also increase.
Prospects that we decide to drill may not yield oil or natural gas in commercially viable quantities or quantities sufficient to meet our targeted rate of return.
A prospect is a property in which we own an interest or have operating rights and that has what our geoscientists believe, based on available seismic and geological information, to be an indication of potential oil or natural gas. Our prospects are in various stages of evaluation, ranging from a prospect that is ready to be drilled to a prospect that will require substantial additional evaluation and interpretation. There is no way to predict in advance of drilling and testing whether any particular prospect will yield oil or natural gas in sufficient quantities to recover drilling or completion costs or to be economically viable. The use of seismic data and other technologies and the study of producing fields in the same area will not enable us to know conclusively prior to drilling whether oil or natural gas will be present or, if present, whether oil or natural gas will be present in commercial quantities. The analysis that we perform using data from other wells, more fully explored prospects and/or producing fields may not be useful in predicting the characteristics and potential reserves associated with our drilling prospects. If we drill additional unsuccessful wells, our drilling success rate may decline and we may not achieve our targeted rate of return.
Federal hydraulic fracturing legislation could increase our costs and restrict our access to our oil and gas reserves.
Several proposals are before the United States Congress that, if implemented, would subject the process of hydraulic fracturing to regulation under the Safe Drinking Water Act. Hydraulic fracturing involves the injection of water, sand and chemicals under pressure into rock formations to stimulate natural gas production. The use of hydraulic fracturing is necessary to produce commercial quantities of crude oil and natural gas from many reservoirs including the Haynesville shale, Cotton Valley and other tight natural gas reservoirs.
Although it is not possible at this time to predict the final outcome of any legislation regarding hydraulic fracturing, any new federal restrictions on hydraulic fracturing that may be imposed in areas in which we conduct business could significantly increase our operating, capital and compliance costs as well as delay or inhibit our ability to develop our oil and natural gas reserves.
The proposed US federal budget for fiscal year 2011 includes certain provisions that, if passed as originally submitted, will have an adverse effect on us.
On February 1, 2010, the federal government released its proposed budget for fiscal year 2011. The proposed budget contains provisions which would impose new taxes and which would repeal many tax incentives and deductions that are currently used by independent oil and gas producers. The provisions being considered that would impact us are: elimination of the ability to fully deduct intangible drilling costs in the year incurred, repeal of the manufacturing tax deduction for oil and gas companies, increasing the geological and geophysical cost amortization period, and implementation of a fee on non-producing leases located on federal lands. If these proposals are enacted, our current income tax liability will increase, potentially significantly, which would have a negative impact on our cash flow from operating activities. A reduction in operating cash flow could require us to reduce our drilling activities. Since none of these proposals have yet to be included in new legislation, we do not know the ultimate impact they may have on our business.
Our debt service requirements could adversely affect our operations and limit our growth.
We had $470.8 million in debt as of December 31, 2009, and our ratio of total debt to total capitalization was approximately 31%.
Our outstanding debt will have important consequences, including, without limitation:
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a portion of our cash flow from operations will be required to make debt service payments;
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our ability to borrow additional amounts for working capital, capital expenditures (including acquisitions) or other purposes will be limited; and
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our debt could limit our ability to capitalize on significant business opportunities, our flexibility in planning for or reacting to changes in market conditions and our ability to withstand competitive pressures and economic downturns.
In addition, future acquisition or development activities may require us to alter our capitalization significantly. These changes in capitalization may significantly increase our debt. Moreover, our ability to meet our debt service obligations and to reduce our total debt will be dependent upon our future performance, which will be subject to general economic conditions and financial, business and other factors affecting our operations, many of which are beyond our control. If we are unable to generate sufficient cash flow from operations in the future to service our indebtedness and to meet other commitments, we will be required to adopt one or more alternatives, such as refinancing or restructuring our indebtedness, selling material assets or seeking to raise additional debt or equity capital. We cannot assure you that any of these actions could be effected on a timely basis or on satisfactory terms or that these actions would enable us to continue to satisfy our capital requirements.
Our bank credit facility contains a number of significant covenants. These covenants will limit our ability to, among other things:
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borrow additional money;
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merge, consolidate or dispose of assets;
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make certain types of investments;
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enter into transactions with our affiliates; and
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pay dividends.
Our failure to comply with any of these covenants could cause a default under our bank credit facility and the respective indentures governing our 67/8% senior notes due 2012 and 83/8% senior notes due 2017. A default, if not waived, could result in acceleration of our indebtedness, in which case the debt would become immediately due and payable. If this occurs, we may not be able to repay our debt or borrow sufficient funds to refinance it given the current status of the credit markets. Even if new financing is available, it may not be on terms that are acceptable to us. Complying with these covenants may cause us to take actions that we otherwise would not take or not take actions that we otherwise would take.
The unavailability or high cost of drilling rigs, equipment, supplies or qualified personnel and oilfield services could adversely affect our ability to execute our exploration and development plans on a timely basis and within our budget.
Our industry has experienced a shortage of drilling rigs, equipment, supplies and qualified personnel in recent years as the result of higher demand for these services. Costs and delivery times of rigs, equipment and supplies have been substantially greater than they were several years ago. In addition, demand for, and wage rates of, qualified drilling rig crews have escalated due to the higher activity levels. Shortages of drilling rigs, equipment or supplies or qualified personnel in the areas in which we operate could delay or
restrict our exploration and development operations, which in turn could adversely affect our financial condition and results of operations because of our concentration in those areas.
Our business involves many uncertainties and operating risks that can prevent us from realizing profits and can cause substantial losses.
Our future success will depend on the success of our exploration and development activities. Exploration activities involve numerous risks, including the risk that no commercially productive natural gas or oil reserves will be discovered. In addition, these activities may be unsuccessful for many reasons, including weather, cost overruns, equipment shortages and mechanical difficulties. Moreover, the successful drilling of a natural gas or oil well does not ensure we will realize a profit on our investment. A variety of factors, both geological and market-related, can cause a well to become uneconomical or only marginally economical. In addition to their costs, unsuccessful wells can hurt our efforts to replace production and reserves.
Our business involves a variety of operating risks, including:
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unusual or unexpected geological formations;
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fires;
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explosions;
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blow-outs and surface cratering;
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uncontrollable flows of natural gas, oil and formation water;
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natural disasters, such as hurricanes, tropical storms and other adverse weather conditions;
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pipe, cement, or pipeline failures;
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casing collapses;
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mechanical difficulties, such as lost or stuck oil field drilling and service tools;
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abnormally pressured formations; and
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environmental hazards, such as natural gas leaks, oil spills, pipeline ruptures and discharges of toxic gases.
If we experience any of these problems, well bores, gathering systems and processing facilities could be affected, which could adversely affect our ability to conduct operations.
We could also incur substantial losses as a result of:
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injury or loss of life;
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severe damage to and destruction of property, natural resources and equipment;
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pollution and other environmental damage;
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clean-up responsibilities;
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regulatory investigation and penalties;
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suspension of our operations; and
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repairs to resume operations.
We pursue acquisitions as part of our growth strategy and there are risks in connection with acquisitions.
Our growth has been attributable in part to acquisitions of producing properties and companies. We expect to continue to evaluate and, where appropriate, pursue acquisition opportunities on terms we consider favorable. However, we cannot assure you that suitable acquisition candidates will be identified in the future, or that we will be able to finance such acquisitions on favorable terms. In addition, we compete against other companies for acquisitions, and we cannot assure you that we will successfully acquire any
material property interests. Further, we cannot assure you that future acquisitions by us will be integrated successfully into our operations or will increase our profits.
The successful acquisition of producing properties requires an assessment of numerous factors beyond our control, including, without limitation:
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recoverable reserves;
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exploration potential;
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future oil and natural gas prices;
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operating costs; and
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potential environmental and other liabilities.
In connection with such an assessment, we perform a review of the subject properties that we believe to be generally consistent with industry practices. The resulting assessments are inexact and their accuracy uncertain, and such a review may not reveal all existing or potential problems, nor will it necessarily permit us to become sufficiently familiar with the properties to fully assess their merits and deficiencies. Inspections may not always be performed on every well, and structural and environmental problems are not necessarily observable even when an inspection is made.
Additionally, significant acquisitions can change the nature of our operations and business depending upon the character of the acquired properties, which may be substantially different in operating and geologic characteristics or geographic location than our existing properties. While our current operations are focused in the East Texas/North Louisiana and South Texas regions, we may pursue acquisitions or properties located in other geographic areas.
We operate in a highly competitive industry, and our failure to remain competitive with our competitors, many of which have greater resources than we do, could adversely affect our results of operations.
The oil and natural gas industry is highly competitive in the search for and development and acquisition of reserves. Our competitors often include companies that have greater financial and personnel resources than we do. These resources could allow those competitors to price their products and services more aggressively than we can, which could hurt our profitability. Moreover, our ability to acquire additional properties and to discover reserves in the future will be dependent upon our ability to evaluate and select suitable properties and to close transactions in a highly competitive environment.
Our competitors may use superior technology that we may be unable to afford or which would require costly investment by us in order to compete.
If our competitors use or develop new technologies, we may be placed at a competitive disadvantage, and competitive pressures may force us to implement new technologies at a substantial cost. In addition, our competitors may have greater financial, technical and personnel resources that allow them to enjoy technological advances and may in the future allow them to implement new technologies before we can. We cannot be certain that we will be able to implement technologies on a timely basis or at a cost that is acceptable to us. One or more of the technologies that we currently use or that we may implement in the future may become obsolete. All of these factors may inhibit our ability to acquire additional prospects and compete successfully in the future.
Substantial exploration and development activities could require significant outside capital, which could dilute the value of our common shares and restrict our activities. Also, we may not be able to obtain needed capital or financing on satisfactory terms, which could lead to a limitation of our future business opportunities and a decline in our oil and natural gas reserves.
We expect to expend substantial capital in the acquisition of, exploration for and development of oil and natural gas reserves. In order to finance these activities, we may need to alter or increase our capitalization substantially through the issuance of debt or equity securities, the sale of non-strategic assets or other means. The issuance of additional equity securities could have a dilutive effect on the value of our common shares, and may not be possible on terms acceptable to us given the current volatility in the financial markets. The issuance of additional debt would require that a portion of our cash flow from operations be used for the payment of interest on our debt, thereby reducing our ability to use our cash flow to fund working capital, capital expenditures, acquisitions, dividends and general corporate requirements, which could place us at a competitive disadvantage relative to other competitors. Additionally, if our revenues decrease as a result of lower oil or natural gas prices, operating difficulties or declines in reserves, our ability to obtain the capital necessary to undertake or complete future exploration and development programs and to pursue other opportunities may be limited, which could result in a curtailment of our operations relating to exploration and development of our prospects, which in turn could result in a decline in our oil and natural gas reserves.
If oil and natural gas prices remain low or continue to decline, we may be required to write-down the carrying values and/or the estimates of total reserves of our oil and natural gas properties, which would constitute a non-cash charge to earnings and adversely affect our results of operations.
Accounting rules applicable to us require that we review periodically the carrying value of our oil and natural gas properties for possible impairment. Based on specific market factors and circumstances at the time of prospective impairment reviews and the continuing evaluation of development plans, production data, economics and other factors, we may be required to write down the carrying value of our oil and natural gas properties. A write-down constitutes a non-cash charge to earnings. We may incur non-cash charges in the future, which could have a material adverse effect on our results of operations in the period taken. We may also reduce our estimates of the reserves that may be economically recovered, which could have the effect of reducing the total value of our reserves. Such a reduction in carrying value could impact our borrowing ability and may result in accelerating the repayment date of any outstanding debt.
Our reserve estimates depend on many assumptions that may turn out to be inaccurate. Any material inaccuracies in our reserve estimates or underlying assumptions will materially affect the quantities and present value of our reserves.
Reserve engineering is a subjective process of estimating the recovery from underground accumulations of oil and natural gas that cannot be precisely measured. The accuracy of any reserve estimate depends on the quality of available data, production history and engineering and geological interpretation and judgment. Because all reserve estimates are to some degree imprecise, the quantities of oil and natural gas that are ultimately recovered, production and operating costs, the amount and timing of future development expenditures and future oil and natural gas prices may all differ materially from those assumed in these estimates. The information regarding present value of the future net cash flows attributable to our proved oil and natural gas reserves is only estimated and should not be construed as the current market value of the oil and natural gas reserves attributable to our properties. Thus, such information includes revisions of certain reserve estimates attributable to proved properties included in the preceding year’s estimates. Such revisions reflect additional information from subsequent activities, production history of the properties involved and any adjustments in the projected economic life of such properties resulting from
changes in product prices. Any future downward revisions could adversely affect our financial condition, our borrowing ability, our future prospects and the value of our common stock.
As of December 31, 2009, 45% of our total proved reserves are undeveloped and 10% are developed non-producing. These reserves may not ultimately be developed or produced. Furthermore, not all of our undeveloped or developed non-producing reserves may be ultimately produced at the time periods we have planned, at the costs we have budgeted, or at all. As a result, we may not find commercially viable quantities of oil and natural gas, which in turn may result in a material adverse effect on our results of operations.
If we are unsuccessful at marketing our oil and natural gas at commercially acceptable prices, our profitability will decline.
Our ability to market oil and natural gas at commercially acceptable prices depends on, among other factors, the following:
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the availability and capacity of gathering systems and pipelines;
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federal and state regulation of production and transportation;
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changes in supply and demand; and
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general economic conditions.
Our inability to respond appropriately to changes in these factors could negatively affect our profitability.
Market conditions or operational impediments may hinder our access to oil and natural gas markets or delay our production.
Market conditions or the unavailability of satisfactory oil and natural gas transportation arrangements may hinder our access to oil and natural gas markets or delay our production. The availability of a ready market for our oil and natural gas production depends on a number of factors, including the demand for and supply of oil and natural gas and the proximity of reserves to pipelines and processing facilities. Our ability to market our production depends in a substantial part on the availability and capacity of gathering systems, pipelines and processing facilities, in some cases owned and operated by third parties. Our failure to obtain such services on acceptable terms could materially harm our business. We may be required to shut in wells for a lack of a market or because of the inadequacy or unavailability of pipelines or gathering system capacity. If that were to occur, then we would be unable to realize revenue from those wells until arrangements were made to deliver our production to market.
We depend on our key personnel and the loss of any of these individuals could have a material adverse effect on our operations.
We believe that the success of our business strategy and our ability to operate profitably depend on the continued employment of M. Jay Allison, our President and Chief Executive Officer, and a limited number of other senior management personnel. Loss of the services of Mr. Allison or any of those other individuals could have a material adverse effect on our operations.
Our insurance coverage may not be sufficient or may not be available to cover some liabilities or losses that we may incur.
If we suffer a significant accident or other loss, our insurance coverage will be net of our deductibles and may not be sufficient to pay the full current market value or current replacement value of our lost investment, which could result in a material adverse impact on our operations and financial condition. Our
insurance does not protect us against all operational risks. We do not carry business interruption insurance. For some risks, we may not obtain insurance if we believe the cost of available insurance is excessive relative to the risks presented. Because third party drilling contractors are used to drill our wells, we may not realize the full benefit of workers’ compensation laws in dealing with their employees. In addition, some risks, including pollution and environmental risks, generally are not fully insurable.
We are subject to extensive governmental laws and regulations that may adversely affect the cost, manner or feasibility of doing business.
Our operations and facilities are subject to extensive federal, state and local laws and regulations relating to the exploration for, and the development, production and transportation of, oil and natural gas, and operating safety. Future laws or regulations, any adverse changes in the interpretation of existing laws and regulations or our failure to comply with existing legal requirements may harm our business, results of operations and financial condition. We may be required to make large and unanticipated capital expenditures to comply with governmental laws and regulations, such as:
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lease permit restrictions;
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drilling bonds and other financial responsibility requirements, such as plug and abandonment bonds;
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spacing of wells;
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unitization and pooling of properties;
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safety precautions;
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regulatory requirements; and
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taxation.
Under these laws and regulations, we could be liable for:
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personal injuries;
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property and natural resource damages;
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well reclamation costs; and
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governmental sanctions, such as fines and penalties.
Our operations could be significantly delayed or curtailed and our cost of operations could significantly increase as a result of regulatory requirements or restrictions. We are unable to predict the ultimate cost of compliance with these requirements or their effect on our operations.
Our operations may incur substantial liabilities to comply with environmental laws and regulations.
Our oil and natural gas operations are subject to stringent federal, state and local laws and regulations relating to the release or disposal of materials into the environment and otherwise relating to environmental protection. These laws and regulations:
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require the acquisition of a permit before drilling commences;
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restrict the types, quantities and concentration of substances that can be released into the environment in connection with drilling and production activities;
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limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas; and
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impose substantial liabilities for pollution resulting from our operations.
Failure to comply with these laws and regulations may result in:
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the assessment of administrative, civil and criminal penalties;
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the incurrence of investigatory or remedial obligations; and
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the imposition of injunctive relief.
In June 2009 the United States House of Representatives passed the American Clean Energy and Security Act of 2009. A similar bill, the Clean Energy Jobs and American Power Act, has been introduced in the Senate, but has not passed. Both bills contain the basic feature of establishing a “cap and trade” system for restricting greenhouse gas emissions in the United States. Under such system, certain sources of greenhouse gas emissions would be required to obtain greenhouse gas emission “allowances” corresponding to their annual emissions of greenhouse gases. The number of emission allowances issued each year would decline as necessary over time to meet overall emission reduction goals. As the number of greenhouse gas emission allowances declines each year, the cost or value of allowances is expected to escalate significantly. The ultimate outcome of these legislative initiatives remain uncertain. In addition to the pending climate legislation, the EPA has issued the Final Mandatory Reporting of Greenhouse Gases Rule, which requires many suppliers of fossil fuels or industrial chemicals, manufacturers of vehicles and engines, and other facilities that emit 25,000 metric tons or more of carbon dioxide equivalent per year to begin collecting greenhouse gas emissions data under a new reporting system beginning on January 1, 2010 with the first annual report due March 31, 2011. Although we currently are not required to report under these new regulations, we may be required to do so in the future. Beyond measuring and reporting, the EPA issued an “Endangerment Finding” under section 202(a) of the Clean Air Act, concluding greenhouse gas pollution threatens the public health and welfare of current and future generations. The EPA has proposed regulation that would require permits for and reductions in greenhouse gas emissions for certain facilities, and may issue final rules this year. Since all of our crude oil and natural gas production is in the United States, any laws or regulations that may be adopted to restrict or reduce emissions of greenhouse gases could require us to incur increased operating costs, and could have an adverse effect on demand for the crude oil and natural gas we produce.
In January 2010 the Bureau of Land Management announced that it will be issuing a new draft oil and gas leasing policy that will require, among other things, a more detailed environmental review prior to leasing oil and natural gas resources on federal lands, increased public engagement in the development of master leasing and development plans prior to leasing areas where intensive new oil and gas development is anticipated, and a comprehensive parcel review process. As the policy has not yet been released, we are not able to determine the impact these potential leasing policy changes may have on our business.
Changes in environmental laws and regulations occur frequently, and any changes that result in more stringent or costly waste handling, storage, transport, disposal or cleanup requirements could require us to make significant expenditures to reach and maintain compliance and may otherwise have a material adverse effect on our industry in general and on our own results of operations, competitive position or financial condition. Under these environmental laws and regulations, we could be held strictly liable for the removal or remediation of previously released materials or property contamination regardless of whether we were responsible for the release or contamination or if our operations met previous standards in the industry at the time they were performed. Future environmental laws and regulations, including proposed legislation regulating climate change, may negatively impact our industry. The costs of compliance with these requirements may have an adverse impact on our financial condition, results of operations and cash flows.
Provisions of our articles of incorporation, bylaws and Nevada law will make it more difficult to effect a change in control of us, which could adversely affect the price of our common stock.
Nevada corporate law and our articles of incorporation and bylaws contain provisions that could delay, defer or prevent a change in control of us. These provisions include:
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allowing for authorized but unissued shares of common and preferred stock;
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a classified board of directors;
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requiring special stockholder meetings to be called only by our chairman of the board, our chief executive officer, a majority of the board or the holders of at least 10% of our outstanding stock entitled to vote at a special meeting;
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requiring removal of directors by a supermajority stockholder vote;
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prohibiting cumulative voting in the election of directors; and
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Nevada control share laws that may limit voting rights in shares representing a controlling interest in us.
We have in place a stockholders’ rights plan. The provisions of the stockholders’ rights plan and the above provisions could make an acquisition of us by means of a tender offer or proxy contest or removal of our incumbent directors more difficult. As a result, these provisions could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders, which may limit the price that investors are willing to pay in the future for shares of our common stock.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
We are not a party to any legal proceedings which management believes will have a material adverse effect on our consolidated results of operations or financial condition.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of our security holders during the fourth quarter of 2009.
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed for trading on the New York Stock Exchange under the symbol “CRK.” The following table sets forth, on a per share basis for the periods indicated, the high and low sales prices by calendar quarter for the periods indicated as reported by the New York Stock Exchange.
As of February 26, 2010, we had 47,105,606 shares of common stock outstanding, which were held by 263 holders of record and approximately 15,286 beneficial owners who maintain their shares in “street name” accounts.
We have never paid cash dividends on our common stock. We presently intend to retain any earnings for the operation and expansion of our business and we do not anticipate paying cash dividends in the foreseeable future. Any future determination as to the payment of dividends will depend upon the results of our operations, capital requirements, our financial condition and such other factors as our board of directors may deem relevant. In addition, we are limited under our bank credit facility and by the terms of the indentures for our senior notes from paying or declaring cash dividends.
During the fourth quarter of 2009, we did not repurchase any of our equity securities.
The following table summarizes certain information regarding our equity compensation plans as of December 31, 2009:
We do not have any equity compensation plans that were not approved by stockholders.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The historical financial data presented in the table below as of and for each of the years in the five-year period ended December 31, 2009 are derived from our consolidated financial statements. The financial results are not necessarily indicative of our future operations or future financial results. The data presented below should be read in conjunction with our consolidated financial statements and the notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” During 2008, we divested our interests in offshore operations which were conducted through our subsidiary Bois d’Arc Energy, Inc. (“Bois d’Arc”). Accordingly, we have adjusted the presentation of selected financial data to reflect the offshore operations on a discontinued basis.
Statement of Operations Data:
(1)
Includes lease operating costs and production and ad valorem taxes.
(2)
Includes gain of $158.1 million, net of income taxes of $85.3 million, from the sale of our offshore operations.
Balance Sheet Data:
Cash Flow Data:
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with our selected historical consolidated financial data and our accompanying consolidated financial statements and the notes to those financial statements included elsewhere in this report. The following discussion includes forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and elsewhere in this report, particularly in “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements.”
Overview
We are an independent energy company engaged in the acquisition, exploration, development and production of oil and natural gas in the United States. We own interests in 1,641 (903.4 net to us) producing oil and natural gas wells and we operate 950 of these wells. In managing our business, we are concerned primarily with maximizing return on our stockholders’ equity. To accomplish this goal, we focus on profitably increasing our oil and natural gas reserves and production.
Our offshore operations were historically conducted through our subsidiary, Bois d’Arc. Bois d’Arc was acquired by Stone Energy Corporation (“Stone”) in exchange for a combination of cash and shares of Stone common stock on August 28, 2008. Our offshore operations are presented as discontinued operations in our financial statements for all periods presented. Unless indicated otherwise, the amounts in the accompanying tables and discussion relate to our continuing onshore operations. In 2008, we recorded an impairment of $162.7 million ($105.8 million after income taxes) to reduce our carrying value for our investment in Stone common stock to fair market value.
Our future growth will be driven primarily by acquisition, development and exploration activities. In 2009 our growth in production and proved reserves was primarily driven by our successful drilling activities in the Haynesville shale formation. Under our current drilling budget, we plan to spend approximately $385.0 million in 2010 for development and exploration activities which will primarily be focused on developing our Haynesville shale properties. We plan to drill approximately 59 wells (42.6 net to us) in 2010. Fifty-six of these wells will be horizontal Haynesville shale wells. However, we could increase or decrease the number of wells that we drill depending on oil and natural gas prices. We do not budget for acquisitions as the timing and size of acquisitions are not predictable.
We use the successful efforts method of accounting, which allows only for the capitalization of costs associated with developing proven oil and natural gas properties as well as exploration costs associated with successful exploration activities. Accordingly, our exploration costs consist of costs we incur to acquire and reprocess 3-D seismic data, impairments of our unevaluated leasehold where we were not successful in discovering reserves and the costs of unsuccessful exploratory wells that we drill.
We generally sell our oil and natural gas at current market prices at the point our wells connect to third party purchaser pipelines. We market our products several different ways depending upon a number of factors, including the availability of purchasers for the product, the availability and cost of pipelines near our wells, market prices, pipeline constraints and operational flexibility. Accordingly, our revenues are heavily dependent upon the prices of, and demand for, oil and natural gas. Oil and natural gas prices have historically been volatile and are likely to remain volatile in the future.
Our operating costs are generally comprised of several components, including costs of field personnel, insurance, repair and maintenance costs, production supplies, fuel used in operations, transportation costs, workover expenses and state production and ad valorem taxes.
Like all oil and natural gas exploration and production companies, we face the constant challenge of replacing our reserves. Although in the past we have offset the effect of declining production rates from existing properties through successful acquisition and drilling efforts, there can be no assurance that we will be able to continue to offset production declines or maintain production at current rates through future acquisitions or drilling activity. Our future growth will depend on our ability to continue to add new reserves in excess of production.
Our operations and facilities are subject to extensive federal, state and local laws and regulations relating to the exploration for, and the development, production and transportation of, oil and natural gas, and operating safety. Future laws or regulations, any adverse changes in the interpretation of existing laws and regulations or our failure to comply with existing legal requirements may have an adverse effect on our business, results of operations and financial condition. Applicable environmental regulations require us to remove our equipment after production has ceased, to plug and abandon our wells and to remediate any environmental damage our operations may have caused. The present value of the estimated future costs to plug and abandon our oil and gas wells and to dismantle and remove our production facilities is included in our reserve for future abandonment costs, which was $6.6 million as of December 31, 2009.
Results of Operations
Year Ended December 31, 2009 Compared to Year Ended December 31, 2008
Our operating data for 2008 and 2009 is summarized below:
(1)
Includes lease operating costs and production and ad valorem taxes.
(2)
Represents depreciation, depletion and amortization of oil and gas properties only.
Oil and gas sales. Our oil and gas sales decreased $272.8 million (48%) in 2009 to $290.9 million from sales of $563.7 million in 2008. This decrease primarily reflects lower prices realized by us for natural gas and crude oil in 2009. The average price for natural gas realized by us decreased by 53% in 2009 as compared to 2008. Prices for crude oil decreased by 42% in 2009 as compared to 2008. Our production in 2009 increased by 9% over 2008’s production as our successful drilling in the Haynesville shale more than replaced the declines from our existing producing properties.
Oil and gas operating expenses. Our oil and gas operating expenses, including production taxes, decreased $17.5 million (20%) to $69.2 million in 2009 from operating expenses of $86.7 million in 2008. Oil and gas operating expenses per equivalent Mcf produced decreased to $1.06 as compared to $1.45 in 2008. The decrease in operating costs mainly reflects lower production taxes resulting from the lower oil and natural gas prices.
Exploration expense. We had $0.9 million in exploration expense in 2009 as compared to $5.0 million in 2008. Exploration expense in 2009 primarily related to costs incurred for the acquisition of seismic data. Exploration expense in 2008 includes the cost of one exploratory dry hole, leasehold impairments and cost incurred for seismic data acquisition.
Depreciation, depletion and amortization expense (“DD&A”). DD&A increased $31.0 million (17%) to $213.2 million in 2009 from DD&A of $182.2 million in 2008. Our DD&A rate per Mcfe produced averaged $3.25 in 2009 as compared to $3.03 for 2008. DD&A increased due to our higher production level and an increase in the amortization rate.
Impairment of oil and gas properties. We recorded impairments to our oil and gas properties of $0.1 million in 2009 as compared to impairment expense of $0.9 million in 2008. The impairments in 2009 and 2008 relate to fields where an impairment was indicated based on estimated future cash flows attributable to the fields’ estimated proved oil and natural gas reserves.
General and administrative expenses. General and administrative expenses of $39.2 million for 2009 were 21% higher than general and administrative expenses of $32.3 million for 2008. The increase primarily reflects our higher personnel costs in 2009 due to increased staffing necessary to support our exploration and development activities and an increase of $3.5 million in our stock-based compensation in 2009 as compared to 2008.
Interest expense. Interest expense decreased $9.2 million (37%) to $16.1 million in 2009 from interest expense of $25.3 million in 2008. The decrease was primarily the result of our lower outstanding borrowings and our lower average interest rates in 2009 as well as an increase in capitalized interest related to our unevaluated properties during 2009. Average borrowings under our bank credit facility decreased to $116.8 million in 2009 as compared to $301.5 million for 2008. The average interest rate on the outstanding borrowings under our credit facility decreased to 2.1% in 2009 as compared to 4.5% in 2008. Interest expense in 2009 also includes $6.1 million related to the issuance of $300.0 million of 83/8% senior notes in October 2009. We capitalized interest of $6.6 million and $2.3 million in 2009 and 2008, respectively, which reduced interest expense.
Income taxes. Income tax expense from continuing operations decreased in 2009 to a benefit of $10.8 million from a provision of $38.6 million in 2008. Our effective tax rate of 22.8% in 2009 and our effective tax rate of 39.9% in 2008 differed from federal income tax rate of 35% primarily due to the effect of nondeductible compensation and state income taxes.
Income (loss). We reported a loss of $36.5 million for 2009 as compared to income from continuing operations of $58.2 million for 2008. The loss per diluted share for 2009 was $0.81 on weighted average shares outstanding of 45.0 million as compared to income per share $1.26 for 2008 on weighted average diluted shares outstanding of 44.8 million. The loss in 2009 was primarily attributable to the declines in oil and natural gas prices that we realized.
Year Ended December 31, 2008 Compared to Year Ended December 31, 2007
Our operating data for 2007 and 2008 is summarized below:
(1)
Includes lease operating costs and production and ad valorem taxes.
(2)
Represents depreciation, depletion and amortization of oil and gas properties only.
Oil and gas sales. Our oil and gas sales increased $232.1 million (70%) in 2008 to $563.7 million from $331.6 million in 2007. The increase in our sales is primarily due to a 32% increase in our production combined with stronger oil and natural gas prices in 2008. Our realized oil price in 2008 increased by 43% and our realized natural gas price increased by 28% as compared to 2007. Production in 2008 increased by
15% over 2007 as the result of an acquisition of producing properties in South Texas which closed in December 2007. Our successful drilling activity replaced declines from our existing producing properties and accounted for the remaining 17% production increase in 2008.
Oil and gas operating expenses. Our oil and gas operating expenses, including production taxes, increased $21.9 million (34%) to $86.7 million in 2008 from $64.8 million in 2007. Oil and gas operating expenses per equivalent Mcf produced increased $0.02 to $1.45 in 2008 as compared to $1.43 in 2007. The increase in operating costs is due to the start-up of new wells and higher production and ad valorem taxes due to increased oil and gas prices.
Exploration expense. In 2008, we incurred $5.0 million in exploration expense as compared to $7.0 million in 2007. Exploration expense in 2008 primarily relates to one dry hole drilled, the impairment of unevaluated leases and the acquisition of seismic data. Exploration expense in 2007 included costs for four dry holes, leasehold impairments and costs incurred for seismic data acquisition.
DD&A. DD&A increased $56.9 million (45%) to $182.2 million in 2008 from $125.3 million in 2007. This increase resulted from our 32% increase in production in 2008 as compared to 2007 and an increase in our average DD&A rate from $2.76 to $3.03 per Mcfe produced. The increase in the average DD&A rate results from the higher finding costs associated with our property acquisitions and exploration and development activities in 2007 and 2008.
Impairment of oil and gas properties. We recorded impairments to our oil and gas properties of $0.9 million in 2008 and $0.5 million in 2007. The impairments in 2008 and 2007 relate to fields where an impairment was indicated based on estimated future cash flows attributable to the fields’ estimated proved oil and natural gas reserves.
General and administrative expenses. General and administrative expenses increased $4.5 million (16%) in 2008 to $32.3 million from $27.8 million in 2007. The increase primarily reflects higher personnel costs resulting from increased hiring to support our operating activities and an increase of $1.5 million in stock based compensation in 2008 as compared to 2007.
Interest expense. Interest expense decreased $7.0 million (22%) to $25.3 million in 2008 from $32.3 million in 2007. The decrease was primarily due to lower interest rates in 2008 and the capitalization of interest related to our unevaluated properties on which we are conducting exploration activity. The average interest rate on the outstanding borrowings under our credit facility decreased to 4.5% in 2008 as compared to 6.6% in 2007. We capitalized interest of $2.3 million in 2008 which reduced interest expense. No interest was capitalized in 2007. Average borrowings under our bank credit facility increased to $301.5 million in 2008 as compared to $279.7 million for 2007.
Impairment of marketable securities. We received shares of common stock of Stone from the sale of Bois d’Arc which were initially valued at $211.4 million. Subsequent to August 2008, the market value of the Stone shares declined significantly. We recognized an impairment charge of $162.7 million in the fourth quarter of 2008 based upon our assessment that this decline is other than temporary.
Income taxes. Income tax expense related to continuing operations increased by $9.4 million to $38.6 million in 2008 from $29.2 million for 2007. Higher income tax expenses in 2008 are primarily due to our higher income. Our effective tax rate of 39.9% for continuing operations in 2008 was comparable to our effective tax rate in 2007 of 39.0%.
Income from continuing operations. We reported income from continuing operations of $58.2 million in 2008, as compared to $45.6 million for 2007. The income per diluted share from continuing operations for
2008 was $1.26 on weighted average diluted shares outstanding of 44.8 million as compared to $1.01 for 2007 on weighted average diluted shares outstanding of 44.1 million. The higher income from continuing operations in 2008 results from higher oil and gas sales reflecting increased production and significantly higher oil and natural gas prices received. Higher revenues were only partially offset by higher operating costs, DD&A expense and general and administrative expense. Impairments of $163.6 million in 2008 reduced our income from continuing operations by $106.4 million.
Income from discontinued operations. Income from discontinued operations was $193.7 million in 2008 as compared to $23.3 million in 2007. The increase in income from discontinued operations in 2008 reflects the higher oil and gas prices in 2008 offset in part by higher operating and exploration expenses of the offshore operations. Also included in income from discontinued operations in 2008 is a net gain, after income taxes, of $158.1 million as a result of the sale of our interest in Bois d’Arc.
Liquidity and Capital Resources
Funding for our activities has historically been provided by our operating cash flow, debt or equity financings or asset dispositions. Our net cash provided by operating activities from continuing operations in 2009 totaled $176.3 million. Our other primary source of funds in 2009 was $289.2 million of net proceeds from the issuance of senior notes and $135.0 million of borrowings under our bank credit facility. A portion of the cash proceeds from our senior notes offering in 2009 was used to repay the balance outstanding on our bank credit facility. In 2008, our net cash flow provided by operating activities from continuing operations totaled $450.5 million. Our other primary source of funds in 2008 was the after tax proceeds of $421.8 million from the disposition of assets, including sale of our offshore operations. In 2007, our net cash flow provided by operating activities from continuing operations totaled $201.5 million. Our other primary source of funds in 2007 was a net increase of $325.0 million under our bank credit facility.
Our cash flow from operating activities from continuing operations in 2009 decreased by $274.2 million to $176.3 million as compared to 2008 primarily due to lower revenues which were primarily attributable to the lower natural gas and crude oil prices we realized during 2009. Our cash flow from operating activities from continuing operations in 2008 increased by $249.0 million to $450.5 million as compared to $201.5 million in 2007 primarily due to higher revenues which were attributable to our increased production and higher oil and natural gas prices.
Our primary need for capital, in addition to funding our ongoing operations, relates to the acquisition, development and exploration of our oil and gas properties, and the repayment of our debt. In 2009, our capital expenditures of $344.8 million decreased by $81.6 million as compared to 2008 capital expenditures of $426.4 million. During 2009 we initially funded our capital expenditures with operating cash flow and borrowings of $135.0 million under our bank credit facility. In October 2009 we issued $300.0 million of 83/8% senior notes due in 2017 and used the net proceeds from this offering of $289.2 to pay down the balance outstanding under our bank credit facility and to fund current and future capital expenditures. In 2008, we reduced the amount outstanding under our bank credit facility by $470.0 million, primarily by using the proceeds from our asset sales. Our capital expenditures in 2008 of $426.4 million decreased by $100.6 million from 2007 capital expenditures of $527.0 million. Capital expenditures in 2007 included $191.3 million for acquisitions of producing oil and gas properties. In 2008, we spent $113.0 million to acquire unevaluated acreage primarily relating to the exploration of the Haynesville shale formation. We did not acquire any producing oil and natural gas properties in 2008 or 2009.
Our annual capital expenditure activity is summarized in the following table:
The timing of most of our capital expenditures is discretionary because we have no material long-term capital expenditure commitments except for contracted drilling services. Consequently, we have a significant degree of flexibility to adjust the level of our capital expenditures as circumstances warrant. We currently expect to spend approximately $385.0 million for development and exploration projects in 2010, which will be funded primarily by cash flows from operating activities and cash on hand. Our operating cash flow and, therefore, our capital expenditures are highly dependent on oil and natural gas prices and, in particular, natural gas prices.
We do not have a specific acquisition budget for 2010 because the timing and size of acquisitions are unpredictable. Smaller acquisitions will generally be funded from operating cash flow. With respect to significant acquisitions, we intend to use borrowings under our bank credit facility, or other debt or equity financings to the extent available, to finance such acquisitions. The availability and attractiveness of these sources of financing will depend upon a number of factors, some of which will relate to our financial condition and performance and some of which will be beyond our control, such as prevailing interest rates, oil and natural gas prices and other market conditions. Lack of access to the debt or equity markets due to general economic conditions could impede our ability to complete acquisitions.
We have a $850.0 million bank credit facility with Bank of Montreal, as the administrative agent. The bank credit facility is a five-year revolving credit commitment that matures on December 15, 2011. Indebtedness under the bank credit facility is secured by all of our and our subsidiaries’ assets and is guaranteed by all of our subsidiaries. The bank credit facility is subject to borrowing base availability, which is redetermined semiannually based on the banks’ estimates of the future net cash flows of our oil and natural gas properties. As of December 31, 2009 the borrowing base was $500.0 million, all of which was available. The borrowing base may be affected by the performance of our properties and changes in oil and natural gas prices. The determination of the borrowing base is at the sole discretion of the administrative agent and the bank group. Borrowings under the bank credit facility bear interest, based on the utilization of the borrowing base, at our option at either (1) LIBOR plus 2% to 2.75% or (2) the base rate (which is the higher of the administrative agent’s prime rate, the federal funds rate plus 0.5% or 30 day LIBOR plus 1.5%) plus 0.5% to 1.25%. A commitment fee of 0.5% is payable on the unused borrowing base. The bank credit facility contains covenants that, among other things, restrict the payment of cash dividends in excess of $40.0 million, limit the amount of consolidated debt that we may incur and limit our ability to make certain loans and investments. The only financial covenants are the maintenance of a ratio of current assets, including the availability under the bank credit facility, to current liabilities of at least one-to-one and maintenance of a minimum tangible net worth. We were in compliance with these covenants as of December 31, 2009.
We have $175.0 million of 67/8% senior notes outstanding which are due March 1, 2012. Interest is payable semiannually on each March 1 and September 1. We also have $300.0 million of 87/8% senior notes outstanding which are due October 15, 2017. Interest is payable semiannually on each October 15 and April 15. The senior notes are unsecured obligations and are guaranteed by all of our subsidiaries.
We believe that our cash flow from operations and available borrowings under our bank credit facility will be sufficient to fund our operations and future growth as contemplated under our current business plan. However, if our plans or assumptions change or if our assumptions prove to be inaccurate, we may be required to seek additional capital. We cannot provide any assurance that we will be able to obtain such capital, or if such capital is available, that we will be able to obtain it on acceptable terms.
The following table summarizes our aggregate liabilities and commitments by year of maturity:
Future interest costs are based upon the effective interest rates of our outstanding senior notes.
We have obligations to incur future payments for dismantlement, abandonment and restoration costs of oil and gas properties. These payments are currently estimated to be incurred primarily after 2014. We record a separate liability for the fair value of these asset retirement obligations which totaled $6.6 million as of December 31, 2009.
Federal Taxation
Our federal income tax returns for the years ended December 31, 2006 and 2007 were recently under examination by the Internal Revenue Service, and these examinations have been closed with no additional tax liability. Our federal income tax returns for the years subsequent to December 31, 2007 remain subject to examination. Our income tax returns in major state income tax jurisdictions remain subject to examination for various periods subsequent to December 31, 2004. We currently believe that our significant filing positions are highly certain and that all of our significant income tax filing positions and deductions would be sustained upon audit. Therefore, we have no significant reserves for uncertain tax positions. Interest and penalties resulting from audits by tax authorities have been immaterial and are included in the provision for income taxes in the consolidated statements of operations.
At December 31, 2009, we had federal income tax net operating loss carryforwards of approximately $40.2 million. We have established a $23.0 million valuation allowance against a portion of the net operating loss carryforwards that we acquired in an acquisition due to a “change in control” limitation which will prevent us from fully realizing these carryforwards. The carryforwards expire from 2017 through 2021. The realization of these carryforwards depends on our ability to generate future taxable income in order to utilize these carryforwards.
Critical Accounting Policies
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and use assumptions that can affect the reported amounts of assets, liabilities, revenues or expenses.
Successful efforts accounting. We are required to select among alternative acceptable accounting policies. There are two generally acceptable methods for accounting for oil and gas producing activities. The full cost method allows the capitalization of all costs associated with finding oil and natural gas reserves, including certain general and administrative expenses. The successful efforts method allows only for the capitalization of costs associated with developing proven oil and natural gas properties as well as exploration costs associated with successful exploration projects. Costs related to exploration that are not successful are expensed when it is determined that commercially productive oil and gas reserves were not found. We have elected to use the successful efforts method to account for our oil and gas activities and we do not capitalize any of our general and administrative expenses.
Oil and natural gas reserve quantities. The determination of depreciation, depletion and amortization expense as well as impairments that are recognized on our oil and gas properties are highly dependent on the estimates of the proved oil and natural gas reserves attributable to our properties. Reserve engineering is a subjective process of estimating underground accumulations of oil and natural gas that cannot be precisely measured. The accuracy of any reserve estimate depends on the quality of available data, production history and engineering and geological interpretation and judgment. Because all reserve estimates are to some degree imprecise, the quantities of oil and natural gas that are ultimately recovered, production and operating costs, the amount and timing of future development expenditures and future oil and natural gas prices may all differ materially from those assumed in these estimates. The information regarding present value of the future net cash flows attributable to our proved oil and natural gas reserves are estimates only and should not be construed as the current market value of the estimated oil and natural gas reserves attributable to our properties. Thus, such information includes revisions of certain reserve estimates attributable to proved properties included in the preceding year’s estimates. Such revisions reflect additional information from subsequent activities, production history of the properties involved and any adjustments in the projected economic life of such properties resulting from changes in product prices. Any future downward revisions could adversely affect our financial condition, our borrowing ability, our future prospects and the value of our common stock.
Impairment of oil and gas properties. We evaluate our properties on a field area basis for potential impairment when circumstances indicate that the carrying value of an asset may not be recoverable. If impairment is indicated based on a comparison of the asset’s carrying value to its undiscounted expected future net cash flows, then it is recognized to the extent that the carrying value exceeds fair value. A significant amount of judgment is involved in performing these evaluations since the results are based on estimated future events. Expected future cash flows are determined using estimated future prices based on market based forward prices applied to projected future production volumes. The projected production volumes are based on the property’s proved and risk adjusted probable oil and natural gas reserve estimates at the end of the period. The oil and natural gas prices used for determining asset impairments will generally differ from those used in the standardized measure of discounted future net cash flows because the standardized measure requires the use of the average first day of the month historical price for the year.
Asset retirement obligations. We have obligations to remove tangible equipment and facilities and to restore land at the end of oil and gas production operations. Our removal and restoration obligations are primarily associated with plugging and abandoning wells and removing and disposing of any surface equipment used in production operations. Estimating the future restoration and removal costs is difficult and requires management to make estimates and judgments because most of the removal obligations are many
years in the future. Asset removal technologies and costs are constantly changing, as are regulatory, political, environmental, safety and public relations considerations.
Stock-based compensation. We follow the fair value based method in accounting for equity-based compensation. Under the fair value based method, compensation cost is measured at the grant date based on the fair value of the award and is recognized on a straight-line basis over the award vesting period.
New accounting standards. In December 2007, the Financial Accounting Standards Board (the “FASB”) issued new accounting guidance, which we adopted January 1, 2009, requiring reporting entities to present noncontrolling minority interests as a component of stockholder’s equity instead of a liability and providing guidance on the accounting for transactions between an entity and noncontrolling interests.
In September 2008, the FASB issued new guidance which requires that unvested share-based payment awards containing nonforfeitable rights to dividends be considered participating securities and included in the computation of basic and diluted earnings per share pursuant to the two-class method. Earnings per share data for all periods presented have been adjusted retrospectively for the effects of this new guidance.
In December 2008, the SEC released the Final Rule, “Modernization of Oil and Gas Reporting” (the “Final Rule”) which revises oil and gas reserve estimations and reporting disclosures. This release permits the use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserves volumes. The revised rules also limit the inclusion of proved undeveloped reserves to those that can be developed within a five year period unless specific circumstances justify a longer time. The Final Rule also allows companies to disclose their probable and possible oil and gas reserves. In addition, the new disclosure requirements require companies to: (i) report the independence and qualifications of its oil and gas reserves preparer or auditor; (ii) file reports when a third party is relied upon to prepare reserves estimates or conduct a reserves audit; and (iii) report oil and gas reserves using an average price based upon the average first of the month prior twelve month period rather than a year end price. In October 2009 the SEC staff issued Staff Accounting Bulletin 113 to modify Topic 12, Oil and Gas Producing Activities, in order to conform financial reporting practices for public companies with the Final Rule. In January 2010 the FASB issued new accounting guidance to align the reserve calculation and disclosure requirements within generally accepted accounting principles with the Final Rule. All of these rule changes became effective on December 31, 2009. We have adopted these changes and conformed our reserve estimation and disclosure practices in accordance with the guidance contained in all of these releases.
Related Party Transactions
In recent years, we have not entered into any material transactions with our officers or directors apart from the compensation they are provided for their services. We also have not entered into any business transactions with our significant stockholders or any other related parties.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Oil and Natural Gas Prices
Our financial condition, results of operations and capital resources are highly dependent upon the prevailing market prices of oil and natural gas. These commodity prices are subject to wide fluctuations and market uncertainties due to a variety of factors that are beyond our control. Factors influencing oil and natural gas prices include the level of global demand for crude oil, the foreign supply of oil and natural gas,
the establishment of and compliance with production quotas by oil exporting countries, weather conditions which determine the demand for natural gas, the price and availability of alternative fuels and overall economic conditions. It is impossible to predict future oil and natural gas prices with any degree of certainty. Sustained weakness in oil and natural gas prices may adversely affect our financial condition and results of operations, and may also reduce the amount of oil and natural gas reserves that we can produce economically. Any reduction in our oil and natural gas reserves, including reductions due to price fluctuations, can have an adverse affect on our ability to obtain capital for our exploration and development activities. Similarly, any improvements in oil and natural gas prices can have a favorable impact on our financial condition, results of operations and capital resources. Based on our oil and natural gas production in 2009, a $1.00 change in the price per barrel of oil would have resulted in a change in our cash flow for such period by approximately $0.8 million and a $1.00 change in the price per Mcf of natural gas would have changed our cash flow by approximately $53.0 million.
We hedged approximately 10% of our price risks associated with our natural gas sales during 2009. Because our swap agreements were designated as hedge derivatives, changes in their fair value generally were reported as a component of accumulated other comprehensive loss until the related sales of production occurred. At that time, the realized hedge derivative gain or loss was transferred to oil and gas sales in our consolidated income statement. None of our derivative contracts had margin requirements or collateral provisions that could have required funding prior to the scheduled cash settlement date. We had no crude oil or natural gas derivative financial instruments outstanding as of December 31, 2009 and none of our oil or gas production is hedged in 2010 or thereafter.
Interest Rates
At December 31, 2009, we had $470.8 million of long-term debt. Of this amount, $175.0 million bears interest at a fixed rate of 67/8% and $295.8 million bears interest at 83/8% (with an effective interest rate of 85/8%). The fair market value of our fixed rate debt as of December 31, 2009 was $479.9 million based on the market price of 102% of the face amount. At December 31, 2009, we had no amounts outstanding under our bank credit facility, which is subject to variable rates of interest. Borrowings under the bank credit facility bear interest at a fluctuating rate that is tied to LIBOR or the corporate base rate, at our option. We had no interest rate derivatives outstanding during 2009 or at December 31, 2009.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements are included on pages to of this report.
We have prepared these financial statements in conformity with generally accepted accounting principles. We are responsible for the fairness and reliability of the financial statements and other financial data included in this report. In the preparation of the financial statements, it is necessary for us to make informed estimates and judgments based on currently available information on the effects of certain events and transactions.
Our independent public accountants, Ernst & Young LLP, are engaged to audit our financial statements and to express an opinion thereon. Their audit is conducted in accordance with auditing standards generally accepted in the United States to enable them to report whether the financial statements present fairly, in all material respects, our financial position and results of operations in accordance with accounting principles generally accepted in the United States.
The audit committee of our board of directors is comprised of three directors who are not our employees. This committee meets periodically with our independent public accountants and management. Our independent public accountants have full and free access to the audit committee to meet, with and without management being present, to discuss the results of their audits and the quality of our financial reporting.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer have evaluated, as required by Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this Annual Report on Form 10-K. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the design and operation of our disclosure controls and procedures are adequate and effective in ensuring that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Changes in internal control over financial reporting. There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the fourth quarter of 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The management of Comstock Resources, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with generally accepted accounting principles.
As of December 31, 2009, management assessed the effectiveness of the Company’s internal control over financial reporting based on the criteria for effective internal control over financial reporting established in “Internal Control - Integrated Framework,” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on the assessment, management determined that the Company maintained effective internal control over financial reporting as of December 31, 2009, based on those criteria.
Ernst & Young LLP, the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report on Form 10-K, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. The report, which expresses unqualified opinions on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009 is included below.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Comstock Resources, Inc.
We have audited Comstock Resources, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Comstock Resources, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Comstock Resources, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Comstock Resources, Inc. and subsidiaries as of December 31, 2008 and 2009, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2009 and our report dated February 26, 2010 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Dallas, Texas
February 26, 2010
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item is incorporated herein by reference to “Business - Directors and Executive Officers” in this Form 10-K and to our definitive proxy statement which will be filed with the SEC within 120 days after December 31, 2009.
Code of Ethics. We have adopted a Code of Business Conduct and Ethics that is applicable to all of our directors, officers and employees as required by New York Stock Exchange rules. We have also adopted a Code of Ethics for Senior Financial Officers that is applicable to our Chief Executive Officer and Senior Financial Officers. Both the Code of Business Conduct and Ethics and Code of Ethics for Senior Financial Officers may be found on our website at www.comstockresources.com. Both of these documents are also available, without charge, to any stockholder upon request to: Comstock Resources, Inc., Attn: Investor Relations, 5300 Town and Country Blvd., Suite 500, Frisco, Texas 75034, (972) 668-8800. We intend to disclose any amendments or waivers to these codes that apply to our Chief Executive Officer and senior financial officers on our website in accordance with applicable SEC rules. Please see the definitive proxy statement for our 2010 annual meeting, which will be filed with the SEC within 120 days of December 31, 2009, for additional information regarding our corporate governance policies.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
The information required by this item is incorporated herein by reference to our definitive proxy statement which will be filed with the SEC within 120 days after December 31, 2009.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated herein by reference to our definitive proxy statement which will be filed with the SEC within 120 days after December 31, 2009.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTORS INDEPENDENCE
The information required by this item is incorporated herein by reference to our definitive proxy statement which will be filed with the SEC within 120 days after December 31, 2009.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated herein by reference to our definitive proxy statement which will be filed with the SEC within 120 days after December 31, 2009.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements:
1. The following consolidated financial statements and notes of Comstock Resources, Inc. are included on Pages to of this report:
2. All financial statement schedules are omitted because they are not applicable, or are immaterial or the required information is presented in the consolidated financial statements or the related notes.
(b) Exhibits:
The exhibits to this report required to be filed pursuant to Item 15 (c) are listed below.
*
Filed herewith.
+
Furnished herewith.
#
Management contract or compensatory plan document.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
COMSTOCK RESOURCES, INC.
By:
/s/ M. JAY ALLISON
M. Jay Allison
President and Chief Executive Officer
(Principal Executive Officer)
Date: February 26, 2010
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
COMSTOCK RESOURCES, INC.
FINANCIAL STATEMENTS
INDEX
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Comstock Resources, Inc.
We have audited the accompanying consolidated balance sheets of Comstock Resources, Inc. and subsidiaries as of December 31, 2008 and 2009, and the related consolidated statements of operations, stockholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Comstock Resources, Inc. and subsidiaries at December 31, 2008 and 2009, and the consolidated results of their operations and cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, during the year ended December 31, 2009 the Company adopted new accounting standards relating to the manner in which basic and diluted earnings per share are calculated and the presentation of noncontrolling interests in consolidated subsidiaries, and changed its oil and gas reserves and related disclosures as a result of adopting new oil and gas reserve estimation and disclosure requirements.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Comstock Resources, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2010 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Dallas, Texas
February 26, 2010
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of December 31, 2008 and 2009
The accompanying notes are an integral part of these statements.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2007, 2008 and
The accompanying notes are an integral part of these statements.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
For the Years Ended December 31, 2007, 2008 and
The accompanying notes are an integral part of these statements.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2007, 2008 and
The accompanying notes are an integral part of these statements.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1)
Summary of Significant Accounting Policies
Accounting policies used by Comstock Resources, Inc. reflect oil and natural gas industry practices and conform to accounting principles generally accepted in the United States of America.
Basis of Presentation and Principles of Consolidation
Comstock Resources, Inc. is engaged in oil and natural gas exploration, development and production, and the acquisition of producing oil and natural gas properties. The Company’s operations are primarily focused in Texas and Louisiana. The consolidated financial statements include the accounts of Comstock Resources, Inc. and its wholly owned or controlled subsidiaries (collectively, “Comstock” or the “Company”). All significant intercompany accounts and transactions have been eliminated in consolidation. The Company accounts for its undivided interest in properties using the proportionate consolidation method, whereby its share of assets, liabilities, revenues and expenses are included in its financial statements.
Discontinued Offshore Operations
On August 28, 2008, the Company’s subsidiary, Bois d’Arc Energy, Inc. (“Bois d’Arc”) completed a merger with Stone Energy Corporation (“Stone”) pursuant to which each outstanding share of the common stock of Bois d’Arc was exchanged for cash in the amount of $13.65 per share and 0.165 shares of Stone common stock. Prior to the merger, Comstock conducted all of its offshore operations through Bois d’Arc. As a result of the merger, Comstock received net proceeds of $439.0 million in cash and 5,317,069 shares of Stone common stock in exchange for its interest in Bois d’Arc. As a result of the merger of Bois d’Arc and Stone, the consolidated financial statements and the related notes thereto present the Company’s offshore operations as a discontinued operation. No general and administrative or interest costs incurred by Comstock have been allocated to the discontinued operations during the periods presented. Unless indicated otherwise, the amounts presented in the accompanying notes to the consolidated financial statements relate to the Company’s continuing operations.
The merger of Bois d’Arc with Stone resulted in Comstock recognizing a gain on the disposal of the discontinued operations in the three months ended September 30, 2008 of $158.1 million, after income taxes of $85.3 million and the Company’s share of transaction-related costs incurred by Bois d’Arc of $11.7 million. Transaction-related costs incurred by Bois d’Arc included accounting, legal and investment banking fees, change-in-control and other compensation costs that became obligations as a result of the merger.
Income from discontinued operations is comprised of the following:
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Reclassifications
Certain reclassifications have been made to prior periods’ financial statements to conform to the current presentation.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual amounts could differ from those estimates. Changes in the future estimated oil and natural gas reserves or the estimated future cash flows attributable to the reserves that are utilized for impairment analysis could have a significant impact on the future results of operations.
Concentration of Credit Risk and Accounts Receivable
Financial instruments that potentially subject the Company to a concentration of credit risk consist principally of cash and cash equivalents, accounts receivable and derivative financial instruments. The Company places its cash with high credit quality financial institutions and its derivative financial instruments with financial institutions and other firms that management believes have high credit ratings. Substantially all of the Company’s accounts receivable are due from either purchasers of oil and gas or participants in oil and gas wells for which the Company serves as the operator. Generally, operators of oil and gas wells have the right to offset future revenues against unpaid charges related to operated wells. Oil and gas sales are generally unsecured. The Company has not had any significant credit losses in the past and believes its accounts receivable are fully collectible. Accordingly, no allowance for doubtful accounts has been provided.
Marketable Securities
Marketable securities are recorded at fair value, and temporary unrealized holding gains and losses are recorded, net of income tax, as a separate component of accumulated other comprehensive income. Unrealized losses are charged against net earnings when a decline in fair value is determined to be other than temporary. Comstock considers several factors to determine whether a loss is other than temporary. These factors include but are not limited to: (i) the length of time a security is in an unrealized loss position, (ii) the extent to which fair value is less than cost, (iii) the financial condition and near term prospects of the issuer and (iv) the ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value. Realized gains and losses are accounted for using the specific identification method.
The Company received shares of Stone common stock as part of the proceeds from the sale of its interest in Bois d’Arc. The Company does not exert influence over the operating and financial policies of Stone and has classified its investment in these shares as an available-for-sale security in the accompanying consolidated balance sheet. Prior to the lapse of certain trading restrictions in August 2009, the fair value of the Stone common stock included a discount to the public market price to reflect certain trading restrictions.
When the Stone shares were acquired in August 2008, the value was determined to be $211.4 million by an independent valuation specialist. As of December 31, 2008 the estimated fair value of the Stone shares had fallen to $48.9 million. Comstock determined that this decline in the fair value of the Stone common
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
stock in 2008 was not temporary, which resulted in the recognition of an impairment charge of $162.7 million before income taxes in 2008. As of December 31, 2009, the estimated fair value of the Stone shares, based on the market price for the shares, was $96.0 million after recognizing an unrealized gain before income taxes of $47.1 million.
Other Current Assets
Other current assets at December 31, 2008 and 2009 consist of the following:
Property and Equipment
The Company follows the successful efforts method of accounting for its oil and natural gas properties. Acquisition costs for proved oil and natural gas properties, costs of drilling and equipping productive wells, and costs of unsuccessful development wells are capitalized and amortized on an equivalent unit-of-production basis over the life of the remaining related oil and gas reserves. Equivalent units are determined by converting oil to natural gas at the ratio of one barrel of oil for six thousand cubic feet of natural gas. Cost centers for amortization purposes are determined on a field area basis. Costs incurred to acquire oil and gas leasehold are capitalized. Unproved oil and gas properties are periodically assessed and any impairment in value is charged to exploration expense. The estimated future costs of dismantlement, restoration, plugging and abandonment of oil and gas properties and related facilities disposal are capitalized when asset retirement obligations are incurred and amortized as part of depreciation, depletion and amortization expense. The costs of unproved properties which are determined to be productive are transferred to proved oil and gas properties and amortized on an equivalent unit-of-production basis. Exploratory expenses, including geological and geophysical expenses and delay rentals for unevaluated oil and gas properties, are charged to expense as incurred. Exploratory drilling costs are initially capitalized as unproved property but charged to expense if and when the well is determined not to have found proved oil and gas reserves. Exploratory drilling costs are evaluated within a one-year period after the completion of drilling.
The Company assesses the need for an impairment of the costs capitalized for its oil and gas properties on a property or cost center basis. If impairment is indicated based on undiscounted expected future cash flows attributable to the property, then a provision for impairment is recognized to the extent that net capitalized costs exceed the estimated fair value of the property. Expected future cash flows are determined using estimated future prices based on market based forward prices applied to projected future production volumes. The projected production volumes are based on the property’s proved and risk adjusted probable oil and natural gas reserve estimates at the end of the period. The oil and natural gas prices used for determining asset impairments will generally differ from those used in the standardized measure of discounted future net cash flows because the standardized measure requires the use of actual prices on the last day of the period, for periods prior to December 31, 2009, and an average price based on the first day of
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
each month of the year commencing with December 31, 2009. The Company recognized impairment charges related to its oil and gas properties of $0.5 million, $0.9 million and $0.1 million in 2007, 2008, and 2009, respectively.
Other property and equipment consists primarily of gas gathering systems, computer equipment, furniture and fixtures and interests in private aircraft which are depreciated over estimated useful lives ranging from five to 311/2 years on a straight-line basis.
Reserve for Future Abandonment Costs
The Company records a liability in the period in which an asset retirement obligation is incurred, in an amount equal to the discounted estimated fair value of the obligation that is capitalized. Thereafter this liability is accreted up to the final retirement cost. Accretion of the discount is included as part of depreciation, depletion and amortization in the accompanying consolidated financial statements. The Company’s asset retirement obligations relate to future plugging and abandonment costs of its oil and gas properties and related facilities disposal.
The following table summarizes the changes in the Company’s total estimated liability:
Other Assets
Other assets primarily consist of deferred costs associated with issuance of the Company’s senior notes and bank credit facility. These costs are amortized over the life of the senior notes and the life of the bank credit facility on a straight-line basis which approximates the amortization that would be calculated using an effective interest rate method.
Stock-based Compensation
The Company follows the fair value based method in accounting for equity-based compensation. Under the fair value based method, compensation cost is measured at the grant date based on the fair value of the award and is recognized on a straight-line basis over the award vesting period. Excess tax benefits on stock-based compensation are recognized as an increase to additional paid-in capital and as a part of cash flows from financing activities. Comstock’s excess income tax benefit realized from tax deductions associated with stock-based compensation totaled $6.5 million, $8.8 million and $1.1 million for the years ended December 31, 2007, 2008 and 2009, respectively.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Segment Reporting
The Company presently operates in one business segment, the exploration and production of oil and natural gas.
Derivative Instruments and Hedging Activities
The Company accounts for derivative instruments (including certain derivative instruments embedded in other contracts) as either an asset or liability measured at its fair value. Changes in the fair value of derivatives are recognized currently in earnings unless specific hedge accounting criteria are met. The Company estimates fair value based on quotes obtained from the counterparties to the derivative contract. The fair value of derivative contracts that expire in less than one year are recognized as current assets or liabilities. Those that expire in more than one year are recognized as long-term assets or liabilities. Derivative financial instruments that are not accounted for as hedges are adjusted to fair value through income. If the derivative is designated as a cash flow hedge, changes in fair value are recognized in other comprehensive income until the hedged item is recognized in earnings.
Major Purchasers
In 2009 the Company had two purchasers of its oil and natural gas production that accounted for 22% and 11%, respectively, of total oil and gas sales. In 2008, the Company had three purchasers of its oil and natural gas production that accounted for 14%, 12% and 11%, respectively, of total oil and gas sales. In 2007, the Company had three purchasers of its oil and natural gas production that accounted for 15%, 11% and 11%, respectively, of total oil and gas sales. The loss of any of these customers would not have a material adverse effect on the Company as there is an available market for its crude oil and natural gas production from other purchasers.
Revenue Recognition and Gas Balancing
Comstock utilizes the sales method of accounting for oil and natural gas revenues whereby revenues are recognized at the time of delivery based on the amount of oil or natural gas sold to purchasers. The amount of oil or natural gas sold may differ from the amount to which the Company is entitled based on its revenue interests in the properties. The Company did not have any significant imbalance positions at December 31, 2008 or 2009.
General and Administrative Expenses
General and administrative expenses are reported net of reimbursements of overhead costs that are received from working interest owners of the oil and gas properties operated by the Company of $9.3 million, $10.1 million and $10.2 million in 2007, 2008 and 2009, respectively.
Income Taxes
The Company accounts for income taxes using the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax basis, as well as the future tax consequences attributable to the future utilization of existing tax net operating loss and other types of carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
to taxable income in the years in which those temporary differences and carryforwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that the change in rate is enacted.
Earnings Per Share
Basic earnings per share is determined without the effect of any outstanding potentially dilutive stock options and diluted earnings per share is determined with the effect of outstanding stock options that are potentially dilutive. On January 1, 2009, the Company adopted new accounting guidance issued by the Financial Accounting Standards Board (the “FASB”) which requires that unvested share-based payment awards containing nonforfeitable rights to dividends be considered participating securities and included in the computation of basic and diluted earnings per share pursuant to the two-class method. Earnings per share data for all periods presented have been adjusted retrospectively for the effects of this new guidance. The effect of adoption in each year was as follows:
Basic and diluted earnings per share for 2007, 2008 and 2009 were determined as follows:
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Weighted average shares of unvested restricted stock included in common stock outstanding were as follows:
Stock options and warrants to purchase common stock at exercise prices in excess of the average actual stock price for the period that were anti-dilutive and that were excluded from the determination of diluted earnings per share are as follows:
Such options were excluded as anti-dilutive to earnings per share due to the net loss in 2009. In 2008, the excluded options that were anti-dilutive were at exercise prices in excess of the average actual stock price for the period.
At December 31, 2008 and 2009, 1,691,750 and 2,036,450 shares of unvested restricted stock, respectively, are included in common stock outstanding as such shares have a nonforfeitable right to participate in any dividends that might be declared and have the right to vote.
Fair Value Measurements
The Company holds certain items that are required to be measured at fair value. These include cash equivalents held in money market funds, marketable securities comprised of shares of Stone common stock, and derivative financial instruments in the form of natural gas price swap agreements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. A three-level hierarchy is followed for disclosure to show the extent and level of judgment used to estimate fair value measurements:
Level 1 - Inputs used to measure fair value are unadjusted quoted prices that are available in active markets for the identical assets or liabilities as of the reporting date.
Level 2 - Inputs used to measure fair value, other than quoted prices included in Level 1, are either directly or indirectly observable as of the reporting date through correlation with market data, including quoted prices for similar assets and liabilities in active markets and quoted prices in markets that are not active. Level 2 also includes assets and liabilities that are valued using models or other pricing methodologies that do not require significant judgment since the input assumptions used in the models, such as interest rates and volatility factors, are corroborated by readily observable data from actively quoted markets for substantially the full term of the financial instrument.
Level 3 - Inputs used to measure fair value are unobservable inputs that are supported by little or no market activity and reflect the use of significant management judgment. These values are generally determined using pricing models for which the assumptions utilize management’s estimates of market participant assumptions.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Prior to August 2009, the fair value of the Stone common stock recorded by the Company included a discount from the quoted public market price to reflect the impact of trading restrictions. The Company determined the impact of the trading restrictions on the fair value of the Stone common stock utilizing a standard option pricing model based on inputs that were either readily available in public markets or which could be derived from information available in publicly quoted markets. Accordingly, the Company categorized the Stone common stock valuation as a Level 2 measurement for periods prior to August 2009. For periods subsequent to August 2009, the date at which the trading restrictions lapsed, the Company measures the value of the Stone common stock based on unadjusted public market prices, and the valuation of these shares is now categorized as a Level 1 measurement. The Company’s natural gas price swap agreements were not traded on a public exchange. The value of natural gas price swap agreements, prior to their expiration in December 2009, was determined utilizing a discounted cash flow model based on inputs that are not readily available in public markets and, accordingly, the valuation of these swap agreements was categorized as a Level 3 measurement.
The following table summarizes financial assets accounted for at fair value as of December 31, 2009:
The following table summarizes the changes in the fair values of the natural gas swap derivative financial instruments, which are Level 3 liabilities, for the twelve months ended December 31, 2008 and 2009:
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table presents the carrying amounts and estimated fair value of the Company’s other financial instruments as of December 31, 2008 and 2009:
The fair market value of the Company’s fixed rate debt was based on the market prices as of December 31, 2008 and 2009. The fair market value of the floating rate debt outstanding at December 31, 2008 approximated its carrying value.
Statements of Cash Flows
For the purpose of the consolidated statements of cash flows, the Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. At December 31, 2008 and 2009, the Company’s cash investments consisted of prime shares in institutional preferred money market funds.
Cash payments made for interest and income taxes for the years ended December 31, 2007, 2008 and 2009, respectively, were as follows:
The Company capitalizes interest on its unevaluated oil and gas property costs during periods when it is conducting exploration activity on this acreage. The Company capitalized interest of $2.3 million and $6.6 million in 2008 and 2009, respectively, which reduced interest expense and increased the carrying value of its unevaluated oil and gas properties.
New Accounting Standards
In December 2007, the FASB issued new accounting guidance, which the Company adopted January 1, 2009, requiring reporting entities to present noncontrolling minority interests as a component of stockholder’s equity instead of a liability and providing guidance on the accounting for transactions between an entity and noncontrolling interests. As a result of the implementation of this guidance, $220.3 million relating to noncontrolling interests in Bois d’Arc as of December 31, 2006 has been reclassified from liabilities to noncontrolling interests within stockholder’s equity.
In September 2008, the FASB issued new guidance which requires that unvested share-based payment awards containing nonforfeitable rights to dividends be considered participating securities and included in the computation of basic and diluted earnings per share pursuant to the two-class method. Earnings per share data for all periods presented have been adjusted retrospectively for the effects of this new guidance.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In December 2008, the Securities and Exchange Commission released the Final Rule, “Modernization of Oil and Gas Reporting” (the “Final Rule”) which revises oil and gas reserve estimations and reporting disclosures. This release permits the use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserves volumes. The revised rules also limit the inclusion of proved undeveloped reserves to those that can be developed within a five year period unless specific circumstances justify a longer time. The Final Rule allows companies to disclose their probable and possible oil and gas reserves. In addition, the new disclosure requirements require companies to: (i) report the independence and qualifications of its oil and gas reserves preparer or auditor; (ii) file reports when a third party is relied upon to prepare reserves estimates or conduct a reserves audit; and (iii) report oil and gas reserves using an average price based upon the average first of the month prior twelve month period rather than a year-end price. In October 2009, the SEC staff issued Staff Accounting Bulletin 113 to modify Topic 12, Oil and Gas Producing Activities, in order to conform financial reporting practices for public companies with the Final Rule. In January 2010, the FASB issued new accounting guidance to align the reserve estimation and disclosure requirements within generally accepted accounting principles with the Final Rule. All of these rule changes became effective on December 31, 2009. The Company has adopted these changes and conformed its reserve estimation and disclosure practices in accordance with the guidance contained in all of these releases.
Comprehensive Income
Comprehensive income consists of the following:
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table provides a summary of the amounts included in accumulated other comprehensive income (loss), net of income taxes, which are solely attributable to the Company’s natural gas price swap financial instruments and marketable securities, for the years ended December 31, 2008 and 2009:
Subsequent Events
Subsequent events were evaluated through February 26, 2010, the date the consolidated financial statements were issued.
(2)
Acquisitions and Dispositions of Oil and Gas Properties
In June 2007, the Company acquired oil and gas properties in South Texas for $31.2 million in cash. The Company acquired proved oil and gas reserves of 9.1 billion cubic feet (“Bcf”) of natural gas. The transaction was funded with borrowings under Comstock’s bank credit facility. The pro forma impact of this acquisition was not material to the Company’s historical results of operations.
In December 2007, the Company acquired certain oil and gas properties in South Texas for $160.1 million in cash. The Company acquired proved oil and gas reserves of 70.1 Bcf. The transaction was funded with borrowings under the Company’s bank credit facility and the pro forma effect of the transaction was not material to the Company’s historical results of operations.
In June and September 2008, the Company sold its interests in certain producing properties in East and South Texas and received aggregate net proceeds of $129.6 million. Comstock recognized a gain of $26.6 million on these sales for financial reporting purposes.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(3)
Oil and Gas Producing Activities
Set forth below is certain information regarding the aggregate capitalized costs of oil and gas properties and costs incurred by the Company for its oil and gas property acquisition, development and exploration activities:
Capitalized Costs
Costs Incurred
(4)
Long-term Debt
Long-term debt is comprised of the following:
The discount is being amortized over the life of the senior notes using the effective interest rate method.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes Comstock’s debt as of December 31, 2009 by year of maturity:
Comstock has a $850.0 million bank credit facility with Bank of Montreal, as the administrative agent. The credit facility is a five year revolving credit commitment that matures on December 15, 2011. Indebtedness under the credit facility is secured by substantially all of Comstock’s assets and is guaranteed by all of its subsidiaries. The credit facility is subject to borrowing base availability, which is redetermined semiannually based on the banks’ estimates of the Company’s future net cash flows of oil and natural gas properties. The borrowing base may be affected by the performance of Comstock’s properties and changes in oil and natural gas prices. The determination of the borrowing base is at the sole discretion of the administrative agent and the bank group. As of December 31, 2009, the borrowing base was $500.0 million, all of which was available. Borrowings under the credit facility bear interest, based on the utilization of the borrowing base, at Comstock’s option at either (1) LIBOR plus 2% to 2.75% or (2) the base rate (which is the higher of the administrative agent’s prime rate, the federal funds rate plus 0.5% or 30 day LIBOR plus 1.5%) plus 0.5% to 1.25%. A commitment fee of 0.5% is payable annually on the unused borrowing base. The credit facility contains covenants that, among other things, restrict the payment of cash dividends in excess of $40.0 million, limit the amount of consolidated debt that Comstock may incur and limit the Company’s ability to make certain loans and investments. The only financial covenants are the maintenance of a ratio of current assets, including availability under the bank credit facility, to current liabilities of at least one-to-one and maintenance of a minimum tangible net worth. The Company was in compliance with these covenants as of December 31, 2009.
Comstock has $175.0 million of 67/8% senior notes outstanding which mature on March 1, 2012. Interest is payable semiannually on each March 1 and September 1. The Company also has $300.0 million of 83/8% senior notes outstanding which mature on October 15, 2017. Interest is payable semiannually on each April 15 and October 15. The senior notes are unsecured obligations of Comstock and are guaranteed by all of Comstock’s subsidiaries. The subsidiary guarantors are 100% owned and all of the guarantees are full and conditional and joint and several. As of December 31, 2009, Comstock had no assets or operations which are independent of its subsidiaries. There are no restrictions on the ability of Comstock to obtain funds from its subsidiaries through dividends or loans.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(5)
Commitments and Contingencies
Commitments
The Company rents office space and other facilities under noncancelable operating leases. Rent expense for the years ended December 31, 2007, 2008 and 2009 was $0.8 million, $1.0 million and $1.2 million, respectively. Minimum future payments under the leases are as follows:
As of December 31, 2009, the Company had commitments for contracted drilling rigs of $97.2 million through September 2012. The Company also has entered into natural gas transportation agreements through July 2019. Maximum commitments under these transportation agreements as of December 31, 2009 totaled $36.9 million.
Contingencies
From time to time, the Company is involved in certain litigation that arises in the normal course of its operations. The Company records a loss contingency for these matters when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company does not believe the resolution of these matters will have a material effect on the Company’s financial position or results of operations.
(6)
Stockholders’ Equity
The authorized capital stock of Comstock consists of 75 million shares of common stock, $.50 par value per share, and 5 million shares of preferred stock, $10.00 par value per share. The preferred stock may be issued in one or more series, and the terms and rights of such stock will be determined by the Board of Directors. There were no shares of preferred stock outstanding at December 31, 2008 or 2009.
Comstock’s Board of Directors has designated 500,000 shares of the preferred stock as Series B Junior Participating Preferred Stock (the “Series B Junior Preferred Stock”) in connection with the adoption of a shareholder rights plan. At December 31, 2008 and 2009, there were no shares of Series B Junior Preferred Stock issued or outstanding. The Series B Junior Preferred Stock is entitled to receive cumulative quarterly dividends per share equal to the greater of $1.00 or 100 times the aggregate per share amount of all dividends (other than stock dividends) declared on common stock since the immediately preceding quarterly dividend payment date or, with respect to the first payment date, since the first issuance of Series B Junior Preferred Stock. Holders of the Series B Junior Preferred Stock are entitled to 100 votes per share (subject to adjustment to prevent dilution) on all matters submitted to a vote of the stockholders. The Series B Junior Preferred Stock is neither redeemable nor convertible. The Series B Junior Preferred Stock ranks senior to the common stock but junior to all other classes of preferred stock.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The Company had 80,600 stock purchase warrants outstanding at December 31, 2008, all of which were exercised during 2009. Warrants were exercised to purchase 7,600, 98,900 and 80,600 shares in 2007, 2008 and 2009, respectively. Such exercises yielded net proceeds to the Company of $0.1 million, $1.8 million and $1.6 million in 2007, 2008 and 2009, respectively.
(7)
Stock-based Compensation
The Company grants restricted shares of common stock and stock options to key employees and directors as part of their compensation. On May 19, 2009, the stockholders approved the 2009 Long-term Incentive Plan for management including officers, directors and managerial employees which replaced the 1999 Long-term Incentive Plan. As of December 31, 2009, the 2009 Long-term Incentive Plan provides for future awards of stock options, restricted stock grants or other equity awards of up to 3,447,675 shares of common stock.
During 2007, 2008 and 2009, the Company recorded $10.8 million, $12.3 million and $15.8 million, respectively, in stock-based compensation expense in general and administrative expenses. The excess income tax benefit realized from tax deductions associated with stock-based compensation totaled $6.5 million, $8.8 million and $1.1 million for the years ended December 31, 2007, 2008 and 2009, respectively.
Stock Options
The Company amortizes the fair value of stock options granted over the vesting period using the straight-line method. The fair value of each award is estimated as of the date of grant using the Black-Scholes options pricing model. Total compensation expense recognized for all outstanding stock options for the years ended December 31, 2007, 2008 and 2009 was $1.6 million, $1.5 million and $0.8 million, respectively.
The Company did not issue any stock options during 2009. The following table summarizes the assumptions used to value stock options granted in the years ended December 31, 2007 and 2008:
The expected volatility for grants is calculated using an analysis of the common stock’s historical volatility. Risk-free interest rates are determined using the implied yield currently available for zero-coupon U.S. government issues with a remaining term equal to the expected life of the options.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table summarizes information related to stock options outstanding at December 31, 2009:
The following tables summarize information related to stock option activity under the Company’s incentive plans for the years ended December 31, 2007, 2008 and 2009:
As of December 31, 2009, total unrecognized compensation cost related to unvested stock options of $0.4 million was expected to be recognized over a period of one year. The aggregate intrinsic value of stock options outstanding at December 31, 2009 was $7.7 million based on the closing price for the Company’s common stock on December 31, 2009. The aggregate intrinsic value of vested stock options was $7.5 million on December 31, 2009. Options granted in 2007 and 2008 were granted with exercise prices equal to the closing prices of the Company’s common stock on the respective grant dates. The total intrinsic value of options exercised was $17.1 million, $24.4 million and $0.6 million for the years ended December 31, 2007, 2008 and 2009, respectively.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Restricted Stock
The fair value of restricted stock grants is amortized over the vesting period using the straight-line method. Total compensation expense recognized for restricted stock grants was $9.2 million, $10.8 million and $15.0 million for the years ended December 31, 2007, 2008 and 2009, respectively. The fair value of each restricted share on the date of grant is equal to its fair market price. A summary of restricted stock activity for the years ended December 31, 2007, 2008 and 2009 is presented below:
Total unrecognized compensation cost related to unvested restricted stock of $43.4 million as of December 31, 2009 is expected to be recognized over a period of three years. The fair value of restricted stock which vested in 2007, 2008 and 2009 was $5.7 million, $6.9 million and $9.4 million, respectively.
(8)
Retirement Plan
The Company has a 401(k) profit sharing plan which covers all of its employees. At its discretion, Comstock may match a certain percentage of the employees’ contributions to the plan. Matching contributions to the plan were $255,000, $302,000 and $358,000 for the years ended December 31, 2007, 2008 and 2009, respectively.
(9)
Income Taxes
The following is an analysis of the consolidated income tax expense (benefit) from continuing operations:
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Deferred income taxes are provided to reflect the future tax consequences or benefits of differences between the tax basis of assets and liabilities and their reported amounts in the financial statements using enacted tax rates. The difference between the Company’s customary rate of 35% and the effective tax rate on income from continuing operations is due to the following:
The tax effects of significant temporary differences representing the net deferred tax asset and liability at December 31, 2008 and 2009 were as follows:
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
At December 31, 2009, Comstock had the following carryforwards available to reduce future income taxes:
The utilization of the net operating loss carryforward is limited to approximately $1.1 million per year pursuant to a prior change of control of an acquired company. Accordingly, a valuation allowance of $23.0 million, with a tax effect of $8.0 million, has been established for the estimated net operating loss carryforwards that will not be utilized. Realization of the net operating carryforwards requires Comstock to generate taxable income within the carryforward period.
The Company’s federal income tax returns for the years ended December 31, 2006 and 2007 were recently under examination by the Internal Revenue Service and have been closed with no additional tax liability. The Company’s federal income tax returns for the years subsequent to December 31, 2007 remain subject to examination. The Company’s income tax returns in major state income tax jurisdictions remain subject to examination for various periods subsequent to December 31, 2004. The Company currently believes that all significant filing positions are highly certain and that all of its significant income tax filing positions and deductions would be sustained upon audit. Therefore, the Company has no significant reserves for uncertain tax positions. Interest and penalties resulting from audits by tax authorities have been immaterial and are included in the provision for income taxes in the consolidated statements of operations.
(10)
Derivatives and Hedging Activities
Comstock periodically uses swaps, floors and collars to hedge oil and natural gas prices and interest rates. Swaps are settled monthly based on differences between the prices specified in the instruments and the settlement prices of futures contracts. Generally, when the applicable settlement price is less than the price specified in the contract, Comstock receives a settlement from the counterparty based on the difference multiplied by the volume or amounts hedged. Similarly, when the applicable settlement price exceeds the price specified in the contract, Comstock pays the counterparty based on the difference. Comstock generally receives a settlement from the counterparty for floors when the applicable settlement price is less than the price specified in the contract, which is based on the difference multiplied by the volumes hedged. For collars, generally Comstock receives a settlement from the counterparty when the settlement price is below the floor and pays a settlement to the counterparty when the settlement price exceeds the cap. No settlement occurs when the settlement price falls between the floor and cap.
In January 2008, Comstock entered into natural gas swaps to fix the price at $8.00 per Mmbtu (at the Houston Ship Channel) for 520,000 Mmbtu’s per month of production from certain properties in South Texas for the period February 2008 through December 2009. The Company designated these swaps at their inception as cash flow hedges. Realized gains and losses were included in oil and natural gas sales in the month of production. Changes in the fair value of derivative instruments designated as cash flow hedges to the extent they were effective in offsetting cash flows attributable to the hedged risk were recorded in other comprehensive income until the hedged item was recognized in earnings. Changes in fair value resulting from ineffectiveness was recognized currently in oil and natural gas sales as unrealized gains (losses). The Company realized losses of $4.8 million and gains of $26.3 million on the natural gas price swaps settled
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
during 2008 and 2009, respectively, which are included in oil and gas sales in the accompanying consolidated statements of operations. As of December 31, 2009, the Company had no derivative financial instruments outstanding.
(11)
Supplementary Quarterly Financial Data (Unaudited)
The Company recognized a gain on the disposal of its discontinued offshore operations in the three months ended September 30, 2008 of approximately $158.1 million, after income taxes of $85.3 million. The Company recognized an unrealized loss before income taxes of $162.7 million in the three months ended December 31, 2008 to write down its marketable securities. Basic and diluted per share amounts for the three months ended December 31, 2008 and for all periods presented in 2009 are the same due to the net loss during these periods.
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(12)
Oil and Gas Reserves Information (Unaudited)
Set forth below is a summary of the changes in Comstock’s net quantities of crude oil and natural gas reserves for each of the three years ended December 31, 2009:
The proved oil and gas reserves utilized in the preparation of the financial statements were estimated by independent petroleum consultants of Lee Keeling and Associates in accordance with guidelines established by the Securities and Exchange Commission and the FASB, which require that reserve reports be prepared under existing economic and operating conditions with no provision for price and cost escalation except by contractual agreement. All of the Company’s reserves are located onshore in the continental United States of America.
The following table sets forth the standardized measure of discounted future net cash flows relating to proved reserves at December 31, 2008 and 2009:
COMSTOCK RESOURCES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
The following table sets forth the changes in the standardized measure of discounted future net cash flows relating to proved reserves for the years ended December 31, 2007, 2008 and 2009:
New rules issued by the Securities and Exchange Commission relating to the estimation and disclosure of oil and natural gas reserves were adopted in 2009. The standardized measure of discounted future net cash flows at the end of 2009 were determined based on the simple average of the first of month market prices for oil and natural gas during 2009 which were $49.60 per barrel for oil and $3.54 per Mcf for natural gas. Under the prior rules the prices would have been based on the market prices at December 31, 2009, which would have been $64.43 per barrel for oil and $5.29 per Mcf for natural gas. In 2009 the average first of the month market prices for oil and natural gas were substantially lower than the year end market prices. The new rules also impacted the undeveloped proved reserves that were included in the Company’s reserve estimates. The standardized measure of discounted future net cash flows would have been approximately $912.0 million under the previous rules.
Future development and production costs are computed by estimating the expenditures to be incurred in developing and producing proved oil and gas reserves at the end of the year, based on year end costs and assuming continuation of existing economic conditions. Future income tax expenses are computed by applying the appropriate statutory tax rates to the future pre-tax net cash flows relating to proved reserves, net of the tax basis of the properties involved. The future income tax expenses give effect to permanent differences and tax credits, but do not reflect the impact of future operations.