Comstock Resources - 10-Q quarterly report FY

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For The Quarterly Period Ended September 30, 2008

OR

Commission File No. 001-03262

COMSTOCK RESOURCES, INC.

(Exact name of registrant as specified in its charter)

5300 Town and Country Blvd., Suite 500, Frisco, Texas 75034

(Address of principal executive offices)

Telephone No.: (972) 668-8800

 

 

 

 

COMSTOCK RESOURCES, INC.

QUARTERLY REPORT

For The Quarter Ended September 30, 2008

INDEX

 

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

 

The accompanying notes are an integral part of these statements.

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

 

 

 

 

 

The accompanying notes are an integral part of these statements.

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

AND COMPREHENSIVE INCOME

For the Nine Months Ended September 30, 2008

(Unaudited)

 

 

 

The accompanying notes are an integral part of these statements.

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

 

 

 

 

 

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2008

(Unaudited)

(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES –

In management's opinion, the accompanying unaudited consolidated financial statements contain all adjustments (consisting solely of normal recurring adjustments) necessary to present fairly the financial position of Comstock Resources, Inc. and subsidiaries ("Comstock" or the "Company") as of September 30, 2008 and the related results of operations for the three months and nine months ended September 30, 2008 and 2007 and cash flows for the nine months ended September 30, 2008 and 2007.

The accompanying unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted pursuant to those rules and regulations, although Comstock believes that the disclosures made are adequate to make the information presented not misleading.  These unaudited consolidated financial statements should be read in conjunction with the financial statements and notes thereto of the Company included in Comstock's Annual Report on Form 10-K for the year ended December 31, 2007.

In connection with an acquisition of certain oil and gas properties, Comstock entered into a transaction structured as a reverse like-kind exchange in accordance with Section 1031 of the Internal Revenue Code pursuant to which Comstock assigned the right to acquire ownership in the acquired oil and gas properties to an exchange accommodation titleholder.  Comstock operated these properties pursuant to lease and management agreements.  Because the Company was the primary beneficiary of these arrangements, the acquired properties were included in the consolidated balance sheet as of December 31, 2007, and all revenues earned and expenses incurred related to the properties were included in the Company's consolidated results of operations during the term of the agreements.  The Company completed the like-kind exchange transaction for federal tax purposes when certain designated oil and gas properties were sold in June 2008.  Accordingly, the ownership of the oil and gas properties acquired in December 2007 was transferred to the Company and the agreements with the exchange accommodation titleholder terminated.

The results of operations for the three months and nine months ended September 30, 2008 are not necessarily an indication of the results expected for the full year.

These unaudited consolidated financial statements include the accounts of Comstock and subsidiaries in which it has a controlling interest.  Intercompany balances and transactions have been eliminated in consolidation.

 

The Company's offshore operations have historically been conducted through its subsidiary Bois d'Arc Energy, Inc. ("Bois d'Arc Energy").  On August 28, 2008, Bois d'Arc Energy completed a merger with Stone Energy Corporation ("Stone") pursuant to which each outstanding share of Bois d'Arc Energy was exchanged for cash in the amount of $13.65 per share and 0.165 shares of Stone common stock.  As a result of this transaction, Comstock received net proceeds of $439.0 million in cash and 5,317,069 shares of Stone in exchange for its interest in Bois d'Arc Energy.  In connection with the merger, Comstock agreed not to sell its shares of Stone common stock prior to August 28, 2009 and to certain other restrictions relating to its ownership of the Stone common stock.

 

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

 

As a result of the merger, the consolidated financial statements and the related notes thereto present the Company's offshore operations as discontinued operations.  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 Energy with Stone resulted in Comstock recognizing a gain on the disposal of the discontinued operations in the three months ended September 30, 2008 of approximately $158.1 million, after income taxes of $85.3 million and the Company's share of transaction-related costs incurred by Bois d'Arc Energy of $11.7 million.  Transaction-related costs incurred by Bois d'Arc Energy 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 for the three and nine months ended September 30, 2008 is comprised of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

Assets and liabilities of discontinued operations as of December 31, 2007 were as follows:

 

 

Reclassifications

Certain reclassifications have been made to prior periods' financial statements to conform to the current presentation.

Marketable Securities

The Company received shares of Stone common stock as part of the proceeds from sale of its interest in Bois d'Arc Energy.  The Company does not exert influence over the operating and financial polices of Stone, and has classified its investment in these shares as an available-for-sale security in the consolidated balance sheet as of September 30, 2008.  Available-for-sale securities are accounted for at fair value, with any unrealized gains and losses reported in the consolidated balance sheet within accumulated other comprehensive income (loss) as a separate component of stockholders' equity.  The fair value of the Stone common stock includes a discount to the public market price to reflect certain trading restrictions.  The Company utilizes the specific identification method to determine the cost of the securities sold.

The Company reviews its available-for-sale securities to determine whether a decline in fair value below the respective cost basis is other than temporary.  If the decline in fair value is judged to be other than temporary, the cost basis of the security is written down to fair value and the amount of the write-down is included in the consolidated statement of operations.  As of September 30, 2008, the decline in the fair value of the Stone common stock since the date it was received was not determined to be other than temporary.  The Stone shares were acquired in August 2008 and valued at $211.4 million.  As of September 30, 2008 the estimated fair value of the Stone shares was $181.9 million after recognizing an unrealized loss before income taxes of $29.5 million.

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

Asset Retirement Obligations

 

Comstock's asset retirement obligations relate to future plugging and abandonment expenses on its oil and gas properties and related facilities disposal.  The following table summarizes the changes in Comstock's total estimated liability during the nine months ended September 30, 2008 and 2007:

Derivative Instruments 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 counter party 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 counter party based on the difference.  Comstock generally receives a settlement from the counter party 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 volume amounts hedged.  For collars, generally Comstock receives a settlement from the counter party when the settlement price is below the floor and pays a settlement to the counter party 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 which 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 are 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 are effective in offsetting cash flows attributable to the hedged risk are recorded in other comprehensive income until the hedged item is recognized in earnings.  Any change in fair value resulting from ineffectiveness is recognized currently in oil and natural gas sales as unrealized gains (losses).  The Company realized losses of $2.7 million and $7.4 million on the natural gas price swaps during the three and nine months ended September 30, 2008, respectively, which are included in oil and gas sales in the accompanying Consolidated Statements of Operations.  As of September 30, 2008, the estimated fair value of the Company's derivative financial instruments, which equals their carrying value, was a net asset of $2.7 million, of which $2.9 million was classified as a current asset and $0.2 million was classified as long-term liability.  The Company had no derivative financial instruments outstanding during the nine months ended September 30, 2007.

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

 

Stock-Based Compensation

Comstock accounts for employee stock-based compensation under the fair value method.  Compensation cost is measured at the grant date based on the fair value of the award and is recognized over the award vesting period.  During the three months ended September 30, 2008 and 2007, the Company recognized $3.3 million and $2.6 million, respectively, in stock-based compensation expense within general and administrative expenses related to stock option and restricted stock grants.  Stock-based compensation expense for the nine months ended September 30, 2008 and 2007 was $9.0 million and $7.9 million, respectively.  The excess income tax benefit realized from the deductions associated with stock-based compensation for the nine months ended September 30, 2008 and 2007 was $8.8 million and $0.6 million, respectively.

The fair value of stock option grants is estimated on the date of the grant using a Black-Scholes option pricing model.  Some of the inputs to the option valuation model are subjective, including assumptions regarding expected stock price volatility.  During the nine months ended September 30, 2008, Comstock granted options to purchase 40,000 shares at an exercise price of $54.36 per share.  The fair value of the options awarded was determined to be $19.76 per share.  Assumptions used to value these stock options included expected volatility of 38.9%, expected lives of 4.3 years, a risk-free interest rate of 3.3% and an expected dividend yield of zero.  As of September 30, 2008, total unrecognized compensation cost related to nonvested stock options of $1.6 million is expected to be recognized over a period of 2.2 years.  Options outstanding at September 30, 2008 totaled 456,870, of which 305,120 were exercisable.

As of September 30, 2008, Comstock had 1.3 million shares of unvested restricted stock outstanding at a weighted average grant date fair value of $31.60 per share.  Total unrecognized compensation cost related to the unvested restricted stock grants of $22.3 million as of September 30, 2008 is expected to be recognized over a period of 3.3 years.

Income Taxes

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:

 

 

 

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

The following is an analysis of consolidated income tax expense from continuing operations:

Earnings Per Share

Basic earnings per share is determined without the effect of any outstanding potentially dilutive stock options or unvested restricted stock and diluted earnings per share is determined with the effect of outstanding stock options and unvested restricted stock that are potentially dilutive.  Basic and diluted earnings per share for the three months and nine months ended September 30, 2008 and 2007, respectively, were determined as follows:

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

Stock options 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:

 

 

In September 2006, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157").  This statement establishes a framework for fair value measurements in the financial statements by providing a single definition of fair value, provides guidance on the methods used to estimate fair value and increases disclosures about estimates of fair value.  The Company adopted SFAS 157 and its related amendments for financial assets and liabilities effective as of January 1, 2008.  SFAS 157 will be effective for non-financial assets and liabilities in financial statements issued for fiscal years beginning after November 15, 2008.

 

 

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

SFAS 157 defines fair value 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.  SFAS 157 establishes a three-level hierarchy 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 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.

At January 1, 2008, the Company had no financial assets and liabilities that were accounted for at fair value.  Accordingly, adoption of SFAS 157 had no impact on the carrying amounts of the Company's assets and liabilities.  As of September 30, 2008, the Company held certain items that are required to be measured at fair value on a recurring basis.  These included cash equivalents held in money market funds, short-term marketable securities comprised of shares of Stone common stock, and derivative instruments in the form of natural gas price swap agreements.  The fair value of the Stone common stock recorded by the Company includes a discount from the quoted public market price to reflect the impact of certain trading restrictions.  The Company determines the impact of the trading restriction on the fair value of the Stone common stock utilizing a standard option pricing model based on inputs that are either readily available in public markets or can be derived from information available in publicly quoted markets.  Therefore, the Company has categorized the Stone common stock as Level 2.  The Company's natural gas price swap agreements are not traded on a public exchange.  The value of natural gas price swap agreements is determined utilizing a discounted cash flow model based on inputs that are not readily available in public markets and, accordingly, these swap agreements have been categorized as Level 3 within the valuation hierarchy.

The following table summarizes financial assets and liabilities accounted for at fair value as of September 30, 2008:

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

The following table summarizes the changes in the fair values of the natural gas swaps, which are Level 3 liabilities, for the nine months ended September 30, 2008:

Supplementary Information With Respect to the Consolidated 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 September 30, 2008 the Company's cash investments consisted of cash held in an institutional money market fund which has daily liquidity and cash in interest bearing accounts at a large commercial bank.  At December 31, 2007 the Company's cash investments consisted of overnight Eurodollar deposits with a bank.

The following is a summary of cash payments made for interest and income taxes:

The Company capitalizes interest on its unevaluated oil and gas property costs during periods when it is conducting exploration activity on this acreage.  For the three and nine months ended September 30, 2008 the Company capitalized $0.6 million of interest which reduced interest expense and increased the carrying value of its unevaluated oil and gas properties.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

COMSTOCK RESOURCES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Continued)

Comprehensive Income

Comprehensive income (loss) consists of the following:

The following table provides a rollforward of the amounts included in Accumulated other comprehensive income (loss), net of income taxes, for the three and nine months ended September 30, 2008:

(2)  LONG-TERM DEBT  –

At September 30, 2008, long-term debt was comprised of $175.0 million of 6⅞% Senior Notes due in 2012.  The 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 unconditional and joint and several.  As of September 30, 2008, Comstock also has 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)

 

 

(3)  COMMITMENTS AND CONTINGENCIES –

From time to time, Comstock 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.

In connection with its exploration and development activities, the Company contracts for drilling rigs under terms of up to four years.  As of September 30, 2008, the Company had commitments for contracted drilling services of $146.4 million.  The Company also has entered into a natural gas transportation agreement for 30,000 Mbtu's of natural gas per day which expires on August 31, 2013.  Minimum commitments under this transportation agreement as of September 30, 2008 totaled $13.7 million.

(4)  SALE OF PROPERTIES –

During the three months ended September 30, 2008, the Company sold its interests in certain producing properties in South Texas and received net proceeds of $15.8 million.  Comstock recognized a gain of $5.4 million ($3.5 million after income taxes) on these sales which is included in the accompanying consolidated statement of operations.  During the first six months of 2008, the Company sold its interests in certain producing properties in East and South Texas and received net proceeds of $113.8 million.  Comstock recognized a gain of $21.2 million ($13.9 million after income taxes) on these sales which is also included in the accompanying consolidated statement of operations.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

INDEPENDENT ACCOUNTANTS' REVIEW REPORT

We have reviewed the consolidated balance sheet of Comstock Resources, Inc. (a Nevada corporation) and subsidiaries (the Company) as of September 30, 2008, and the related consolidated statements of operations for the three- and nine-month periods ended September 30, 2008 and 2007, the consolidated statement of stockholders' equity and comprehensive income for the nine months ended September 30, 2008, and the consolidated statements of cash flows for the nine months ended September 30, 2008 and 2007.  These financial statements are the responsibility of the Company's management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States).  A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated interim financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Comstock Resources, Inc. and subsidiaries as of December 31, 2007, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended [not presented herein], and in our report dated February 28, 2008, we expressed an unqualified opinion on those consolidated financial statements and included an explanatory paragraph regarding the Company's adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), Share Based Payment, effective January 1, 2006.  On August 28, 2008, Bois d'Arc Energy, Inc., a subsidiary of the Company completed a merger with Stone Energy Corporation, which resulted in Bois d'Arc Energy, Inc. being classified as discontinued operations, resulting in the revision of the December 31, 2007 consolidated balance sheet. We have not audited the revised consolidated balance sheet reflecting the reclassifications for discontinued operations.

/s/ Ernst & Young LLP

Dallas, Texas

November 5, 2008

 

This report contains forward-looking statements that involve risks and uncertainties that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  Actual results may differ materially from those anticipated in our forward-looking statements due to many factors.  The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included in this report and in our annual report filed on Form 10-K for the year ended December 31, 2007.

Discontinued Operations

Our offshore operations have historically been conducted through our subsidiary, Bois d'Arc Energy, Inc. ("Bois d'Arc Energy").  Bois d'Arc Energy was acquired by Stone Energy Corporation ("Stone") in exchange for a combination of cash and shares of Stone common stock on August 28, 2008.  Accordingly, the 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 operations.

Results of Operations

 

Revenues –

Oil and gas sales increased $80.8 million to $163.9 million for the three months ended September 30, 2008 from $83.1 million for the third quarter of 2007.  This increase resulted from both higher production and higher crude oil and natural gas prices.  Our production in the third quarter of 2008 increased to 15.0 Bcfe, a 23% increase over production of 12.2 Bcfe in the third quarter of 2007.  The production increase was attributable to our development drilling activity and a producing property acquisition in South Texas which was completed in December 2007.  Our average realized crude oil price increased by 64% and our average realized natural gas price increased by 62% in the third quarter of 2008 as compared to the third quarter of 2007.  Our natural gas sales for the three months ended September 30, 2008 have been reduced by a loss of $2.7 million from our hedging activities.

 

 

Oil and gas sales increased $227.5 million to $463.6 million for the nine months ended September 30, 2008 from $236.1 million for the first nine months of 2007.  Our production in the first nine months of 2008 increased to 44.9 Bcfe or 36% higher than production of 33.1 Bcfe in the first nine months of 2007.  The production increase was attributable to our development drilling and the recent acquisition.  Our average realized crude oil price increased by 74% and our average realized natural gas price increased by 42% in the first nine months of 2008 as compared to the first nine months of 2007.  Our natural gas sales for the nine months ended September 30, 2008 have been reduced by a loss of $7.4 million from our hedging activities.

The 2008 third quarter and nine months financial results include a $5.4 million gain on the sales of certain properties in South Texas for which we received net proceeds of $15.8 million.  The sales closed in August and September 2008.  The financial results for the nine months ended September 30, 2008 include a gain of $21.2 million on sales of certain properties that closed during the first six months of 2008 for which we received net proceeds of $113.8 million.

 

Costs and Expenses- -

 

Our oil and gas operating expenses, including production taxes, increased $4.6 million (27%) to $21.6 million in the third quarter of 2008 from $17.0 million in the third quarter of 2007.  Oil and gas operating expenses per equivalent Mcf produced increased $0.04 (3%) to $1.44 in the third quarter of 2008 from $1.40 in the third quarter of 2007.  Oil and gas operating expenses also increased $17.4 million (36%) to $66.1 million in the first nine months of 2008 from $48.7 million in the first nine months of 2007.  Oil and gas operating expenses per Mcfe produced of $1.47 for the nine months ended September 30, 2008 were unchanged from the nine months ended September 30, 2007.  These increases in operating costs reflect our higher production level and the impact of higher oil and natural gas prices on production and severance taxes.

 

Exploration expense of $2.8 million for the three months ended September 30, 2008 includes $2.0 million for impairment of unevaluated leases in Mississippi for which no drilling is planned and costs related to an exploratory dry hole drilled in South Texas.  Exploration expense of $1.4 million in the three months ended September 30, 2007 includes the costs of two exploratory dry hole wells drilled in Mississippi and impairment of unevaluated leases in Mississippi.  Exploration expense of $5.0 million for the nine months ended September 30, 2008 relates primarily to an exploratory dryhole drilled in South Texas and the impairment of unevaluated leases in Mississippi.  Exploration expense in the first nine months of 2007 of $3.7 million was mainly associated with exploratory dry holes drilled in Mississippi and impairment of unevaluated leases in Mississippi.

 

Depreciation, depletion and amortization ("DD&A") increased $12.5 million (38%) to $45.9 million in the third quarter of 2008 from DD&A expense of $33.4 million in the third quarter of 2007.  Our DD&A per equivalent Mcf produced increased $0.33 to $3.06 for the three months ended September 30, 2008 from $2.73 for the three months ended September 30, 2007.  DD&A for the first nine months of 2008 increased $40.9 million (45%) to $131.9 million from $91.0 million for the nine months ended September 30, 2007.  Our DD&A rate per Mcfe for the first nine months of 2008 of $2.93 increased $0.19 (7%) above the DD&A rate of $2.74 for the first nine months of 2007.  These increases primarily reflect our higher production during 2008 and the higher capitalized costs associated with our drilling program and our acquisition completed in 2007.

 

General and administrative expense, which is reported net of overhead reimbursements, increased by $1.5 million to $7.2 million for the third quarter of 2008 as compared to general and administrative expense of $5.7 million for the third quarter of 2007.  Included in general and administrative expense is stock-based compensation of $3.3 million and $2.6 million for the three months ended September 30, 2008 and 2007, respectively.  For the first nine months of 2008, general and administrative expense increased to $20.3 million from $17.5 million for the nine months ended September 30, 2007.  Included in general and administrative expense is stock-based compensation of $9.0 million and $7.9 million for the nine months ended September 30, 2008 and 2007, respectively.  Increases in general and administrative expenses in 2008 primarily reflect the additional personnel we have added.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense decreased $4.0 million (46%) to $4.8 million for the third quarter of 2008 from interest expense of $8.8 million in the third quarter of 2007.  The decrease was primarily due to lower interest rates.  Although our average borrowings outstanding increased to $300.7 million during the third quarter of 2008 as compared to $256.5 million in the third quarter of 2007, we had no borrowings outstanding under our bank credit facility during the month of September 2008 as we repaid the entire outstanding balance in late August 2008.  The average interest rate we were charged on the outstanding borrowings under our credit facility decreased to 3.7% in the third quarter of 2008 as compared to 6.9% in the third quarter of 2007.  Interest expense for the nine months ended September 30, 2008 increased $0.4 million (2%) to $23.2 million from $22.8 million for the nine months ended September 30, 2007.  The increase is attributable to higher average borrowings under the bank credit facility which was partially offset by lower interest rates.  Average borrowings outstanding increased to $461.6 million during the first nine months of 2008 as compared to $254.7 million for the nine months ended September 30, 2007.  The average interest rate under our bank credit facility decreased to 4.5% in the first nine months of 2008 as compared to 6.6% in the first nine months of 2007.  We capitalized interest of $0.6 million which reduced interest expense for the three and nine months ended September 30, 2008.  No interest was capitalized in 2007.

Income tax expense related to continuing operations increased by $26.3 million to $32.8 million for the three months ended September 30, 2008 as compared to $6.5 million for the three months ended September 30, 2007.  Income tax expense related to continuing operations increased $69.8 million to $90.0 million for the nine months ended September 30, 2008 from $20.2 million for the first nine months of 2007.  Higher income tax expenses in 2008 are primarily due to our higher income.  Our effective tax rates for continuing operations in 2008 are lower than the comparable rates in 2007 due mainly to increased pre-tax income in 2008 which reduced the impact of nondeductible stock based compensation and state income taxes on our effective rate.

We reported income from continuing operations of $54.8 million for the three months ended September 30, 2008, as compared to $10.1 million for the three months ended September 30, 2007.  The income per diluted share from continuing operations for the third quarter of 2008 was $1.20 on weighted average diluted shares outstanding of 45.8 million as compared to $0.23 for the third quarter of 2007 on weighted average diluted shares outstanding of 44.4 million.  Net income from continuing operations for the nine months ended September 30, 2008 was $154.6 million, as compared to net income from continuing operations of $32.5 million for the nine months ended September 30, 2007.  Income per share from continuing operations for the nine months ended September 30, 2008 was $3.40 on weighted average diluted shares outstanding of 45.4 million as compared to net income per share from continuing operations of $0.73 on weighted average diluted shares outstanding of 44.3 million for the nine months ended September 30, 2007.  The higher net income 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.

Income from discontinued operations of $169.9 million in the three months ended September 30, 2008 was $163.6 million (87%) higher than income from discontinued operations of $6.3 million during the three months ended September 30, 2007.  Income from discontinued operations increased $179.0 million to $193.7 million during the first nine months of 2008 as compared to $14.7 million for the first nine months of 2007.  The increases in income from discontinued operations in 2008 reflect 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 is a net gain, after income taxes, of $159.1 million during the three and nine months ended September 30, 2008 as a result of the sale of our interest in Bois d'Arc Energy.

Liquidity and Capital Resources

Funding for our activities has historically been provided by our operating cash flow, debt or equity financings or asset dispositions.  For the nine months ended September 30, 2008, our primary sources of funds were net cash flow from continuing operations of $331.0 million, net proceeds from asset sales of $129.5 million and net proceeds from the sale of our interest in Bois d'Arc Energy of $439.0 million.  Our net cash flow from continuing operating activities increased $182.1 million (122%) to $331.0 million in the first nine months of 2008 from $148.9 million for the nine months ended September 30, 2007.  This increase is primarily due to the higher revenues we had in the first nine months of 2008 driven by the 36% increase in our oil and gas production and higher oil and natural gas prices.

Our primary needs for capital, in addition to funding our ongoing operations, relate to the acquisition, development and exploration of our oil and gas properties and the repayment of our debt.  In the first nine months of 2008, we incurred capital expenditures of $309.8 million primarily for our development and exploration activities.  Our cash flow provided by operating activities of $331.0 million was sufficient to fund our capital expenditures for the first nine months of 2008.  We used the proceeds from our asset sales, including the sale of our interest in Bois d'Arc Energy, to repay all borrowings outstanding under our bank credit facility during the nine months ended September 30, 2008.

The following table summarizes our capital expenditure activity, on an accrual basis, for the nine months ended September 30, 2008 and 2007:

We spent $309.3 million and $255.6 million on our development and exploration activities during the nine months ended September 30, 2008 and 2007, respectively.  The expenditures in 2008 include $109.2 million for acquisitions of leases in the emerging Haynesville Shale play in East Texas and North Louisiana.  We expect to spend approximately $425.0 million in total for development and exploration projects during 2008.  Development and exploration activities are funded primarily with operating cash flow and with borrowings under our bank credit facility.

The timing of most of our capital expenditures is discretionary because we have no material long-term capital expenditure commitments except for commitments for contract drilling services.  Consequently, we have a significant degree of flexibility to adjust the level of our capital expenditures as circumstances warrant.  As of September 30, 2008 we have contracted for the services of drilling rigs through October 2012 at an aggregate cost of $146.4 million and we have minimum commitments of $13.7 million to transport natural gas through August 2013.  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 2013.  We record a separate liability for the fair value of these asset retirement obligations which totaled $7.4 million as of September 30, 2008.

The gain on the sale of our interest in Bois d'Arc Energy generated a current tax liability of $146.4 million which we intend to pay in December 2008.

We have a $850.0 million bank credit facility with the Bank of Montreal, as the administrative agent.  The credit facility is a five-year revolving credit commitment that matures on December 15, 2011.  The 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.  The borrowing base may be affected by the performance of our properties and changes in oil and natural gas prices.  As of September 30, 2008 the borrowing base was $590.0 million, all of which was available.  On October 29, 2008 this borrowing base was reaffirmed by our bank group.  Indebtedness under the bank credit facility is secured by substantially all of our and our subsidiaries' oil and gas properties and is guaranteed by all of our subsidiaries.  Borrowings under the credit facility bear interest, based on the utilization of the borrowing base, at our option of either LIBOR plus 1.0% to 1.75% or the base rate (which is the higher of the prime rate or the federal funds rate) plus 0% to 0.5%.  A commitment fee of 0.25% to 0.375% based on the utilization of the borrowing base is payable 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 we may incur and limit our ability to make certain loans and investments.  The only financial covenants are the maintenance of a current ratio and maintenance of a minimum tangible net worth.  We were in compliance with these covenants as of September 30, 2008.  We also have $175.0 million of 6⅞% senior notes due March 1, 2012, with interest payable semiannually on each March 1 and September 1.  The 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 facilities 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 terms acceptable to us.

Critical Accounting Policies

The information included in "Management's Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies" in our annual report filed on Form 10-K for the year ended December 31, 2007 is incorporated herein by reference.

In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157").  This statement establishes a framework for fair value measurements in the financial statements by providing a single definition of fair value, provides guidance on the methods used to estimate fair value and increases disclosures about estimates of fair value.  We adopted SFAS 157 and its related amendments for financial assets and liabilities effective as of January 1, 2008.  See Note 1 to the consolidated financial statements.  Adoption of SFAS 157 had no impact on the carrying values of our assets and liabilities.  SFAS 157 will be effective for non-financial assets and liabilities in financial statements issued for fiscal years beginning after November 15, 2008.

In December 2007, the FASB issued SFAS No. 141R, "Business Combinations" ("SFAS 141R") which requires measurements based on fair value as determined under the provisions of SFAS 157 and is effective for financial statements issued for fiscal years beginning after December 15, 2008.  SFAS 141R establishes accounting and reporting standards for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree.  This statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination.  SFAS 141R will impact the accounting and disclosures for any business combinations we engage in after January 1, 2009.  However, the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions we consummate after that date.

In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities – An Amendment of FASB Statement No. 133" ("SFAS 161").  This standard applies to derivative instruments, nonderivative instruments that are designated and qualify as hedging instruments and related hedged items accounted for under SFAS 133.  SFAS 161 does not change the accounting for derivatives and hedging activities, but requires enhanced disclosures concerning the effect on the financial statements from their use.  SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  Currently, we do not have any instruments that would be impacted by SFAS 161.