COMSTOCK RESOURCES INC quarterly report, Q3 FY2019

Comstock Resources, Inc. — Q3 2019 Form 10-Q

Reporting period: Quarter ended September 30, 2019; filed November 12, 2019. Amounts are in U.S. dollars. Comparisons with 2018 require caution: the Jones Contribution created a new accounting basis in August 2018, and the Covey Park acquisition closed July 16, 2019. Q3 2019 includes only 77 days of Covey Park operations.

Key financial results

Metric	Q3 2019	Nine months 2019
Oil and gas sales	$224.4 million	$479.4 million
Operating income	$76.4 million	$173.2 million
Net income	$6.8 million	$41.8 million
Net income (loss) available to common stockholders	$(1.3) million; $(0.01) per share	$33.6 million; $0.26 per share
Operating cash flow	Not separately provided for the quarter	$282.8 million

• Q3 operating margin was approximately 34%; nine-month operating margin was approximately 36%. These figures precede interest, taxes and other non-operating items.
• Q3 production was 97.2 Bcf of natural gas and 604,000 barrels of oil. Average realized prices were $1.99/Mcf for gas and $51.24/barrel for oil.
• Nine-month cash capital expenditures were $308.7 million; operating cash flow less this cash expenditure was approximately negative $25.9 million, before acquisition spending and financing flows. Management separately reported $355.6 million of capital expenditures for development and exploration activity, including accrued amounts.
• Cash was $53.2 million at September 30, 2019, versus $23.2 million at December 31, 2018. Current assets were $268.4 million and current liabilities were $389.5 million.
• Long-term debt carrying value was $2.508 billion. Principal outstanding comprised $1.265 billion under the revolving credit facility, $625 million of 7.5% notes due 2025, and $850 million of 9.75% notes due 2026. The facility borrowing base was $1.575 billion; the filing reports $1.265 billion drawn.

Material changes and notable transactions

• On July 16, 2019, Comstock acquired Covey Park for cash, common stock and Series A convertible preferred stock; it also assumed Covey Park debt and repaid existing Covey Park borrowings and preferred equity. The transaction was valued at approximately $2.2 billion. Covey Park contributed approximately $117.2 million of operating revenue from closing through September 30.
• Acquisition-related transaction costs were $41.1 million for the nine months, including advisory, legal, severance and change-of-control costs. Q3 derivative gains were $24.9 million; nine-month gains were $31.9 million. These gains and the transaction costs materially affected reported earnings.
• The acquisition was funded in part through issuance of $300 million of common stock and $175 million of Series B preferred stock to the majority stockholder, alongside borrowings and cash. Series A preferred stock with a $210 million face value was issued as acquisition consideration and recorded at $200 million fair value.
• At September 30, the company had $385 million face value of 10% convertible preferred stock. Conversion may begin after July 16, 2020 at $4 per common share, subject to adjustment; conversion of all preferred shares would represent 96.25 million common shares.
• Pro forma results, assuming the acquisition had occurred at the start of each period, show nine-month 2019 revenue of $858.0 million and net income of $201.3 million, versus $790.7 million and $92.0 million, respectively, for nine-month 2018. These unaudited figures exclude acquisition costs and do not include expected synergies.

Outlook, risks and contingencies

• Management expected to spend a further $145 million in the remaining three months of 2019 on drilling, completions and other development activity, including 26 gross wells to drill and 30 gross wells to complete. It expected to fund future development and exploration with operating cash flow; capital spending timing was described as discretionary.
• Commodity prices are a major risk. The company had gas swaps, collars and oil collars in place, and entered additional 2020 gas swaps after quarter-end. Derivative gains include changes in fair value and should not be treated as equivalent to recurring operating cash flow.
• The credit facility carries variable-rate debt; management estimated that a 100-basis-point rate change would alter interest expense on outstanding variable-rate borrowings by approximately $12.6 million. Financial covenant testing begins with the quarter ending December 31, 2019; the company reported compliance as of September 30.
• Pre-2018 tax losses are generally subject to an estimated $3.3 million annual Section 382 limitation, although recognized built-in gains may increase the limit during 2018–2023. Deferred tax assets are subject to valuation allowances.
• The company reported no material expected effect from ordinary-course litigation and no proved-property impairments in the periods presented. It noted that future commodity prices, reserves, drilling results and costs could lead to future impairments.
• On November 1, 2019, after quarter-end, Comstock acquired North Louisiana properties for 4.5 million newly issued common shares; the properties were producing 12 MMcf/day and included approximately 3,000 net acres.

Most important facts for investors to verify

• Review the Covey Park purchase-price allocation, acquired debt and the ultimate effect of the acquisition on leverage, cash generation and integration costs.
• Assess the potential dilution and 10% dividend burden from the $385 million preferred stock, including conversion terms and the company’s redemption rights.
• Reconcile operating cash flow, cash capital spending and the higher capital-spending figure that includes accrued items; assess funding needs against remaining borrowing capacity.
• Examine commodity hedge volumes, prices, maturities and fair-value sensitivity, and distinguish realized settlements from unrealized gains.
• Track covenant calculations once testing begins, variable-rate exposure, and the effect of the planned 2019 capital program on liquidity.
• Consider related-party transactions and governance: the majority stockholder participated in preferred and common equity financing and had operating and acreage transactions with the company.