CRK

Comstock Resources, Inc. - 10-Q Summary (Quarter Ended Sept 30, 2005)

Business Context and Reporting Period

This Form 10-Q covers the quarterly and nine-month periods ended September 30, 2005, for Comstock Resources, Inc., an independent oil and gas exploration and production company. The reporting period was significantly impacted by the conversion of its offshore subsidiary, Bois d'Arc Energy, from a limited liability company to a corporation and its subsequent Initial Public Offering (IPO) in May 2005. This event triggered a change in accounting from proportionate consolidation to the equity method. Additionally, the company completed a major acquisition of onshore properties from EnSight Energy Partners in May 2005 and faced operational disruptions in the Gulf of Mexico due to Hurricanes Katrina and Rita.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total oil and gas sales increased 13% in Q3 2005 and 10% for the nine-month period compared to 2004. This was driven by a 43% increase in average onshore natural gas prices and a 24% increase in onshore crude oil prices, alongside increased production volumes from new drilling and the EnSight acquisition.
• Net Income Decline: Despite higher revenues, net income for the nine months ended Sept 30, 2005, decreased 38% to $19.1 million from $31.0 million in 2004. This decline is primarily due to non-cash, one-time items: a $54.9 million equity loss related to Bois d'Arc's conversion (including a $64.6 million deferred tax provision) and a $21.0 million unrealized loss on derivatives.
• Derivative Losses: The company recorded an unrealized loss of $17.6 million in Q3 and $21.0 million for the nine months on derivative instruments due to rising natural gas prices following Hurricane Rita. These were not designated as cash flow hedges.
• Debt Reduction: Long-term debt decreased significantly from $403.0 million at year-end 2004 to $282.0 million at Sept 30, 2005, following the repayment of $297.0 million in principal, funded by operating cash flow and a $121.2 million public stock offering.

Guidance, Outlook, and Risks

• Capital Expenditures: The company spent $329.2 million on capital expenditures in the first nine months of 2005, primarily for the EnSight acquisition ($191.6 million) and development drilling. Management has budgeted approximately $25.0 million for development and exploration for the fourth quarter of 2005, intending to fund this through internally generated cash flow.
• Liquidity: Comstock maintains a $400.0 million revolving credit facility with a borrowing base of $300.0 million as of Sept 30, 2005. With $107.0 million currently outstanding, significant borrowing capacity remains available. Management believes cash flow from operations and available borrowings are sufficient to fund operations and growth.
• Market Risks: The company is highly sensitive to oil and natural gas price fluctuations. A $1.00 change in the price per Mcf of natural gas would impact cash flow by approximately $23.4 million based on nine-month production levels. Interest rate risk exists on the $107.0 million variable-rate portion of its debt.
• Operational Risks: Hurricanes Katrina and Rita caused significant production shut-ins in the Gulf of Mexico (Bois d'Arc operations) and deferred production onshore. Approximately 30% of Bois d'Arc's production in Q3 was deferred due to storm damage and pipeline outages.

Investor Verification Checklist

• Bois d'Arc Accounting Impact: Verify the sustainability of earnings by excluding the one-time $64.6 million tax provision and $54.9 million equity loss related to the Bois d'Arc conversion, which management notes would have resulted in adjusted net income of $54.6 million for the nine-month period.
• Derivative Exposure: Review the $21.1 million liability for derivative instruments and the specific terms of the natural gas collars (floors at $4.50, caps ranging from $8.25 to $10.30) to assess future cash flow volatility.
• EnSight Acquisition Integration: Confirm the production ramp-up and reserve additions (120.2 Bcfe) from the EnSight acquisition are performing as projected to offset the high capital expenditure incurred.
• Debt Covenants: Monitor compliance with the credit facility covenants, specifically the current ratio and minimum tangible net worth, given the company's reliance on the borrowing base which is subject to semiannual redetermination based on commodity prices.
• Adjusted EPS: Note that reported diluted EPS of $0.47 for the nine months excludes significant non-cash charges; management estimates adjusted EPS would have been $1.35 without the Bois d'Arc and derivative impacts.