CRK

Comstock Resources, Inc. - 10-Q Summary (Q2 2007)

Business Context and Reporting Period

This report covers the quarterly period ended June 30, 2007. Comstock Resources, Inc. is an independent oil and natural gas exploration and production company. A significant accounting change occurred in the third quarter of 2006 when Comstock acquired additional interests in Bois d'Arc Energy, Inc., resulting in its consolidation as a subsidiary. Financial results for 2006 have been retroactively adjusted to reflect this consolidation. The company operates onshore properties (primarily East Texas/North Louisiana) and offshore properties (via Bois d'Arc Energy in the Gulf of Mexico).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Oil and gas sales increased 40% ($50.0 million) in Q2 2007 compared to Q2 2006, driven by a 32% increase in production volumes and higher natural gas prices. For the six-month period, sales increased 25% ($64.3 million).
• Net Income Decline (YTD): While Q2 net income increased 17% year-over-year, net income for the six months ended June 30, 2007, decreased 32% to $30.8 million from $45.2 million in the prior year. This decline was primarily due to higher exploration expenses and depreciation, depletion, and amortization (DD&A), offsetting revenue gains. The 2006 period also included a $9.4 million gain on derivatives not present in 2007.
• Expense Increases:
  • Exploration Expense: Surged to $19.9 million in Q2 2007 from $3.7 million in Q2 2006, largely due to dry holes in offshore and onshore operations.
  • DD&A: Increased 81% in Q2 2007 to $59.8 million, driven by higher production levels and increased amortization rates from recent acquisitions and drilling costs.
  • Interest Expense: Rose 67% in Q2 2007 to $10.2 million due to higher average borrowings and interest rates.
• Production Volumes: Total production increased 32% in Q2 2007. Bois d'Arc Energy production increased 47% year-over-year, aided by new wells and the restoration of pipelines damaged by 2005 hurricanes.

Guidance, Outlook, and Risks

• Capital Expenditure Outlook: The company expects to spend approximately $301.0 million on onshore development and exploration in 2007. Bois d'Arc Energy expects to spend $200.0 million on offshore projects. Total capital spending is discretionary and subject to adjustment based on market conditions.
• Liquidity: The company maintains a $600.0 million revolving credit facility (Comstock) and a $225.0 million facility (Bois d'Arc Energy). As of June 30, 2007, total availability was $206.0 million ($106.0 million + $100.0 million). Management believes operating cash flow and available borrowings are sufficient to fund current plans.
• Market Risks: Financial results are highly sensitive to oil and natural gas prices. A $1.00 change in oil price impacts cash flow by ~$1.3 million, while a $1.00 change in natural gas price impacts cash flow by ~$33.0 million (based on H1 2007 production). Interest rate risk exists on $419.0 million of variable-rate debt.
• Commitments: The company has contracted drilling services totaling $39.8 million through September 2008 and seismic data commitments of $11.0 million through December 2008.

Investor Verification Checklist

• Exploration Success Rate: Verify the impact of the significant increase in exploration expenses ($19.9M in Q2) on future reserve additions, given the mention of multiple dry holes.
• Debt Covenants: Confirm continued compliance with borrowing base covenants, which are redetermined semiannually and dependent on commodity prices and production performance.
• Bois d'Arc Integration: Monitor the sustainability of the production recovery at Bois d'Arc Energy following the 2005 hurricane disruptions and the associated cost structure.
• Capital Allocation: Assess the balance between the aggressive capital expenditure program ($329M in H1) and the resulting leverage, particularly given the decline in YTD net income.
• Derivative Hedging: Note the absence of outstanding derivatives in 2007 compared to 2006, increasing exposure to commodity price volatility.