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Clayton Williams Energy 10-Q 2008 UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
Not
applicable
(Former
name, former address and former fiscal year, if changed since last
report)
CLAYTON
WILLIAMS ENERGY, INC
TABLE
OF CONTENTS
2
CLAYTON
WILLIAMS ENERGY, INC.
CONSOLIDATED
BALANCE SHEETS
(Dollars
in thousands)
The
accompanying notes are an integral part of these consolidated financial
statements.
3
CLAYTON
WILLIAMS ENERGY, INC.
CONSOLIDATED
BALANCE SHEETS
(Dollars
in thousands)
The
accompanying notes are an integral part of these consolidated financial
statements.
4
CLAYTON WILLIAMS ENERGY, INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars
in thousands, except per share)
The
accompanying notes are an integral part of these consolidated financial
statements.
5
CLAYTON WILLIAMS ENERGY, INC.
CONSOLIDATED
STATEMENT OF STOCKHOLDERS' EQUITY
(Unaudited)
(Dollars
in thousands)
The
accompanying notes are an integral part of these consolidated financial
statements.
6
CLAYTON
WILLIAMS ENERGY, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars
in thousands)
The
accompanying notes are an integral part of these consolidated financial
statements.
7
CLAYTON WILLIAMS ENERGY, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
September
30, 2008
(Unaudited)
1.
Nature of Operations
Clayton
Williams Energy, Inc. (a Delaware corporation) and its subsidiaries
(collectively, the “Company” or “CWEI”) is an independent oil and gas company
engaged in the exploration for and development and production of oil and natural
gas primarily in its core areas in Texas, Louisiana and New
Mexico. Approximately 26% of the Company’s outstanding common stock
is beneficially owned by Clayton W. Williams, Jr. (“Mr. Williams”),
Chairman of the Board and Chief Executive Officer of the Company, and
approximately 25% is owned by a partnership in which Mr. Williams’ adult
children are limited partners.
Substantially
all of the Company’s oil and gas production is sold under short-term contracts
which are market-sensitive. Accordingly, the Company’s financial
condition, results of operations, and capital resources are highly dependent
upon prevailing market prices of, and demand for, oil and natural
gas. These commodity prices are subject to wide fluctuations and
market uncertainties due to a variety of factors that are beyond the control of
the Company. These factors include the level of global demand for
petroleum products, foreign supply of oil and gas, the establishment of and
compliance with production quotas by oil-exporting countries, the strength of
the U.S. dollar, weather conditions, the price and availability of alternative
fuels, and overall economic conditions, both foreign and domestic.
2.
Presentation
The
preparation of these consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management of the Company 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 periods. Actual results
could differ materially from those estimates.
The
consolidated financial statements include the accounts of Clayton Williams
Energy, Inc., its wholly-owned subsidiaries and the accounts of the Larclay JV
(see Note 11). The Company also accounts for its undivided interests
in oil and gas limited partnerships using the proportionate consolidation
method. Under this method, the Company consolidates its proportionate
share of assets, liabilities, revenues and expenses of these limited
partnerships utilizing accounting policies followed by the
Company. Less than 5% of the Company’s consolidated total assets and
total revenues are derived from oil and gas limited partnerships. All
significant intercompany transactions and balances associated with the
consolidated operations have been eliminated.
In the
opinion of management, the Company's unaudited consolidated financial statements
as of September 30, 2008 and for the interim periods ended September 30, 2008
and 2007 include all adjustments which are necessary for a fair presentation in
accordance with accounting principles generally accepted in the United
States. These interim results are not necessarily indicative of the
results to be expected for the year ending December 31, 2008.
Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted in this Form 10-Q pursuant to the
rules and regulations of the Securities and Exchange Commission
(“SEC”). These consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and notes thereto
included in the Company's Form 10-K for the year ended December 31,
2007.
8
3.
Recent Accounting Pronouncements
In March
2008, the Financial Accounting Standards Board (“FASB”) issued SFAS
No. 161, “Disclosures
about Derivative Instruments and Hedging Activities, an amendment of FASB
Statement No. 133” (“SFAS 161”). This statement is intended to
improve transparency in financial reporting by requiring enhanced disclosures of
an entity’s derivative instruments and hedging activities and their effects on
the entity’s financial position, financial performance, and cash flows. SFAS 161
applies to all derivative instruments within the scope of SFAS 133 as well as
related hedged items, bifurcated derivatives, and non-derivative instruments
that are designated and qualify as hedging instruments. Entities with
instruments subject to SFAS 161 must provide more robust qualitative disclosures
and expanded quantitative disclosures. SFAS 161 is effective prospectively for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008, with early application permitted. The Company
is currently evaluating the disclosure implications of this
statement.
In
December 2007, the FASB issued SFAS 141R, “Business Combinations”
(“SFAS 141R”) and SFAS 160, “Noncontrolling Interests in
Consolidated Financial Statements” (“SFAS 160”). SFAS 141R
requires most identifiable assets, liabilities, noncontrolling interests, and
goodwill acquired in a business combination to be recorded at “fair value.” The
Statement applies to all business combinations, including combinations among
mutual entities and combinations by contract alone. Under SFAS 141R, all
business combinations will be accounted for by applying the acquisition method.
SFAS 141R is effective for periods beginning on or after December 15,
2008. SFAS 160 will require noncontrolling interests (previously referred
to as minority interests) to be treated as a separate component of equity, not
as a liability or other item outside of permanent equity. The
statement applies to the accounting for noncontrolling interests and
transactions with noncontrolling interest holders in consolidated financial
statements. SFAS 160 is effective for periods beginning on or after
December 15, 2008 and will be applied prospectively to all noncontrolling
interests, including any that arose before the effective date except that
comparative period information must be recast to classify noncontrolling
interests in equity, attribute net income and other comprehensive income to
noncontrolling interests, and provide other disclosures required by
SFAS 160. The impact on the Company’s financial statements from
the adoption of SFAS 141R and SFAS 160 in 2009 will depend on future acquisition
activity.
4.
Long-Term Debt
Long-term
debt consists of the following:
7¾% Senior Notes due
2013
In July
2005, the Company issued, in a private placement, $225 million of aggregate
principal amount of 7¾% Senior Notes due 2013 (“Senior Notes”). The
Senior Notes were issued at face value and bear interest at 7¾% per year,
payable semi-annually on February 1 and August 1 of each year, beginning
February 1, 2006.
At any
time prior to August 1, 2009, the Company may redeem some or all of the Senior
Notes at a redemption price equal to 100% of the principal amount of the Senior
Notes to be redeemed, plus a make-whole premium, plus any accrued and unpaid
interest. On and after August 1, 2009, the Company may redeem some or
all of the Senior Notes at redemption prices (expressed as percentages of
principal amount) equal to 103.875% for the twelve-month period beginning on
August 1, 2009, 101.938% for the twelve-month period beginning on August 1,
9
2010, and
100.00% beginning on August 1, 2011 or for any period thereafter, in each case
plus accrued and unpaid interest.
The
Indenture governing the Senior Notes contains covenants that restrict the
ability of the Company and its restricted subsidiaries to: (i) borrow
money; (ii) issue redeemable or preferred stock; (iii) pay
distributions or dividends; (iv) make investments; (v) create liens
without securing the Senior Notes; (vi) enter into agreements that restrict
dividends from subsidiaries; (vii) sell certain assets or merge with or
into other companies; (viii) enter into transactions with affiliates;
(ix) guarantee indebtedness; and (x) enter into new lines of
business. One such covenant prohibits the Company from borrowing any
additional funds under the revolving credit facility if the Company’s
outstanding balance on the facility exceeds 30% of Adjusted Consolidated Net
Tangible Assets, as defined in the Indenture. The Company was in
compliance with these covenants at September 30, 2008.
Secured Bank Credit
Facility
The
Company’s secured bank credit facility provides for a revolving loan facility in
an amount not to exceed the lesser of the borrowing base, as established by the
banks, or that portion of the borrowing base determined by the Company to be the
elected borrowing limit. The borrowing base, which is based on the
discounted present value of future net revenues from oil and gas production, is
subject to redetermination at any time, but at least semi-annually in May and
November, and is made at the discretion of the banks. If, at any time, the
redetermined borrowing base is less than the amount of outstanding indebtedness,
the Company will be required to (i) pledge additional collateral, (ii) prepay
the excess in not more than five equal monthly installments, or (iii) elect to
convert the entire amount of outstanding indebtedness to a term obligation based
on amortization formulas set forth in the loan agreement. Substantially
all of the Company’s oil and gas properties are pledged to secure advances under
the credit facility. The borrowing base was reduced in May 2008 from
$275 million to $250 million in connection with our sale of certain
properties in South Louisiana. In June 2008, we elected to maintain
the borrowing base at $250 million instead of increasing it to levels supported
by the collateral values assigned by the banks. After allowing for
outstanding letters of credit totaling $804,000, the Company had
$125.9 million available under the credit facility at September 30,
2008.
The
revolving credit facility provides for interest at rates based on the agent
bank’s prime rate plus margins ranging from .25% to 1%, or if elected by the
Company based on LIBOR plus margins ranging from 1.5% to 2.25%. The
Company also pays a commitment fee on the unused portion of the revolving credit
facility. Interest and fees are payable at least
quarterly. The effective annual interest rate on borrowings under the
combined credit facility, excluding bank fees and amortization of debt issue
costs, for the nine months ended September 30, 2008 was 4.9%.
The loan
agreement applicable to the revolving credit facility contains financial
covenants that are computed quarterly. The working capital covenant
requires the Company to maintain a ratio of current assets to current
liabilities of at least 1 to 1. Another financial covenant under the
credit facility requires the Company to maintain a ratio of indebtedness to cash
flow of no more than 3 to 1. The computations of current assets,
current liabilities, cash flow and indebtedness are defined in the loan
agreement. The Company was in compliance with all financial and
non-financial covenants at September 30, 2008.
Secured Term Loan of Larclay
JV
In
connection with the Company’s investment in Larclay JV (see Note 11), Larclay JV
obtained a $75 million secured term loan facility from a lender to finance
the construction and equipping of 12 new drilling rigs. The Larclay
JV term loan is secured by substantially all of the assets of Larclay
JV. Initially, the Company pledged additional collateral in the form
of a $19 million letter of credit. In February 2007, the letter
of credit was cancelled and replaced by a $19.5 million guaranty from the
Company. Although the Company is not a maker on the Larclay JV
term loan, it is providing partial credit support for the Larclay JV term
loan and is required to fully consolidate the accounts of Larclay JV under FASB
Interpretation No. 46R “Consolidation of Variable Interest
Entities – an Interpretation of ARB No. 51 (as amended)” (“FIN
46R”).
10
The
Larclay JV term loan, as amended, bears interest at a floating rate based on a
LIBOR average, plus 3.25%, and provides for monthly interest payments through
June 2007 and monthly principal and interest payments thereafter sufficient to
retire the principal balance by 35% in the first year, 25% in each of the next
two years, and 15% in the fourth year. Two voluntary prepayments of
$10 million each may be made in 2008 and 2009 without a prepayment
penalty. The Larclay JV term loan prohibits Larclay JV from making
any cash distributions to the Company or Lariat until the balance on the term
loan is fully repaid, and repayments by Larclay JV of any loans by the Company
or Lariat are subordinated to the loans outstanding under the term loan and are
subject to other restrictions. At September 30, 2008, the effective
interest rate on the Larclay JV term loan was 6.4%.
5.
Other Non-Current Liabilities
Other
non-current liabilities consist of the following:
Changes
in abandonment obligations for the nine months ended September 30, 2008 and 2007
are as follows:
6.
Compensation Plans
Stock-Based
Compensation
The
Company has reserved 1,798,200 shares of common stock for issuance under the
1993 Stock Compensation Plan (“1993 Plan”). The 1993 Plan provides
for the issuance of nonqualified stock options with an exercise price which is
not less than the market value of the Company’s common stock on the date of
grant. All options granted through September 30, 2008 expire 10 years
from the date of grant and become exercisable based on varying vesting
schedules. The Company issues new shares, not repurchased shares, to
option holders that exercise stock options under the 1993 Plan. At
September 30, 2008, 101,766 shares remain available for issuance under this
plan.
The
Company has reserved 86,300 shares of common stock for issuance under the
Outside Directors Stock Option Plan (“Directors Plan”). Since the
inception of the Directors Plan, the Company has issued options covering 52,000
shares of common stock at option prices ranging from $3.25 to $41.74 per
share. All outstanding options expire 10 years from the grant date
and are fully exercisable upon issuance. At September 30, 2008,
34,300 shares remain available for issuance under this plan. 11
The
following table sets forth certain information regarding the Company’s stock
option plans as of and for the nine months ended September 30,
2008:
The
following table summarizes information with respect to options outstanding at
September 30, 2008, all of which are currently exercisable.
The
following table presents certain information regarding stock-based compensation
amounts for the nine months ended September 30, 2008 and 2007.
After-Payout Incentive
Plan
The
Compensation Committee of the Board of Directors has adopted an incentive plan
for officers, key employees and consultants who promote the Company’s drilling
and acquisition programs. Management’s objective in adopting this
plan is to further align the interests of the participants with those of the
Company by granting the participants an after-payout interest in the production
developed, directly or indirectly, by the participants. The plan
generally provides for the creation of a series of partnerships or participation
arrangements (“APO Arrangements”) between the Company and the participants to
which the Company contributes a portion of its economic interest in wells
drilled or acquired within certain areas. Generally, the Company pays
all costs to acquire, drill and produce applicable wells and receives all
revenues until it has recovered all of its costs, plus interest
(“payout”). At payout, the participants receive 99% to 100% of all
subsequent revenues and pay 99% to 100% of all subsequent expenses attributable
to the APO Arrangements. 12
Between
5% and 7.5% of the Company’s economic interests in specified wells drilled or
acquired by the Company subsequent to October 2002 are subject to APO
Arrangements (excluding properties acquired in a merger with Southwest
Royalties, Inc. in May 2004). The Company records its allocable share
of the assets, liabilities, revenues, expenses and oil and gas reserves of these
APO Arrangements in its consolidated financial statements. The
Company recognized $3.9 million of non-cash compensation expense during the
nine-month period ended September 30, 2008 and $1.5 million for the
nine-month period ended September 30, 2007 for the estimated fair value of the
APO Arrangements granted during those periods.
Reward
Plans
The
Company has created four bonus plans designed to reward eligible officers,
employees and other service providers for continued quality service to the
Company, and to encourage retention of those persons by providing them the
opportunity to receive bonus payments that are based on profits derived from a
portion of the Company’s working interest in certain wells drilled by the
Company.
One bonus
plan was activated in January 2007 and established a quarterly bonus amount
equal to the after-payout cash flow from a 22.5% working interest in one
well. Under the plan, two-thirds of the quarterly bonus amount is
payable to the participants until the full vesting date of October 25,
2011. After the full vesting date, the deferred portion of the
quarterly bonus amount, with interest at 4.83% per year, as well as 100% of all
subsequent quarterly bonus amounts, are payable to participants.
In June
2008, the Company activated three additional bonus plans. Each of
these plans establishes a quarterly bonus amount equal to 7% of the after-payout
cash flow from wells drilled in the respective plan areas after the effective
date set forth in each plan, which dates range from January 1, 2007 to May 5,
2008. Under these plans, 100% of the quarterly bonus amount is
payable to the participants, and the full vesting date is May 5,
2013.
The
quarterly bonus amount in these plans is allocated among the participants based
on each participant’s bonus percentage. To continue as a participant
in the plans, participants must remain in the employment or service of the
Company through the full vesting date. Participants who remain in the
employment or service of the Company through the full vesting date will continue
as participants for the duration of the plans, subject to certain
restrictions. The full vesting date may be accelerated in the event
of a change of control or sale transaction, as defined in the plan
documents.
The
Company recognizes compensation expense related to these bonus plans over the
vesting period. The Company recorded compensation expense of $382,000
for the nine months ended September 30, 2008, and $104,000 for the nine months
ended September 30, 2007, in connection with these bonus plans.
7.
Derivatives
Commodity
Derivatives
From time
to time, the Company utilizes commodity derivatives, consisting of swaps, floors
and collars, to attempt to optimize the price received for its oil and gas
production. When using swaps to hedge oil and natural gas production,
the Company receives a fixed price for the respective commodity and pays a
floating market price as defined in each contract (generally NYMEX futures
prices), resulting in a net amount due to or from the
counterparty. In floor transactions, the Company receives a fixed
price (put strike price) if the market price falls below the put strike price
for the respective commodity. If the market price is greater than the
put strike price, no payments are due from either party. Costless
collars are a combination of puts and calls, and contain a fixed floor price
(put strike price) and ceiling price (call strike price). If the
market price for the respective commodity exceeds the call strike price or falls
below the put strike price, then the Company receives the fixed price and pays
the market price. If the market price is between the call and the put
strike prices, no payments are due from either party. Commodity
derivatives are settled monthly as the contract production periods
mature.
13
The
following summarizes information concerning the Company’s net positions in open
commodity derivatives applicable to periods subsequent to September 30,
2008. The settlement prices of commodity derivatives are based on
NYMEX futures prices.
Swaps:
In July
2008, the Company terminated certain fixed-price gas swaps covering 100,000
MMBtu at a price of $10.32 per MMBtu in October 2008, resulting in an aggregate
loss of $195,000, which will be paid to the counterparty monthly as the
applicable contracts are settled.
In
September 2007, the Company terminated certain fixed-priced oil swaps covering
30,000 barrels at a price of $76.65 from October 2008 through December 2008,
resulting in an aggregate loss of approximately $332,000, which will be paid to
the counterparty monthly as the applicable contracts are settled.
Interest Rate
Derivative
At
September 30, 2008, the Company was a party to an interest rate
swap. Under this derivative, the Company pays a fixed rate for the
notional principal balance and receives a floating market rate based on
LIBOR. The interest rate swap is settled quarterly. The
following summarizes information concerning the Company’s interest rate swap at
September 30, 2008.
Interest
Rate Swap:
Accounting For
Derivatives
The
Company accounts for its derivatives in accordance with SFAS 133. The
Company did not designate any of its currently open commodity or interest rate
derivatives as cash flow hedges; therefore, all changes in the fair value of
these contracts prior to maturity, plus any realized gains or losses at
maturity, are recorded as other income (expense) in the Company’s statements of
operations. For the nine months ended September 30, 2008, the Company
reported a $62 million net loss on derivatives, consisting of a
$23.9 million gain related to changes in mark-to-market valuations and a
$85.9 million realized loss for settled contracts. For the nine
months ended September 30, 2007, the Company reported a $13 million loss on
derivatives, consisting of a $15.2 million loss related to changes in
mark-to-market valuations, net of a $2.2 million realized gain on settled
contracts.
8.
Financial Instruments
Cash and
cash equivalents, receivables, accounts payable and accrued liabilities were
each estimated to have a fair value approximating the carrying amount due to the
short maturity of those instruments. Indebtedness under the Company’s
secured bank credit facility was estimated to have a fair value approximating
the carrying amount since the interest rate is generally market
sensitive. The estimated fair value of the Company’s Senior Notes at
September 30, 2008 and December 31, 2007 was approximately
$196.9 million for both periods, based on market
valuations. 14
Determination of Fair
Value
The
Company adopted SFAS No. 157, “Fair Value Measurements”
(“SFAS 157”) (as amended) effective January 1, 2008. SFAS 157 defines
fair value, establishes a framework for measuring fair value, outlines a fair
value hierarchy based on the quality of inputs used to measure fair value and
enhances disclosure requirements for fair value measurements. As
permitted by FSP No. 157-2, the Company has not applied the provisions of SFAS
157 to nonfinancial assets and liabilities. The Company has not
applied the provisions of SFAS 157 to its asset retirement
obligations.
Fair
value is defined as the price at which an asset could be exchanged in a current
transaction between knowledgeable, willing parties at the measurement date.
Where available, fair value is based on observable market prices or parameters
or derived from such prices or parameters. Where observable prices or inputs are
not available, use of unobservable prices or inputs are used to estimate the
current fair value, often using an internal valuation model. These valuation
techniques involve some level of management estimation and judgment, the degree
of which is dependent on the item being valued.
In
accordance with SFAS 157, the Company categorizes its assets and liabilities
recorded at fair value in the accompanying consolidated balance sheets based
upon the level of judgment associated with the inputs used to measure their fair
value. Hierarchical levels, defined by SFAS 157 and directly related to the
amount of subjectivity associated with the inputs to fair valuation of these
assets and liabilities, are as follows:
Level 1 - Inputs
are unadjusted, quoted prices in active markets for identical assets or
liabilities at the measurement date.
Level 2 - Inputs
(other than quoted prices included in Level 1) are either directly or indirectly
observable for the asset or liability through correlation with market data at
the measurement date and for the duration of the instrument’s anticipated
life.
Level 3 - Inputs
reflect management’s best estimate of what market participants would use in
pricing the asset or liability at the measurement date. Consideration is given
to the risk inherent in the valuation technique and the risk inherent in the
inputs to the model.
The fair
value of the Company’s investment in common stock of SandRidge (see Note 11) is
measured using Level 1 inputs, and is determined by market prices on an active
market.
The fair
value of derivative contracts are measured using Level 2 inputs, and are
determined by either market prices on an active market for similar assets or by
prices quoted by a broker or other market-corroborated prices.
15
The
estimated fair values of assets and liabilities included in the accompanying
consolidated balance sheets at September 30, 2008 and December 31, 2007 are
summarized below.
9.
Inventory
The
Company maintains an inventory of tubular goods and other well equipment for use
in its exploration and development drilling activities. Any gains or
losses on disposition of inventory, and any losses on write-down of inventory to
its estimated market value, are reported as gain or loss on sales of property
and equipment in the accompanying consolidated statements of
operations. The 2007 period included a charge of $8.9 million to
write-down inventory to its estimated market value at March 31,
2007. The write-down resulted primarily from the sale of certain
surplus equipment at an auction in March 2007. The Company received
$4.5 million of net proceeds from the auction in April 2007 when the
auction sale was consummated.
10. Income Taxes The
Company’s effective federal and state income tax rate for the nine months ended
September 30, 2008 of 35.9% differed from the statutory federal rate of 35% due
to increases in the tax provision related primarily to the effects of the
recently-enacted Texas Margin Tax and certain non-deductible expenses, offset in
part by tax benefits derived from excess statutory depletion
deductions.
The
Company and its subsidiaries file federal income tax returns with the United
States Internal Revenue Service (“IRS”) and state income tax returns in various
state tax jurisdictions. The Company’s tax returns for fiscal years
after 2002 currently remain subject to examination by appropriate taxing
authorities. None of the Company’s income tax returns are under
examination at this time.
In June
2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes” (“FIN 48”). Upon adoption of FIN 48, the Company recorded a
liability for taxes payable related to unrecognized tax benefits arising from
uncertain tax positions taken by the Company in previous periods. A
reconciliation of the changes in this tax liability as of September 30, 2008 and
December 31, 2007 is as follows:
16
No
unrecognized tax benefits originated during the first nine months of
2008. Reductions in the 2007 tax liability resulted from changes in
accounting methods which were submitted to the taxing authority during
2007. All of the remaining unrecognized tax benefits at September 30,
2008 relate to tax positions for which the ultimate deductibility is highly
certain but for which there is uncertainty about the timing of such
deductions. Because of the impact of deferred tax accounting, the
disallowance of the shorter deduction period would not affect the annual
effective tax rate but would only accelerate the payment of taxes to the taxing
authority or change the amount of deferred tax assets related to net operating
loss carryforwards.
Tax
liabilities recorded under FIN 48 are included in other non-current liabilities
in the accompanying consolidated financial statements, and any interest and
penalties accrued on unrecognized tax benefits, are recorded as interest expense
in the accompanying statements of operations. However, due to the
Company’s net operating loss carryforwards, no interest or penalties have been
accrued on the Company’s unrecognized tax benefits.
11. Investments
Larclay
JV
In April
2006, the Company formed a joint venture (“Larclay JV”) with Lariat Services,
Inc. (“Lariat”) to construct, own and operate 12 new drilling
rigs. The Company and Lariat each own a 50% interest in Larclay
JV. A lender provided a $75 million secured term loan to Larclay JV
to finance most of the cost of constructing and initially equipping the rigs
(see Note 4). The Company has made loans to Larclay JV totaling $10.1
million to finance excess construction costs and its 50% share of working
capital assessments made by Larclay JV. Loans to Larclay JV are due
on demand and bear interest, payable monthly, at the same rate as the secured
term loan. However, the loans are subject to a subordination
agreement with the secured lender that imposes restrictions on payments of
principal and interest on the loans.
Also in
April 2006, the Company entered into a three-year drilling contract with Larclay
JV assuring the availability of each rig for use in the ordinary course of the
Company’s exploration and development drilling program throughout the term of
the drilling contract. The drilling contract expires on the earlier
of December 31, 2009 or the termination and liquidation of Larclay
JV. The provisions of the drilling contract provide that the Company
contract for each rig on a well-by-well basis at then current market
rates. If a rig is not needed by the Company at any time during the
term of the contract, Larclay JV may contract with other operators for the use
of such rig, subject to certain restrictions. If a rig is idle, the
Company will pay Larclay JV an idle rig rate ranging from $8,100 per day to
$10,300 per day (plus crew labor expenses, if applicable), depending on the size
of the rig. The Company’s maximum potential obligation to pay idle
rig rates over the term of this drilling contract, excluding any crew labor
expenses, totals approximately $42.2 million at September 30,
2008. The Company paid $669,000 for idle rig fees during the nine
months ended September 30, 2008.
Although
the Company and Lariat own equal interests in Larclay JV, the Company meets the
definition of the primary beneficiary of Larclay JV’s expected cash flows under
FIN 46R. As the primary beneficiary under FIN 46R, the Company is
required to include the accounts of Larclay JV in the Company’s consolidated
financial statements. As of September 30, 2008, Lariat’s equity
ownership in the net assets of Larclay JV was $5.2 million, which is
recorded as minority interest and included in other non-current liabilities in
the accompanying consolidated financial statements. The Company’s
intercompany accounts and profits with Larclay JV have been eliminated in
consolidation.
SandRidge Energy
Inc.
During
the fourth quarter of 2007, SandRidge Energy Inc. (“SandRidge”) became publicly
traded and listed its shares on the New York Stock Exchange. The
Company’s original cost investment in SandRidge was increased to fair market
value in 2007 and the change in fair market value of $4.2 million, net of tax of
$1.5 million, was recorded in accumulated other comprehensive income at December
31, 2007. In September 2008, the Company sold its investment of
200,460 shares in SandRidge for $4.3 million. After eliminating the
investment, the associated accumulated other comprehensive income and deferred
income tax liability, the Company recorded a gain of $1.3 million in other
income.
17
12. Oil
and Gas Properties
The
following sets forth the capitalized costs for oil and gas properties as of
September 30, 2008 and December 31, 2007.
13. Sales
of Property and Equipment
In April
2008, the Company and its affiliates sold all of their interests in 16 producing
wells for approximately $89.2 million, net of customary closing
adjustments. The Company recorded a gain of approximately $33.1
million in the second quarter of 2008 in connection with this
transaction. In April 2008, the Company sold a surplus well servicing
unit for $1.8 million and recorded a gain of approximately $75,000 in the second
quarter of 2008 and sold two 2,000 horsepower drilling rigs in June 2008 for
$21.8 million, net of customary closing adjustments and recorded a gain of $5.7
million. In September 2008, the Company sold its interest in a
prospect in North Louisiana for $3.2 million and recorded a gain of $3.1
million.
14. Segment
Information
In
accordance with SFAS No. 131 “Disclosures about Segments of an
Enterprise and Related Information” (“SFAS 131”), the Company has
two reportable operating segments, which are oil and gas exploration and
production and contract drilling services.
The
following tables present selected financial information regarding the Company’s
operating segments for the three-month and nine-month periods ended September
30, 2008 and 2007.
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