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SM Energy Co 10-Q 2010

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2010

 

Commission File Number 001-31539

 

GRAPHIC

 

SM ENERGY COMPANY

(Exact name of registrant as specified in its charter)

 

Delaware

 

41-0518430

(State or other jurisdiction

 

(I.R.S. Employer

of incorporation or organization)

 

Identification No.)

 

1775 Sherman Street, Suite 1200, Denver, Colorado
(Address of principal executive offices)

 

80203
(Zip Code)

 

(303) 861-8140

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso  No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

As of July 28, 2010 the registrant had 63,007,624 shares of common stock, $0.01 par value, outstanding.

 

 

 



 

SM ENERGY COMPANY

INDEX

 

 

 

 

PAGE

Part I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets June 30, 2010, and December 31, 2009

3

 

 

 

 

 

 

Condensed Consolidated Statements of Operations Three and Six Months Ended June 30, 2010, and 2009

4

 

 

 

 

 

 

Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) June 30, 2010, and June 30, 2009

5

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows Six Months Ended June 30, 2010, and 2009

6

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements June 30, 2010

8

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

25

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk (included within the content of Item 2)

59

 

 

 

 

 

Item 4.

Controls and Procedures

59

 

 

 

 

Part II.

OTHER INFORMATION

 

 

 

 

 

 

Item 1A.

Risk Factors

59

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

60

 

 

 

 

 

Item 6.

Exhibits

61

 



 

PART I.  FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

 

SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS  (UNAUDITED)

(In thousands, except share amounts)

 

 

 

June 30,

 

December 31,

 

 

 

2010

 

2009

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

10,249

 

$

10,649

 

Accounts receivable

 

108,427

 

116,136

 

Refundable income taxes

 

23,215

 

32,773

 

Prepaid expenses and other

 

14,284

 

14,259

 

Derivative asset

 

45,481

 

30,295

 

Deferred income taxes

 

 

4,934

 

Total current assets

 

201,656

 

209,046

 

 

 

 

 

 

 

Property and equipment (successful efforts method), at cost:

 

 

 

 

 

Land

 

1,483

 

1,371

 

Proved oil and gas properties

 

3,066,300

 

2,797,341

 

Less - accumulated depletion, depreciation, and amortization

 

(1,203,841

)

(1,053,518

)

Unproved oil and gas properties, net of impairment allowance of $62,507 in 2010 and $66,570 in 2009

 

138,531

 

132,370

 

Wells in progress

 

97,312

 

65,771

 

Materials inventory, at lower of cost or market

 

31,305

 

24,467

 

Oil and gas properties held for sale less accumulated depletion, depreciation, and amortization

 

7,115

 

145,392

 

Other property and equipment, net of accumulated depreciation of $16,478 in 2010 and $14,550 in 2009

 

15,472

 

14,404

 

 

 

2,153,677

 

2,127,598

 

 

 

 

 

 

 

Other noncurrent assets:

 

 

 

 

 

Derivative asset

 

30,169

 

8,251

 

Restricted cash subject to Section 1031 Exchange

 

19,595

 

 

Other noncurrent assets

 

12,288

 

16,041

 

Total other noncurrent assets

 

62,052

 

24,292

 

 

 

 

 

 

 

Total Assets

 

$

2,417,385

 

$

2,360,936

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable and accrued expenses

 

$

270,030

 

$

236,242

 

Derivative liability

 

37,903

 

53,929

 

Deposit associated with oil and gas properties held for sale

 

 

6,500

 

Deferred income taxes

 

4,970

 

 

Total current liabilities

 

312,903

 

296,671

 

 

 

 

 

 

 

Noncurrent liabilities:

 

 

 

 

 

Long-term credit facility

 

 

188,000

 

Senior convertible notes, net of unamortized discount of $16,288 in 2010, and $20,598 in 2009

 

271,212

 

266,902

 

Asset retirement obligation

 

64,284

 

60,289

 

Asset retirement obligation associated with oil and gas properties held for sale

 

1,526

 

18,126

 

Net Profits Plan liability

 

136,420

 

170,291

 

Deferred income taxes

 

408,997

 

308,189

 

Derivative liability

 

24,046

 

65,499

 

Other noncurrent liabilities

 

15,164

 

13,399

 

Total noncurrent liabilities

 

921,649

 

1,090,695

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock, $0.01 par value - authorized: 200,000,000 shares; issued: 63,110,068 shares in 2010 and 62,899,122 shares in 2009; outstanding, net of treasury shares: 63,007,433 shares in 2010 and 62,772,229 shares in 2009

 

631

 

629

 

Additional paid-in capital

 

174,973

 

160,516

 

Treasury stock, at cost: 102,635 shares in 2010 and 126,893 shares in 2009

 

(489

)

(1,204

)

Retained earnings

 

992,685

 

851,583

 

Accumulated other comprehensive income (loss)

 

15,033

 

(37,954

)

Total stockholders’ equity

 

1,182,833

 

973,570

 

 

 

 

 

 

 

Total Liabilities and Stockholders’ Equity

 

$

2,417,385

 

$

2,360,936

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3



 

SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In thousands, except per share amounts)

 

 

 

For the Three Months

 

For the Six Months

 

 

 

Ended June 30,

 

Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

 

 

 

 

 

 

Operating revenues and other income:

 

 

 

 

 

 

 

 

 

Oil and gas production revenue

 

$

175,887

 

$

145,279

 

$

388,774

 

$

275,696

 

Realized oil and gas hedge gain

 

9,329

 

43,279

 

11,924

 

98,899

 

Gain on divestiture activity

 

7,021

 

1,244

 

127,999

 

645

 

Marketed gas system and other operating revenue

 

19,460

 

15,396

 

43,135

 

29,178

 

Total operating revenues and other income

 

211,697

 

205,198

 

571,832

 

404,418

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Oil and gas production expense

 

45,168

 

49,465

 

93,508

 

105,294

 

Depletion, depreciation, amortization, and asset retirement obligation liability accretion

 

79,770

 

70,391

 

157,535

 

162,103

 

Exploration

 

14,498

 

19,490

 

28,396

 

33,088

 

Impairment of proved properties

 

 

6,043

 

 

153,092

 

Abandonment and impairment of unproved properties

 

2,375

 

11,631

 

3,279

 

15,533

 

Impairment of materials inventory

 

 

2,719

 

 

11,335

 

General and administrative

 

25,398

 

18,160

 

48,884

 

34,559

 

Change in Net Profits Plan liability

 

(6,599

)

2,449

 

(33,871

)

(20,842

)

Marketed gas system expense

 

15,807

 

13,609

 

37,853

 

26,992

 

Unrealized derivative (gain) loss

 

(2,087

)

11,288

 

(9,822

)

13,134

 

Other expense

 

578

 

5,814

 

1,530

 

11,456

 

Total operating expenses

 

174,908

 

211,059

 

327,292

 

545,744

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

36,789

 

(5,861

)

244,540

 

(141,326

)

 

 

 

 

 

 

 

 

 

 

Nonoperating income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

54

 

105

 

183

 

127

 

Interest expense

 

(6,343

)

(7,663

)

(13,130

)

(13,759

)

 

 

 

 

 

 

 

 

 

 

Income (loss) before income taxes

 

30,500

 

(13,419

)

231,593

 

(154,958

)

Income tax benefit (expense)

 

(12,432

)

5,097

 

(87,347

)

59,013

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

18,068

 

$

(8,322

)

$

144,246

 

$

(95,945

)

 

 

 

 

 

 

 

 

 

 

Basic weighted-average common shares outstanding

 

62,917

 

62,418

 

62,855

 

62,377

 

 

 

 

 

 

 

 

 

 

 

Diluted weighted-average common shares outstanding

 

64,566

 

62,418

 

64,493

 

62,377

 

 

 

 

 

 

 

 

 

 

 

Basic net income (loss) per common share

 

$

0.29

 

$

(0.13

)

$

2.29

 

$

(1.54

)

 

 

 

 

 

 

 

 

 

 

Diluted net income (loss) per common share

 

$

0.28

 

$

(0.13

)

$

2.24

 

$

(1.54

)

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4



 

SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(In thousands, except share amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

 

Other

 

Total

 

 

 

Common Stock

 

Paid-in

 

Treasury Stock

 

Retained

 

Comprehensive

 

Stockholders’

 

 

 

Shares

 

Amount

 

Capital

 

Shares

 

Amount

 

Earnings

 

Income (Loss)

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances, December 31, 2009

 

62,899,122

 

$

629

 

$

160,516

 

(126,893

)

$

(1,204

)

$

851,583

 

$

(37,954

)

$

973,570

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

144,246

 

 

144,246

 

Change in derivative instrument fair value

 

 

 

 

 

 

 

53,765

 

53,765

 

Reclassification to earnings

 

 

 

 

 

 

 

(782

)

(782

)

Minimum pension liability adjustment

 

 

 

 

 

 

 

4

 

4

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

197,233

 

Cash dividends, $ 0.05 per share

 

 

 

 

 

 

(3,144

)

 

(3,144

)

Issuance of common stock under Employee Stock Purchase Plan

 

27,456

 

 

799

 

 

 

 

 

799

 

Issuance of common stock upon settlement of RSUs following expiration of restriction period, net of shares used for tax withholdings, including income tax cost of RSUs

 

34,588

 

1

 

(545

)

 

 

 

 

(544

)

Sale of common stock, including income tax benefit of stock option exercises

 

148,902

 

1

 

3,054

 

 

 

 

 

3,055

 

Stock-based compensation expense

 

 

 

11,149

 

24,258

 

715

 

 

 

11,864

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances, June 30, 2010

 

63,110,068

 

$

631

 

$

174,973

 

(102,635

)

$

(489

)

$

992,685

 

$

15,033

 

$

1,182,833

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances, December 31, 2008

 

62,465,572

 

$

625

 

$

141,283

 

(176,987

)

$

(1,892

)

$

957,200

 

$

65,293

 

$

1,162,509

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss, net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

 

 

 

 

 

(95,945

)

 

(95,945

)

Change in derivative instrument fair value

 

 

 

 

 

 

 

(11,852

)

(11,852

)

Reclassification to earnings

 

 

 

 

 

 

 

(45,494

)

(45,494

)

Minimum pension liability adjustment

 

 

 

 

 

 

 

4

 

4

 

Total comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(153,287

)

Cash dividends, $ 0.05 per share

 

 

 

 

 

 

(3,120

)

 

(3,120

)

Issuance of common stock under Employee Stock Purchase Plan

 

49,767

 

 

858

 

 

 

 

 

858

 

Issuance of common stock upon settlement of RSUs following expiration of restriction period, net of shares used for tax withholdings, including income tax cost of RSUs

 

86,505

 

1

 

(3,249

)

 

 

 

 

(3,248

)

Sale of common stock, including income tax benefit of stock option exercises

 

19,570

 

 

207

 

 

 

 

 

207

 

Stock-based compensation expense

 

1,250

 

 

6,873

 

50,094

 

636

 

 

 

7,509

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances, June 30, 2009

 

62,622,664

 

$

626

 

$

145,972

 

(126,893

)

$

(1,256

)

$

858,135

 

$

7,951

 

$

1,011,428

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5



 

SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

 

 

 

For the Six Months

 

 

 

Ended June 30,

 

 

 

2010

 

2009

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

144,246

 

$

(95,945

)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

 

 

 

 

 

Gain on divestiture activity

 

(127,999

)

(645

)

Depletion, depreciation, amortization, and asset retirement obligation liability accretion

 

157,535

 

162,103

 

Exploratory dry hole expense

 

327

 

4,667

 

Impairment of proved properties

 

 

153,092

 

Abandonment and impairment of unproved properties

 

3,279

 

15,533

 

Impairment of materials inventory

 

 

11,335

 

Stock-based compensation expense

 

11,864

 

7,509

 

Change in Net Profits Plan liability

 

(33,871

)

(20,842

)

Unrealized derivative (gain) loss

 

(9,822

)

13,134

 

Loss related to hurricanes

 

 

7,120

 

Amortization of debt discount and deferred financing costs

 

6,657

 

5,703

 

Deferred income taxes

 

78,820

 

(63,148

)

Plugging and abandonment

 

(6,222

)

(2,355

)

Other

 

2,937

 

1,619

 

Changes in current assets and liabilities:

 

 

 

 

 

Accounts receivable

 

7,628

 

49,149

 

Refundable income taxes

 

9,558

 

13,161

 

Prepaid expenses and other

 

(148

)

(7,091

)

Accounts payable and accrued expenses

 

26,299

 

(12,338

)

Excess income tax benefit from the exercise of stock options

 

(938

)

 

Net cash provided by operating activities

 

270,150

 

241,761

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Net proceeds from sale of oil and gas properties

 

247,998

 

1,081

 

Capital expenditures

 

(304,627

)

(215,826

)

Acquisition of oil and gas properties

 

 

(44

)

Deposits to restricted cash

 

(19,595

)

 

Receipts from restricted cash

 

 

14,398

 

Receipts from short-term investments

 

 

1,002

 

Other

 

(6,492

)

 

Net cash used in investing activities

 

(82,716

)

(199,389

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from credit facility

 

204,059

 

1,766,000

 

Repayment of credit facility

 

(392,059

)

(1,791,000

)

Debt issuance costs related to credit facility

 

 

(11,060

)

Proceeds from sale of common stock

 

2,916

 

1,066

 

Dividends paid

 

(3,144

)

(3,120

)

Excess income tax benefit from the exercise of stock options

 

938

 

 

Other

 

(544

)

 

Net cash used in financing activities

 

(187,834

)

(38,114

)

 

 

 

 

 

 

Net change in cash and cash equivalents

 

(400

)

4,258

 

Cash and cash equivalents at beginning of period

 

10,649

 

6,131

 

Cash and cash equivalents at end of period

 

$

10,249

 

$

10,389

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

6



 

SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (Continued)

 

Supplemental schedule of additional cash flow information and noncash investing and financing activities:

 

 

 

For the Six Months

 

 

 

Ended June 30,

 

 

 

2010

 

2009

 

 

 

(In thousands)

 

 

 

 

 

 

 

Cash paid for interest

 

$

8,152

 

$

8,837

 

 

 

 

 

 

 

Cash refunded for income taxes

 

$

(2,392

)

$

(10,441

)

 

As of June 30, 2010, and 2009, $105.4 million, and $57.9 million, respectively, are included as additions to oil and gas properties and accounts payable and accrued expenses in the accompanying condensed consolidated balance sheets.  These oil and gas additions are reflected as cash used in investing activities in the periods that the payables are settled.

 

The accompanying notes are an integral part of these consolidated financial statements.

 

7



 

SM ENERGY COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

June 30, 2010

 

Note 1 — The Company and Business

 

SM Energy Company (“SM Energy” or the “Company”), formerly named St. Mary Land & Exploration Company or referred to as St. Mary, is an independent energy company engaged in the exploration, exploitation, development, acquisition, and production of natural gas, natural gas liquids, and crude oil.  The Company’s operations are conducted entirely in the continental United States.

 

Note 2 — Basis of Presentation and Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of SM Energy have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Regulation S-X.  They do not include all information and notes required by generally accepted accounting principles for complete financial statements.  However, except as disclosed herein, there has been no material change in the information disclosed in the notes to consolidated financial statements included in SM Energy’s Annual Report on Form 10-K for the year ended December 31, 2009, (the “2009 Form 10-K”).  In the opinion of management, all adjustments, consisting of normal recurring accruals that are considered necessary for a fair presentation of the interim financial information, have been included.  Operating results for the periods presented are not necessarily indicative of expected results for the full year.  In connection with the preparation of the condensed consolidated financial statements of SM Energy, the Company evaluated subsequent events after the balance sheet date of June 30, 2010, through the filing date of this report.

 

Other Significant Accounting Policies

 

The accounting policies followed by the Company are set forth in Note 1 to the Company’s consolidated financial statements in the 2009 Form 10-K, and are supplemented throughout the notes to condensed consolidated financial statements in this report.  It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes included in the 2009 Form 10-K.

 

Note 3 —Divestitures and Assets Held for Sale

 

Legacy Divestiture

 

In February 2010 the Company completed the divestiture of certain non-strategic oil properties located in Wyoming to Legacy Reserves Operating LP, a wholly-owned subsidiary of Legacy Reserves LP (“Legacy”).  The transaction had an effective date of November 1, 2009.  Total cash received, before commission costs and Net Profits Interest Bonus Plan (“Net Profits Plan”) payments, was $125.2 million, of which $6.5 million was received as a deposit in December 2009.  The final sale price is subject to normal post-closing adjustments and is expected to be finalized during the second half of 2010.  The estimated gain on sale related to the divestiture is approximately $65.1 million and may be impacted by the forthcoming post-closing adjustments mentioned above.  The Company determined that the sale does not qualify for discontinued operations accounting under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 205, “Presentation of Financial Statements” (“ASC Topic 205”).  A portion of the transaction was structured to qualify as a like-kind exchange under Section 1031 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”).

 

8



 

Sequel Divestiture

 

In March 2010 the Company completed the divestiture of certain non-strategic oil properties located in North Dakota to Sequel Energy Partners, LP, Bakken Energy Partners, LLC, and Three Forks Energy Partners, LLC (collectively referred to as “Sequel”).  The transaction had an effective date of November 1, 2009.  Total cash received, before commission costs and Net Profits Plan payments, was $126.9 million.  The final sale price is subject to normal post-closing adjustments and is expected to be finalized during the second half of 2010.  The estimated gain on sale related to the divestiture is approximately $50.4 million and may be impacted by the forthcoming post-closing adjustments mentioned above.  The Company determined that the sale does not qualify for discontinued operations accounting under ASC Topic 205.  A portion of the transaction was structured to qualify as a like-kind exchange under Section 1031 of the Internal Revenue Code.

 

Assets Held for Sale

 

In accordance with FASB ASC Topic 360, “Property, Plant, and Equipment” (“ASC Topic 360”), assets are classified as held for sale when the Company commits to a plan to sell the assets and there is reasonable certainty that the sale will take place within one year.  Upon classification as held-for-sale, long-lived assets are no longer depreciated or depleted, and a measurement for impairment is performed to determine if there is any excess of carrying value over fair value less costs to sell.  Subsequent changes to estimated fair value less the cost to sell will impact the measurement of assets held for sale if the fair value is determined to be less than the carrying value of the assets.

 

As of June 30, 2010, the accompanying condensed consolidated balance sheets present $7.1 million in book value of assets held for sale, net of accumulated depletion, depreciation, and amortization.  Additionally, the corresponding asset retirement obligation liability of $1.5 million is separately presented.  The Company determined that these planned asset sales do not qualify for discontinued operations accounting under ASC Topic 205.  Subsequent to June 30, 2010, the Company has completely divested of the assets held for sale.

 

Note 4 — Income Taxes

 

Income tax (expense) benefit for the six-month periods ended June 30, 2010, and 2009, differs from the amounts that would be provided by applying the statutory U.S. federal income tax rate to income (loss) before income taxes as a result of the estimated effect of the domestic production activities deduction, percentage depletion, the effect of state income taxes, and other permanent differences.  The provision for income taxes consists of the following:

 

 

 

For the Three Months
Ended June 30,

 

For the Six Months
Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(In thousands)

 

Current portion of income tax (expense) benefit:

 

 

 

 

 

 

 

 

 

Federal

 

$

1,759

 

$

(2,166

)

$

(8,216

)

$

(3,249

)

State

 

21

 

(495

)

(311

)

(886

)

Deferred portion of income tax (expense) benefit

 

(14,212

)

7,758

 

(78,820

)

63,148

 

Total income tax (expense) benefit

 

$

(12,432

)

$

5,097

 

$

(87,347

)

$

59,013

 

Effective tax rate

 

40.8

%

38.0

%

37.7

%

38.1

%

 

9



 

A change in the Company’s effective tax rate between reported periods will generally reflect differences in its estimated highest marginal state tax rate due to changes in the composition of income between state tax jurisdictions resulting from Company activities.  Non-core asset sales through June 30, 2010, and the Company’s anticipated drilling budget for the rest of 2010 applied against the Company’s cumulative temporary timing differences caused an increase in tax rate for the second quarter of 2010 when compared to the same period of 2009.  The rate is also being impacted period to period as estimates for the domestic production activities deduction, percentage depletion and the impact of potential permanent state tax items affect the presented periods differently because of oil and gas price variability and the impact of non-core asset sales.

 

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and in various states.  With few exceptions, the Company is no longer subject to U.S. federal or state income tax examinations by these tax authorities for years before 2006.  In late 2009 the Internal Revenue Service announced a National Research Program (“NRP”) study of employment tax compliance that includes audits of randomly selected taxpayers for data collection purposes.  During the first quarter of 2010, the Internal Revenue Service initiated an audit of SM Energy for the 2006 tax year focused primarily on compensation.  In the second quarter of 2010 the Company determined its 2006 audit was not part of the NRP study.  At June 30, 2010, the Company is awaiting a $5.5 million refund related to its 2006 tax year as a result of a net operating loss carry back from the Company’s 2008 tax year.  This refund claim was combined with the audit discussed above and cannot be received until the audit is completed and submitted to the Joint Committee on Taxation (“JCT”) for review.  The Company believes the 2006 audit will conclude in the third quarter of 2010 with no material adjustments, and its claim will be submitted to the JCT soon thereafter.  The Company’s remaining refundable income tax balance at June 30, 2010, reflects its utilization of carry backs to claim a taxable net operating loss generated for the 2009 tax year against its 2005 taxable income. On July 20, 2010, the Company received $22.9 million relating to this carry back claim.

 

The Company’s 2005 federal income tax audit was concluded in the first quarter of 2009 with a refund to the Company of $278,000 plus interest of $41,000.  There was no change to the provision for income tax expense as a result of the 2005 examination.

 

Note 5 — Earnings per Share

 

Basic net income or loss per common share of stock is calculated by dividing net income or loss available to common stockholders by the basic weighted-average common shares outstanding for the respective period.  The shares represented by vested restricted stock units (“RSUs”) are included in the calculation of the basic weighted-average common shares outstanding.  The earnings per share calculations reflect the impact of any repurchases of shares of common stock made by the Company.

 

Diluted net income or loss per common share of stock is calculated by dividing adjusted net income or loss by the diluted weighted-average common shares outstanding, which includes the effect of potentially dilutive securities.  Potentially dilutive securities for the diluted earnings per share calculation consist of unvested RSUs, in-the-money outstanding options to purchase the Company’s common stock, contingent Performance Share Awards (“PSAs”), and shares into which the 3.50% Senior Convertible Notes due 2027 (the “3.50% Senior Convertible Notes”) are convertible.

 

The Company’s 3.50% Senior Convertible Notes have a net-share settlement right whereby each $1,000 principal amount of notes may be surrendered for conversion to cash in an amount equal to the principal amount and, if applicable, shares of common stock or cash or any combination of common stock and cash for the amount of conversion value in excess of the principal amount.  The treasury stock method is used to measure the potentially dilutive impact of shares associated with this conversion feature.  The 3.50% Senior Convertible Notes have not been dilutive for any reporting period that they have been outstanding and therefore do not impact the diluted earnings per share calculation for the three-month and six-month periods ended June 30, 2010, and 2009.

 

10



 

The PSAs represent the right to receive, upon settlement of the PSAs after the completion of the three-year performance period, a number of shares of the Company’s common stock that may be from zero to two times the number of PSAs granted on the award date.  The number of potentially dilutive shares related to PSAs is based on the number of shares, if any, which would be issuable at the end of the respective reporting period, assuming that date was the end of the contingency period.  For additional discussion on PSAs, please refer to Note 7 — Compensation Plans under the heading Performance Share Awards Under the Equity Incentive Compensation Plan.

 

The treasury stock method is used to measure the dilutive impact of stock options, RSUs, 3.50% Senior Convertible Notes, and PSAs.  In accordance with FASB ASC Topic 260, “Earnings Per Share” when there is a loss from continuing operations, all potentially dilutive shares will be anti-dilutive.  There were no dilutive shares for the three-month or six-month periods ended June 30, 2009, because the Company recorded a loss for each of those periods.  Unvested RSUs, contingent PSAs, and in-the-money options had a dilutive impact for the three-month and six-month periods ended June 30, 2010, as calculated in the table below.

 

The following table sets forth the calculation of basic and diluted earnings per share:

 

 

 

For the Three Months
Ended June 30,

 

For the Six Months
Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(In thousands, except per share amounts)

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

18,068

 

$

(8,322

)

$

144,246

 

$

(95,945

)

Basic weighted-average common stock outstanding

 

62,917

 

62,418

 

62,855

 

62,377

 

Add: dilutive effect of stock options, unvested RSUs, and contingent PSAs

 

1,649

 

 

1,638

 

 

Add: dilutive effect of 3.50% senior convertible notes

 

 

 

 

 

Diluted weighted-average common shares outstanding

 

64,566

 

62,418

 

64,493

 

62,377

 

Basic net income (loss) per common share

 

$

0.29

 

$

(0.13

)

$

2.29

 

$

(1.54

)

Diluted net income (loss) per common share

 

$

0.28

 

$

(0.13

)

$

2.24

 

$

(1.54

)

 

11



 

Note 6 — Commitments and Contingencies

 

In February 2010 the Company entered into an agreement whereby it is subject to certain natural gas gathering through-put commitments that require a minimum volume delivery of 100 Bcf by the end of the ten year contract term.  As of June 30, 2010, the pipeline volume commitments associated with this agreement for the next five years and thereafter are presented below:

 

 

 

Committed

 

Undiscounted

 

 

 

Volumes

 

Cash Outflows

 

Years Ending December 31,

 

(In Bcf)

 

(In thousands)

 

2010

 

3.0

 

$

540

 

2011

 

6.0

 

1,080

 

2012

 

6.0

 

1,080

 

2013

 

10.0

 

1,800

 

2014

 

10.0

 

1,800

 

Thereafter

 

65.0

 

11,700

 

Total

 

100.0

 

$

18,000

 

 

On July 2, 2010, the Company entered into an agreement whereby it is subject to certain natural gas gathering through-put commitments during the ten year contract term.  The Company will be required to make periodic deficiency payments for any shortfalls in delivering the minimum volume commitments.  In the event that no gas is delivered pursuant to the agreement, the aggregate deficiency payments will total $154.7 million over the life of the contract.

 

Note 7 — Compensation Plans

 

Cash Bonus Plan

 

During the first quarters of 2010 and 2009, the Company paid $7.7 million and $6.0 million for cash bonuses earned in the 2009 and 2008 performance years, respectively.  Within the general and administrative expense and exploration expense line items in the accompanying condensed consolidated statements of operations is $2.9 million of cash bonus expense related to the specific performance year for each of the three-month periods ended June 30, 2010, and 2009, and $6.0 million and $5.3 million for the six-month periods ended June 30, 2010, and 2009, respectively.

 

Performance Share Awards Under the Equity Incentive Compensation Plan

 

The PSAs represent the right to receive, upon settlement of the PSAs after the completion of the three-year performance period, a number of shares of the Company’s common stock that may be from zero to two times the number of PSAs granted on the award date, depending on the extent to which the Company’s performance criteria have been achieved and the extent to which the PSAs have vested.  The performance criteria for the PSAs are based on a combination of the Company’s total shareholder return (“TSR”) for the performance period and the relative performance of the Company’s TSR compared with the TSR of an index of certain peer companies for the performance period.

 

Total stock-based compensation expense related to PSAs for the three-month periods ended June 30, 2010, and 2009, was $3.8 million and $1.1 million, respectively, and $7.4 million and $2.5 million for the six-month periods ended June 30, 2010, and 2009, respectively.  As of June 30, 2010, there was $14.7 million of total unrecognized compensation expense related to unvested PSAs.  The unrecognized compensation expense will be amortized through 2012.

 

12



 

A summary of the status and activity of PSAs for the six-month period ended June 30, 2010, is presented in the following table:

 

 

 

PSAs

 

Weighted-
Average Grant-
Date Fair Value

 

Non-vested, at January 1, 2010

 

1,069,090

 

$

32.52

 

Granted

 

 

$

 

Vested

 

(8,128

)

$

30.50

 

Forfeited

 

(87,527

)

$

31.73

 

Non-vested and outstanding, at June 30, 2010

 

973,435

 

$

32.61

 

 

Subsequent to June 30, 2010, the Company granted 387,651 PSAs as part of its regular annual compensation process.  These PSAs will vest 1/7th on July 1, 2011, 2/7ths on July 1, 2012, and 4/7ths on July 1, 2013.

 

Restricted Stock Unit Incentive Program Under the Equity Incentive Compensation Plan

 

Total RSU compensation expense for both the three-month periods ended June 30, 2010, and 2009, was $1.7 million, and $3.5 million and $3.8 million for the six-month periods ended June 30, 2010, and 2009, respectively.  As of June 30, 2010, there was $5.4 million of total unrecognized compensation expense related to unvested RSU awards.  The unrecognized compensation expense will be amortized through 2012.

 

During the first half of 2010, the Company settled 51,115 RSUs that relate to awards granted in 2008 and 2007 through the issuance of shares of the Company’s common stock in accordance with the terms of the RSU awards.  The Company and the majority of the grant participants mutually agreed to net-share settle the awards to cover income and payroll tax withholdings as provided for in the plan document and the award agreements.  As a result, the Company issued 34,588 shares of common stock associated with these grants.  The remaining 16,527 shares were withheld to satisfy income and payroll tax withholding obligations that occurred upon the delivery of the shares underlying those RSUs.

 

A summary of the status and activity of RSUs for the six-month period ended June 30, 2010, is presented in the following table:

 

 

 

RSUs

 

Weighted-
Average Grant-
Date Fair Value

 

Non-vested, at January 1, 2010

 

407,123

 

$

34.67

 

Granted

 

 

$

 

Vested

 

(49,882

)

$

36.23

 

Forfeited

 

(26,877

)

$

36.48

 

Non-vested and outstanding, at June 30, 2010

 

330,364

 

$

34.28

 

 

Subsequent to June 30, 2010, the Company granted 126,821 RSUs as part of its regular annual compensation process.  Each RSU represents a right to receive one share of the Company’s common stock

 

13



 

to be delivered upon settlement of the vested RSUs.  These RSUs will vest 1/7th on July 1, 2011, 2/7ths on July 1, 2012, and 4/7ths on July 1, 2013.

 

Stock Option Grants Under Prior Stock Option Plans

 

The following table summarizes stock option activity for the six months ended June 30, 2010:

 

 

 

Options

 

Weighted-
Average
Exercise
Price

 

Weighted-
Average
Remaining
Contractual
Term
(In years)

 

Aggregate
Intrinsic Value
(In thousands)

 

 

 

 

 

 

 

 

 

 

 

Outstanding, at January 1, 2010

 

1,274,920

 

$

13.31

 

 

 

 

 

Exercised

 

(148,902

)

$

14.22

 

 

 

 

 

Forfeited

 

 

$

 

 

 

 

 

Outstanding, end of period

 

1,126,018

 

$

13.19

 

2.6

 

$

30,369

 

Vested, or expect to vest, at end of period

 

1,126,018

 

$

13.19

 

2.6

 

$

30,369

 

Exercisable, end of period

 

1,126,018

 

$

13.19

 

2.6

 

$

30,369

 

 

As of June 30, 2010, there was no unrecognized compensation expense related to stock option awards.

 

Director Shares

 

In May 2010 and 2009 the Company issued 24,258 and 50,094 shares, respectively, of the Company’s common stock from treasury to the Company’s non-employee directors.  The shares were issued pursuant to the Company’s Equity Incentive Compensation Plan.  The Company recorded $690,000 and $517,000 of compensation expense for the three-month periods ended June 30, 2010, and 2009, respectively, and $715,000 and $636,000 for the six-month periods ended June 30, 2010, and 2009, respectively.

 

Employee Stock Purchase Plan

 

Under the Company’s Employee Stock Purchase Plan (the “ESPP”), eligible employees may purchase shares of the Company’s common stock through payroll deductions of up to 15 percent of eligible compensation.  The purchase price of the stock is 85 percent of the lower of the fair market value of the stock on the first or last day of the purchase period, and shares issued under the ESPP are restricted for a period of six months from the date issued.  The ESPP is intended to qualify under Section 423 of the Internal Revenue Code.  The Company has set aside 2,000,000 shares of its common stock to be available for issuance under the ESPP, of which 1,440,819 shares are available for issuance as of June 30, 2010.  The fair value of ESPP grants is measured at the date of grant using the Black-Scholes option-pricing model.  There were 27,456 and 49,767 shares issued under the ESPP during the first half of 2010 and 2009, respectively.  The Company expensed $124,000 and $390,000 for the three-month periods ended June 30, 2010, and 2009, respectively, and $263,000 and $541,000 for the six-month periods ended June 30, 2010, and 2009, respectively, based on the estimated fair values on the respective grant dates.

 

Net Profits Plan

 

Prior to 2008, all oil and gas wells that were completed or acquired during each year were assigned to a specific pool for that respective year under the Company’s legacy Net Profits Plan.  Key employees become entitled to payments under the Net Profits Plan after the Company has received net cash flows

 

14



 

returning 100 percent of all costs associated with a pool.  Thereafter, ten percent of future net cash flows generated by the pool are allocated among the participants and distributed at least annually.  The portion of net cash flows from the pool to be allocated among the participants increases to 20 percent after the Company has recovered both 200 percent of the total costs for the pool and 100 percent of pool payments made under the Net Profits Plan at the ten percent level.  The 2007 Net Profits Plan pool was the last pool established by the Company.

 

Cash payments made or accrued under the Net Profits Plan that have been recorded as either general and administrative expense or exploration expense are detailed in the table below:

 

 

 

For the Three Months
Ended June 30,

 

For the Six Months
Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

General and administrative expense

 

$

5,381

 

$

4,541

 

$

12,315

 

$

7,774

 

Exploration expense

 

667

 

471

 

1,258

 

876

 

Total

 

$

6,048

 

$

5,012

 

$

13,573

 

$

8,650

 

 

Additionally, the Company made cash payments under the Net Profits Plan of $1.9 million and $20.1 million for the three-month and six-month periods ended June 30, 2010, respectively, as a result of sales proceeds mainly from the Legacy and Sequel divestitures.  The cash payments are accounted for as a reduction of proceeds, which reduced the gain (loss) on divestiture activity in the accompanying condensed consolidated statements of operations.  There were no cash payments made under the Net Profits Plan as a result of divestitures that occurred during the first half of 2009.

 

The Company records changes in the present value of estimated future payments under the Net Profits Plan as a separate line item in the accompanying condensed consolidated statements of operations.  The change in the estimated liability is recorded as a non-cash expense or benefit in the current period.  The amount recorded as an expense or benefit associated with the change in the estimated liability is not allocated to general and administrative expense or exploration expense because it is associated with the future net cash flows from oil and gas properties in the respective pools rather than results being realized through current period production.  The table below presents the estimated allocation of the change in the liability if the Company did allocate the adjustment to these specific functional line items based on the current allocation of actual distributions made by the Company.  As time progresses, less of the distributions relate to prospective exploration efforts as more of the distributions are made to participants that have terminated employment and do not provide ongoing exploration support to the Company.

 

 

 

For the Three Months
Ended June 30,

 

For the Six Months
Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

General and administrative expense (benefit)

 

$

(5,959

)

$

1,964

 

$

(32,604

)

$

(18,730

)

Exploration expense (benefit)

 

(640

)

485

 

(1,267

)

(2,112

)

Total

 

$

(6,599

)

$

2,449

 

$

(33,871

)

$

(20,842

)

 

15



 

Note 8 — Pension Benefits

 

Pension Plans

 

The Company has a non-contributory pension plan covering substantially all employees who meet age and service requirements (the “Qualified Pension Plan”).  The Company also has a supplemental non-contributory pension plan covering certain management employees (the “Nonqualified Pension Plan”).

 

Components of Net Periodic Benefit Cost for Both Plans

 

The following table presents the total components of the net periodic cost for both the Qualified Pension Plan and the Nonqualified Pension Plan:

 

 

 

For the Three Months
Ended June 30,

 

For the Six Months
Ended June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

 

 

(In thousands)

 

Service cost

 

$

848

 

$

625

 

$

1,696

 

$

1,250

 

Interest cost

 

280

 

233

 

560

 

467

 

Expected return on plan assets

 

(159

)

(107

)

(318

)

(215

)

Amortization of net actuarial loss

 

91

 

93

 

182

 

186

 

Net periodic benefit cost

 

$

1,060

 

$

844

 

$

2,120

 

$

1,688

 

 

Prior service costs are amortized on a straight-line basis over the average remaining service period of active participants.  Gains and losses in excess of ten percent of the greater of the benefit obligation or the market-related value of assets are amortized over the average remaining service period of active participants.

 

Contributions

 

Under the Pension Protection Act of 2006, SM Energy is not required to make a minimum contribution to the pension plans in 2010.

 

Note 9 — Asset Retirement Obligations

 

The Company recognizes an estimated liability for future costs associated with the plugging and abandonment of its oil and gas properties.  A liability for the fair value of an asset retirement obligation and a corresponding increase to the carrying value of the related long-lived asset are recorded at the time a well is completed or acquired.  The increase in carrying value is included in proved oil and gas properties in the accompanying condensed consolidated balance sheets.  The Company depletes the amount added to proved oil and gas property costs and recognizes expense in connection with the accretion of the discounted liability over the remaining estimated economic lives of the respective oil and gas properties.  Cash paid to settle asset retirement obligations is included in the operating section of the Company’s accompanying condensed consolidated statements of cash flows.

 

The Company’s estimated asset retirement obligation liability is based on estimated economic lives, historical experience in plugging and abandoning wells, estimated cost to plug and abandon the wells in the future, and federal and state regulatory requirements.  The liability is discounted using a credit-adjusted risk-free rate estimated at the time the liability is incurred or revised.  The credit-adjusted risk-free rates used to discount the Company’s abandonment liabilities range from 6.5 percent to 12.0 percent.  Revisions to the liability could occur due to changes in estimated abandonment costs or well commerciality, or if federal or state regulators enact new requirements regarding the abandonment of wells.  The asset retirement obligation is considered settled when the well has been plugged and abandoned or divested.

 

16



 

A reconciliation of the Company’s asset retirement obligation liability is as follows:

 

 

 

For the Six Months
Ended June 30, 2010

 

 

 

(In thousands)

 

 

 

 

 

Beginning asset retirement obligation

 

$

102,080

 

Liabilities incurred

 

1,373

 

Liabilities settled

 

(24,583

)

Accretion expense

 

2,845

 

Revision to estimated cash flow

 

(715

)

Ending asset retirement obligation

 

$

81,000

 

 

As of June 30, 2010, the Company had $1.5 million of asset retirement obligation associated with the oil and gas properties held for sale included in a separate line item on the Company’s accompanying condensed consolidated balance sheets.  Additionally, as of June 30, 2010, accounts payable and accrued expenses contained $15.2 million related to the Company’s current asset retirement obligation liability associated with the estimated retirement of some of the Company’s offshore platforms.

 

Note 10 — Derivative Financial Instruments

 

Oil, Natural Gas and NGL Commodity Hedges

 

To mitigate a portion of the exposure to potentially adverse market changes in oil and gas prices and the associated impact on cash flows, the Company has entered into various derivative contracts.  The Company’s derivative contracts in place include swap and collar arrangements for oil, natural gas, and natural gas liquids (“NGLs”).  As of June 30, 2010, the Company has hedge contracts in place through the first quarter of 2013 for a total of approximately 5 million Bbls of anticipated crude oil production, 46 million MMBtu of anticipated natural gas production, and 2 million Bbls of anticipated natural gas liquids production.  As of July 28, 2010, the Company has hedge contracts in place through the second quarter of 2013 for a total of approximately 6 million Bbls of anticipated crude oil production, 50 million MMBtu of anticipated natural gas production, and 2 million Bbls of anticipated natural gas liquids production.

 

The Company attempts to qualify its oil, natural gas, and NGL derivative instruments as cash flow hedges for accounting purposes under FASB ASC Topic 815, “Derivatives and Hedging” (“ASC Topic 815”).  The Company formally documents all relationships between the derivative instruments and the hedged production, as well as the Company’s risk management objective and strategy for the particular derivative contracts.  This process includes linking all derivatives that are designated as cash flow hedges to the specific forecasted sale of oil, natural gas or NGLs.  The Company also formally assesses (both at the derivative’s inception and on an ongoing basis) whether the derivatives being utilized have been highly effective in offsetting changes in the cash flows of hedged production and whether those derivatives may be expected to remain highly effective in future periods.  If it is determined that a derivative has ceased to be highly effective as a hedge, the Company will discontinue hedge accounting for that derivative prospectively.  If hedge accounting is discontinued and the derivative remains outstanding, the Company will recognize all subsequent changes in its fair value in the Company’s consolidated statements of operations for the period in which the change occurs.  As of June 30, 2010, all oil, natural gas, and NGL derivative instruments qualified as cash flow hedges for accounting purposes.  The Company anticipates that all forecasted transactions will occur by the end of their originally specified periods.  All contracts are entered into for other-than-trading purposes.

 

The Company’s oil, natural gas, and NGL hedges are measured at fair value and are included in the accompanying condensed consolidated balance sheets as derivative assets and liabilities.  The Company

 

17



 

derives internal valuation estimates taking into consideration the counterparties’ credit worthiness, the Company’s credit worthiness, and the time value of money.  Those internal valuations are then compared to the counterparties’ mark-to-market statements.  The consideration of the factors results in an estimated exit-price for each derivative asset or liability under a market place participant’s view.  Management believes that this approach provides a reasonable, non-biased, verifiable, and consistent methodology for valuing commodity derivative instruments.  The derivative instruments utilized by the Company are not considered by management to be complex, structured, or illiquid.  The oil, natural gas, and NGL derivative markets are highly active.  The fair value of oil, natural gas, and NGL derivative contracts designated and qualifying as cash flow hedges under ASC Topic 815 was a net asset of $13.7 million and a net liability of $80.9 million at June 30, 2010, and December 31, 2009, respectively.

 

The following table details the fair value of derivatives recorded in the consolidated balance sheets, by category:

 

 

 

Location on
Consolidated Balance
Sheets

 

Fair Value at
June 30, 2010

 

Fair Value at
December 31, 2009

 

 

 

 

 

(In thousands)

 

Derivative assets designated as cash flow hedges:

 

 

 

 

 

 

 

Oil, natural gas, and NGL commodity

 

Current assets

 

$

45,481

 

$

30,295

 

Oil, natural gas, and NGL commodity

 

Other noncurrent assets

 

30,169

 

8,251

 

Total derivative assets designated as cash flow hedges under ASC Topic 815

 

 

 

$

75,650

 

$

38,546

 

 

 

 

 

 

 

 

 

Derivative liabilities designated as cash flow hedges:

 

 

 

 

 

 

 

Oil, natural gas, and NGL commodity

 

Current liabilities

 

$

(37,903

)

$

(53,929

)

Oil, natural gas, and NGL commodity

 

Noncurrent liabilities

 

(24,046

)

(65,499

)

Total derivative liabilities designated as cash flow hedges under ASC Topic 815

 

 

 

$

(61,949

)

$

(119,428

)

 

Realized gains or losses from the settlement of oil, natural gas, and NGL derivative contracts are reported in the total operating revenues and other income section of the accompanying condensed consolidated statements of operations.  The Company realized a net gain of $9.3 million and $43.3 million from its oil, natural gas, and NGL derivative contracts for the three months ended June 30, 2010, and 2009, respectively, and realized a net gain of $11.9 million and $98.9 million from its oil, natural gas, and NGL derivative contracts for the six months ended June 30, 2010, and 2009, respectively.

 

After-tax changes in the fair value of derivative instruments designated as cash flow hedges, to the extent they are effective in offsetting cash flows attributed to the hedged risk, are recorded in accumulated other comprehensive income in the accompanying condensed consolidated balance sheets until the hedged item is realized in earnings upon the sale of the associated hedged production.  As of June 30, 2010, the amount of unrealized gain (loss) net of deferred income taxes to be reclassified from accumulated other comprehensive income to realized oil and gas hedge gain (loss) in the Company’s accompanying condensed consolidated statements of operations in the next twelve months is $11.3 million.

 

The Company seeks to minimize ineffectiveness by entering into oil derivative contracts indexed to the New York Mercantile Exchange West Texas Intermediate (“NYMEX WTI”) index, natural gas derivative contracts indexed to regional index prices associated with pipelines in proximity to the Company’s areas of production, and NGL derivative contracts indexed to Oil Price Information Service Mont Belvieu.  The Company’s derivative contracts utilize the same respective indices or pricing points as

 

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the Company’s sales contracts.  As a result, the derivative contracts used by the Company are highly correlated with the underlying hedged production.

 

The following table details the effect of derivative instruments on other comprehensive income (loss) and the condensed consolidated balance sheets (net of income tax):

 

 

 

Derivatives
Qualifying
as Cash
Flow

 

For the Six Months
Ended June 30,

 

 

 

Hedges

 

2010

 

2009

 

 

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

Amount of (gain) loss on derivatives recognized in OCI during the period (effective portion)

 

Commodity hedges

 

$

(53,765

)

$

11,852

 

Amount of (gain) loss reclassified from AOCI to realized oil and gas hedge gain (loss) (effective portion)

 

Commodity hedges

 

$

(782

)

$

(45,494

)

 

Any change in fair value resulting from hedge ineffectiveness is recognized currently in unrealized derivative (gain) loss in the accompanying condensed consolidated statements of operations.  The following table details the effect of derivative instruments on the condensed consolidated statements of operations:

 

 

 

 

 

(Gain) Loss Recognized in Earnings

 

 

 

Classification of

 

(Ineffective Portion)

 

 

 

(Gain) Loss

 

For the Three Months

 

For the Six Months

 

Derivatives Qualifying

 

Recognized in

 

Ended June 30,

 

Ended June 30,

 

as Cash Flow Hedges

 

Earnings

 

2010

 

2009

 

2010

 

2009

 

 

 

 

 

(In thousands)

 

Commodity hedges

 

Unrealized derivative (gain) loss

 

$

(2,087

)

$

11,288

 

$

(9,822

)

$

13,134

 

 

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Credit Related Contingent Features

 

As of June 30, 2010, only one of the Company’s hedge counterparties was not a member of the Company’s credit facility bank syndicate.  Member banks are secured by the Company’s oil and gas assets, and therefore do not require the Company to post collateral in instances where the Company is in a liability position.  When the Company is in a liability position with a non-member bank, posting of collateral may be required if the Company’s liability balance exceeds the limit set forth in the agreement with the non-member bank.  With the one non-member bank, the amount of collateral, if any, that the Company is required to post depends on a number of financial metrics that are calculated quarterly.  No collateral was posted as of June 30, 2010, or July 28, 2010.

 

Convertible Note Derivative Instruments

 

The contingent interest provision of the 3.50% Senior Convertible Notes is an embedded derivative instrument.  As of June 30, 2010, and December 31, 2009, the value of this derivative was determined to be immaterial.

 

Note 11 — Fair Value Measurements

 

The Company follows the authoritative accounting guidance under FASB ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC Topic 820”) for all assets and liabilities measured at fair value.  ASC Topic 820 establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements.  ASC Topic 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date.  The topic establishes market or observable inputs as the preferred sources of values, followed by assumptions based on hypothetical transactions in the absence of market inputs.  The topic establishes a hierarchy for grouping these assets and liabilities based on the significance level of the following inputs:

 

·                  Level 1 — Quoted prices in active markets for identical assets or liabilities

 

·                  Level 2 — Quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose inputs are observable or whose significant value drivers are observable

 

·      Level 3 — Significant inputs to the valuation model are unobservable

 

The following is a listing of the Company’s financial assets and liabilities that are measured at fair value on a recurring basis and where they are classified within the hierarchy as of June 30, 2010:

 

 

 

Level 1

 

Level 2

 

Level 3

 

 

 

(In thousands)