Swift Energy Company (SFY)

Use of Estimates. >The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires us to make estimates and assumptions that affect the reported amount of certain assets and liabilities and the reported amounts of certain revenues and expenses during each reporting period. We believe our estimates and assumptions are reasonable; however, such estimates and assumptions are subject to a number of risks and uncertainties that may cause actual results to differ materially from such estimates. Significant estimates and assumptions underlying these financial statements include:

·	the estimated quantities of proved oil and natural gas reserves used to compute depletion of oil and natural gas properties and the related present value of estimated future net cash flows there-from,

·	estimates related to the collectability of accounts receivable and the credit worthiness of our customers,

·	estimates of the counterparty bank risk related to letters of credit that our customers may have issued on our behalf,

·	estimates of future costs to develop and produce reserves,

·	accruals related to oil and gas sales, capital expenditures and lease operating expenses,

·	estimates of insurance recoveries related to property damage, and the solvency of insurance providers,

·	estimates in the calculation of share-based compensation expense,

·	estimates of our ownership in properties prior to final division of interest determination,

·	the estimated future cost and timing of asset retirement obligations,

·	estimates made in our income tax calculations, and

·	estimates in the calculation of the fair value of hedging assets.

 

 

 

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While we are not aware of any material revisions to any of our estimates, there will likely be future revisions to our estimates resulting from matters such as new accounting pronouncements, changes in ownership interests, payouts, joint venture audits, re-allocations by purchasers or pipelines, or other corrections and adjustments common in the oil and gas industry, many of which require retroactive application. These types of adjustments cannot be currently estimated and will be recorded in the period during which the adjustment occurs.

Property and Equipment.> We follow the “full-cost” method of accounting for oil and natural gas property and equipment costs. Under this method of accounting, all productive and nonproductive costs incurred in the exploration, development, and acquisition of oil and natural gas reserves are capitalized. Such costs may be incurred both prior to and after the acquisition of a property and include lease acquisitions, geological and geophysical services, drilling, completion, and equipment. Internal costs incurred that are directly identified with exploration, development, and acquisition activities undertaken by us for our own account, and which are not related to production, general corporate overhead, or similar activities, are also capitalized. For the three months ended March 31, 2012 and 2011, such internal costs capitalized totaled $8.3 million and $7.2 million, respectively. Interest costs are also capitalized to unproved oil and natural gas properties. For the three months ended March 31, 2012 and 2011, capitalized interest on unproved properties totaled $2.0 million and $1.9 million, respectively. Interest not capitalized and general and administrative costs related to production and general corporate overhead are expensed as incurred.

The “Property and Equipment” balances on the accompanying condensed consolidated balance sheets are summarized for presentation purposes. The following is a detailed breakout of our “Property and Equipment” balances.

(in thousands)		March 31, 2012				December 31, 2011
Property and Equipment
Proved oil and gas properties		$	4,521,651			$	4,343,867
Unproved oil and gas properties			87,327				84,146
Furniture, fixtures, and other equipment			39,709				38,832
Less – Accumulated depreciation, depletion, and amortization			(2,660,839	)			(2,599,079	)
Property and Equipment, Net		$	1,987,848			$	1,867,766

No gains or losses are recognized upon the sale or disposition of oil and natural gas properties, except in transactions involving a significant amount of reserves or where the proceeds from the sale of oil and natural gas properties would significantly alter the relationship between capitalized costs and proved reserves of oil and natural gas attributable to a cost center. Internal costs associated with selling properties are expensed as incurred.

Future development costs are estimated property-by-property based on current economic conditions and are amortized to expense as our capitalized oil and gas property costs are amortized.

We compute the provision for depreciation, depletion, and amortization (“DD&A”) of oil and natural gas properties using the unit-of-production method. Under this method, we compute the provision by multiplying the total unamortized costs of oil and gas properties—including future development costs, gas processing facilities, and both capitalized asset retirement obligations and undiscounted abandonment costs of wells to be drilled, net of salvage values, but excluding costs of unproved properties—by an overall rate determined by dividing the physical units of oil and natural gas produced during the period by the total estimated units of proved oil and natural gas reserves at the beginning of the period. This calculation is done on a country-by-country basis, and the period over which we will amortize these properties is dependent on our production from these properties in future years. Furniture, fixtures, and other equipment are recorded at cost and are depreciated by the straight-line method at rates based on the estimated useful lives of the property, which range between 2 and 20 years. Repairs and maintenance are charged to expense as incurred. Renewals and betterments are capitalized.

Geological and geophysical (“G&G”) costs incurred on developed properties are recorded in “Proved properties” and therefore subject to amortization. G&G costs incurred that are directly associated with specific unproved properties are capitalized in “Unproved properties” and evaluated as part of the total capitalized costs associated with a prospect. The cost of unproved properties not being amortized is assessed quarterly, on a property-by-property basis, to determine whether such properties have been impaired. In determining whether such costs should be impaired, we evaluate current drilling results, lease expiration dates, current oil and gas industry conditions, international economic conditions, capital availability, and available geological and geophysical information. Any impairment assessed is added to the cost of proved properties being amortized.

 

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Full-Cost Ceiling Test>. At the end of each quarterly reporting period, the unamortized cost of oil and natural gas properties (including natural gas processing facilities, capitalized asset retirement obligations, net of related salvage values and deferred income taxes, and excluding the recognized asset retirement obligation liability) is limited to the sum of the estimated future net revenues from proved properties (excluding cash outflows from recognized asset retirement obligations, including future development and abandonment costs of wells to be drilled, using the preceding 12-months’ average price based on closing prices on the first day of each month, adjusted for price differentials and the effects of hedging, discounted at 10%, and the lower of cost or fair value of unproved properties) adjusted for related income tax effects (“Ceiling Test”). Our hedges in place at March 31, 2011 and December 31, 2011 consisted of price floors that did not materially affect prices used in these calculations. This calculation is done on a country-by-country basis.

The calculation of the Ceiling Test and provision for DD&A is based on estimates of proved reserves. There are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting the future rates of production, timing, and plan of development. The accuracy of any reserves estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. Results of drilling, testing, and production subsequent to the date of the estimate may justify revision of such estimates. Accordingly, reserves estimates are often different from the quantities of oil and natural gas that are ultimately recovered.

Given the volatility of oil and natural gas prices, it is reasonably possible that our estimate of discounted future net cash flows from proved oil and natural gas reserves could continue to change in the near term. If oil and natural gas prices decline from our prices used in the Ceiling Test, it is reasonably possible that non-cash write-downs of oil and natural gas properties would occur in the future. If we have significant declines in our oil and natural gas reserves volumes, which also reduce our estimate of discounted future net cash flows from proved oil and natural gas reserves, non-cash write-downs of our oil and natural gas properties would occur in the future. We cannot control and cannot predict what future prices for oil and natural gas will be, thus we cannot estimate the amount or timing of any potential future non-cash write-down of our oil and natural gas properties if a decrease in oil and/or natural gas prices were to occur.

Revenue Recognition>. Oil and gas revenues are recognized when production is sold to a purchaser at a fixed or determinable price, when delivery has occurred and title has transferred, and if collectability of the revenue is probable. Swift Energy uses the entitlement method of accounting in which we recognize our ownership interest in production as revenue. If our sales exceed our ownership share of production, the natural gas balancing payables are reported in “Accounts payable and accrued liabilities” on the accompanying condensed consolidated balance sheets. Natural gas balancing receivables are reported in “Other current assets” on the accompanying condensed consolidated balance sheets when our ownership share of production exceeds sales. As of March 31, 2012 and December 31, 2011, we did not have any material natural gas imbalances.

Reclassification of Prior Period Balances. >Certain reclassifications have been made to prior period amounts to conform to the current-year presentation.

Accounts Receivable. >We assess the collectability of accounts receivable, and based on our judgment, we accrue a reserve when we believe a receivable may not be collected. At March 31, 2012 and December 31, 2011, we had an allowance for doubtful accounts of approximately $0.1 million. The allowance for doubtful accounts has been deducted from the total “Accounts Receivable” balance on the accompanying condensed consolidated balance sheets.

At March 31, 2012 our “Accounts Receivable” balance included $49.9 million for oil and gas sales, $6.7 million for joint interest owners and $4.6 million for other receivables. At December 31, 2011 our “Accounts Receivable” balance included $54.7 million for oil and gas sales, $4.2 million for joint interest owners and $5.6 million for other receivables.

Debt Issuance Costs>. Legal fees, accounting fees, underwriting fees, printing costs, and other direct expenses associated with extensions of our bank credit facility and public debt offerings were capitalized and are amortized on an effective interest basis over the life of each of the respective note offerings and credit facility.

The 7-1/8% senior notes due 2017 mature on June 1, 2017, and the balance of their issuance costs at March 31, 2012, was $2.5 million, net of accumulated amortization of $1.7 million. The 8-7/8% senior notes due 2020 mature on January 15, 2020, and the balance of their issuance costs at March 31, 2012, was $4.3 million, net of accumulated amortization of $0.8 million. The 7-7/8% senior notes due 2022 mature on March 1, 2022, and the balance of their issuance costs at March 31, 2012, was $4.6 million, net of accumulated amortization of $0.1 million. The issuance costs associated with our revolving credit facility, which was revised and extended in May 2011, have been capitalized and are being amortized over the life of the facility. The balance of revolving credit facility issuance costs at March 31, 2012, was $3.3 million, net of accumulated amortization of $4.2 million.

 

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Price-Risk Management Activities.> The Company follows FASB ASC 815-10, which requires that changes in the derivative’s fair value are recognized currently in earnings unless specific hedge accounting criteria are met. The guidance also establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) is recorded in the condensed consolidated balance sheets as either an asset or a liability measured at its fair value. Hedge accounting for a qualifying hedge allows the gains and losses on derivatives to offset related results on the hedged item in the statement of operations and requires that a company formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. Changes in the fair value of derivatives that do not meet the criteria for hedge accounting, and the ineffective portion of the hedge, are recognized currently in income.

We have a price-risk management policy to use derivative instruments to protect against declines in oil and natural gas prices, mainly through the purchase of price floors and collars. During the three months ended March 31, 2012 and 2011, we recognized a net loss of $0.4 million and $0.2 million, respectively, relating to our derivative activities. This activity is recorded in “Price-risk management and other, net” on the accompanying condensed consolidated statements of operations. Had these losses been recognized in the oil and gas sales account they would not have materially changed our per unit sales prices received. At March 31, 2012, the Company had $0.3 million in derivative gains recorded in “Accumulated other comprehensive gain, net of income tax” on the accompanying condensed consolidated balance sheet. The ineffectiveness reported in “Price-risk management and other, net” for the three months ended March 31, 2012 and 2011 was not material.

        At March 31, 2012, we had oil price floors in effect for the contract months of April through May 2012 that cover oil production of 270,500 Bbls with strike prices ranging between $100.00 and $105.00.

When we entered into these transactions discussed above, they were designated as a hedge of the variability in cash flows associated with the forecasted sale of oil and natural gas production. Changes in the fair value of a hedge that is highly effective and is designated and documented and qualifies as a cash flow hedge, to the extent that the hedge is effective, are recorded in “Accumulated other comprehensive income, net of income tax.” When the hedged transactions are recorded upon the actual sale of the oil and natural gas, these gains or losses are reclassified from “Accumulated other comprehensive income, net of income tax” on the accompanying condensed consolidated balance sheets and are recorded in “Price-risk management and other, net” on the accompanying condensed consolidated statements of operations. The fair values of our derivatives are computed using the Black-Scholes-Merton option pricing model and are periodically verified against quotes from brokers. The fair value of these instruments at March 31, 2012 and December 31, 2011, was $0.8 million and $0.1 million, respectively and was recognized on the accompanying condensed consolidated balance sheet in “Other current assets.”

Supervision Fees. >Consistent with industry practice, we charge a supervision fee to the wells we operate including our wells in which we own up to a 100% working interest. Supervision fees, to the extent they do not exceed actual costs incurred, are recorded as a reduction to “General and administrative, net.”  Our supervision fees are based on COPAS guidelines. The amount of supervision fees charged for the first three months of 2012 and 2011 did not exceed our actual costs incurred. The total amount of supervision fees charged to the wells we operate was $2.8 million and $3.5 million in the first three months of 2012 and 2011, respectively.

Inventories. >Inventories consist primarily of tubulars and other equipment that we expect to place in service in production operations. Inventories carried at cost (weighted average method) are included in “Other current assets” on the accompanying condensed consolidated balance sheets totaling $3.2 million at March 31, 2012 and $3.6 million at December 31, 2011.

Income Taxes. >Under guidance contained in FASB ASC 740-10, deferred taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities, given the provisions of the enacted tax laws.

We follow the recognition and disclosure provisions under guidance contained in FASB ASC 740-10-25. Under this guidance, tax positions are evaluated for recognition using a more-likely-than-not threshold, and those tax positions requiring recognition are measured as the largest amount of tax benefit that is greater than fifty percent likely of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. As a result of adopting this guidance on January 1, 2007, we reported a $1.0 million decrease to our January 1, 2007 retained earnings balance and a corresponding increase to other long-term liabilities. If recognized, these tax benefits would fully impact our effective tax rate. This benefit is likely to be recognized within the next 12 months due to the lapse of the applicable statute of limitations.

 

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We do not believe the total of unrecognized tax positions will significantly increase or decrease during the next 12 months.

Our policy is to record interest and penalties relating to income taxes in income tax expense. As of March 31, 2012, we did not have any amount accrued for interest and penalties on uncertain tax positions.

Our U.S. Federal income tax returns for 2002 forward, our Louisiana income tax returns from 1998 forward, our New Zealand income tax returns after 2005, and our Texas franchise tax returns after 2006 remain subject to examination by the taxing authorities. There are no material unresolved items related to periods previously audited by these taxing authorities. No other state returns are significant to our financial position.

Accounts Payable and Accrued Liabilities>. The “Accounts Payable and Accrued Liabilities” balances on the accompanying condensed consolidated balance sheets are summarized below for presentation purposes. The following is a detailed breakout of certain items within “Accounts Payable and Accrued Liabilities” in the corresponding periods (in thousands):

		March 31, 2012				December 31, 2011
Trade accounts payable (1)		$	39,219			$	42,080
Accrued operating expenses			15,540				15,833
Accrued payroll costs			4,957				14,345
Asset retirement obligation – current portion			9,303				9,279
Accrued taxes			7,446				7,604
Other payables			2,333				6,825
Total accounts payable and accrued liabilities		$	78,798			$	95,966
(1) Included in “trade accounts payable” are liabilities of approximately $22.1 million and $18.7 million at March 31, 2012 and December 31, 2011, respectively, for outstanding checks. This represents the amounts by which checks were issued, but not presented by vendors to the Company’s banks for collection, exceeded balances in the applicable disbursement bank accounts.

Cash and Cash Equivalents. >We consider all highly liquid instruments with an initial maturity of three months or less to be cash equivalents.

Restricted Cash. >These balances primarily include amounts held in escrow accounts to satisfy domestic plugging and abandonment obligations. As of March 31, 2012 and December 31, 2011, these assets include approximately $1.0 million and $1.3 million, respectively. These amounts are restricted as to their current use, and will be released when we have satisfied all plugging and abandonment obligations in certain fields. Restricted cash balances are reported in “Other Long-Term Assets” on the accompanying condensed consolidated balance sheets.

Accumulated Other Comprehensive Income, Net of Income Tax. >We follow the guidance contained in FASB ASC 220-10, which establishes standards for reporting comprehensive income. In addition to net income, comprehensive income or loss includes all changes to equity during a period, except those resulting from investments and distributions to the owners of the Company. At March 31, 2012, the Company had $0.3 million in gains recorded in “Accumulated other comprehensive income, net of income tax” on the accompanying condensed consolidated balance sheet. The components of accumulated other comprehensive income and related tax effects for 2011 were as follows (in thousands):

		Gross Value				Tax Effect				Net of Tax Value
Other comprehensive loss at December 31, 2011		$	---			$	---			$	---
Change in fair value of cash flow hedges			212				(77	)			135
Effect of cash flow hedges settled during the period			198				(72	)			126
Other comprehensive income at March 31, 2012		$	410			$	(149	)		$	261

 

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Asset Retirement Obligation>. We record these obligations in accordance with the guidance contained in FASB ASC 410-20. This guidance requires entities to record the fair value of a liability for legal obligations associated with the retirement obligations of tangible long-lived assets in the period in which it is incurred. When the liability is initially recorded, the carrying amount of the related long-lived asset is increased. The liability is discounted from the expected date of abandonment. Over time, accretion of the liability is recognized each period, and the capitalized cost is depreciated on a unit-of-production basis over the estimated oil and natural gas reserves of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement which is included in the “Property and equipment” balance on our accompanying condensed consolidated balance sheets. This guidance requires us to record a liability for the fair value of our dismantlement and abandonment costs, excluding salvage values.

The following provides a roll-forward of our asset retirement obligation (in thousands):

		2012				2011
Asset Retirement Obligation recorded as of January 1		$	76,393			$	78,879
Accretion expense			1,112				1,136
Liabilities incurred for new wells and facilities construction			282				139
Reductions due to sold and abandoned wells			(79	)			(32	)
Revisions in estimates			1,147				(1,385	)
Asset Retirement Obligation as of March 31		$	78,855			$	78,737

At March 31, 2012 and December 31, 2011, approximately $9.3 million of our asset retirement obligation was classified as a current liability in “Accounts payable and accrued liabilities” on the accompanying condensed consolidated balance sheets.

New Accounting Pronouncements.> In June 2011, the FASB issued ASU No. 2011-05, which changes the required presentation of other comprehensive income. Under the new guidelines, entities will be required to present net income and other comprehensive income, along with the components of net income and other comprehensive income, in either one continuous statement of comprehensive income or in two separate but consecutive statements of net income and comprehensive income. The accounting standards update eliminates the option of presenting the components of other comprehensive income within the statement of changes in stockholders’ equity. We adopted this guidance for the period ending March 31, 2012, which can be seen in our “Statement of Comprehensive Income.”

(3)           Share-Based Compensation

We have various types of share-based compensation plans. Refer to Note 6 of our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, for additional information related to these share-based compensation plans.

We follow guidance contained in FASB ASC 718 to account for share-based compensation.

We receive a tax deduction for certain stock option exercises during the period the options are exercised, generally for the excess of the market value on the exercise date over the exercise price of the options. We receive an additional tax deduction when restricted stock vests at a higher value than the value used to recognize compensation expense at the date of grant. In accordance with guidance contained in FASB ASC 718, we are required to report excess tax benefits from the award of equity instruments as financing cash flows. For the three months ended March 31, 2012 and 2011, we did not recognize any excess tax benefit or shortfall.

Net cash proceeds from the exercise of stock options were $0.3 million and $0.7 million for the three months ended March 31, 2012 and 2011, respectively. The actual income tax benefit from stock option exercises was $0.1 million and $0.9 million for the three months ended March 31, 2012 and 2011, respectively.

Share-based compensation expense for both stock options and restricted stock issued to both employees and non-employees, which was recorded in “General and administrative, net” in the accompanying condensed consolidated statements of operations, was $3.4 million and $2.5 million for the three months ended March 31, 2012 and 2011, respectively. Share-based compensation recorded in lease operating cost was $0.1 million for the three months ended March 31, 2012 and 2011, respectively. We also capitalized $1.3 million and $1.0 million of share-based compensation for the three months ended March 31, 2012 and 2011. We view all awards of stock compensation as a single award with an expected life equal to the average expected life of component awards and amortize the award on a straight-line basis over the life of the award.

 

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Stock Options

We use the Black-Scholes-Merton option pricing model to estimate the fair value of stock option awards with the following weighted-average assumptions for options issued during the indicated periods:

		Three Months Ended
		March 31,
		2012				2011
Dividend yield			0	%			0	%
Expected volatility			61.2	%			58.8	%
Risk-free interest rate			0.8	%			1.9	%
Expected life of options (in years)			4.4				3.9
Weighted-average grant-date fair value		$	15.96			$	19.33

The expected term for grants issued considers all relevant factors including historical and expected future employee exercise behavior. We have analyzed historical volatility, and based on an analysis of all relevant factors, we have used a 5.5 year look-back period to estimate expected volatility of our 2012 and 2011 stock option grants.

At March 31, 2012, we had $6.1 million of unrecognized compensation cost related to stock options, which is expected to be recognized over a weighted-average period of 1.5 years. The following table represents stock option activity for the three months ended March 31, 2012:

		Shares				Wtd. Avg. Exercise Price
Options outstanding, beginning of period			1,375,281			$	32.46
Options granted			323,439			$	32.60
Options canceled			(17,199	)		$	47.15
Options exercised			(27,116	)		$	18.64
Options outstanding, end of period			1,654,405			$	32.56
Options exercisable, end of period			1,065,306			$	31.45

The aggregate intrinsic value and weighted average remaining contract life of options outstanding and exercisable at March 31, 2012 was $5.7 million and 6.5 years and $5.4 million and 5.0 years, respectively. The total intrinsic value of options exercised during the three months ended March 31, 2012 was $0.4 million.

Restricted Stock

The plans, as described in Note 6 of our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, allow for the issuance of restricted stock awards that may not be sold or otherwise transferred until certain restrictions have lapsed. The unrecognized compensation cost related to these awards is expected to be expensed over the period the restrictions lapse (generally one to three years).

The compensation expense for these awards was determined based on the closing market price of our stock at the date of grant applied to the total number of shares that were anticipated to fully vest. As of March 31, 2012, we had unrecognized compensation expense of $27.3 million related to restricted stock awards which is expected to be recognized over a weighted-average period of 1.5 years. The grant date fair value of shares vested during the three months ended March 31, 2012 was $8.3 million.

 

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The following table represents restricted stock activity for the three months ended March 31, 2012:

		Shares				Wtd. Avg. Grant Price
Restricted shares outstanding, beginning of period			834,703			$	31.89
Restricted shares granted			474,200			$	32.62
Restricted shares canceled			(9,053	)		$	32.33
Restricted shares vested			(309,816	)		$	26.73
Restricted shares outstanding, end of period			990,034			$	33.85

(4)           Earnings Per Share

The Company computes earnings per share in accordance with FASB ASC 260-10. Under the guidance, unvested restricted stock grants that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and, therefore, are included in computing basic earnings per share (EPS) pursuant to the two-class method. The two-class method determines earnings per share for each class of common stock and participating securities according to dividends or dividend equivalents and their respective participation rights in undistributed earnings.

Basic earnings per share (“Basic EPS”) has been computed using the weighted average number of common shares outstanding during each period. Diluted EPS for the three month periods ended March 31, 2012 and 2011 assumes, as of the beginning of the period, exercise of stock options using the treasury stock method. Certain of our stock options that would potentially dilute Basic EPS in the future were also antidilutive for the three month periods ended March 31, 2012 and 2011, and are discussed below.

The following is a reconciliation of the numerators and denominators used in the calculation of Basic and Diluted EPS for the three month periods ended March 31, 2012 and 2011 (in thousands, except per share amounts):

		Three Months Ended March 31, 2012												Three Months Ended March 31, 2011
		Income from Continuing Operations				Shares				Per Share Amount				Income from Continuing Operations				Shares				Per Share Amount
Basic EPS:
Income from continuing operations, and Share Amounts		$	3,570				42,674							$	20,249				42,190
Less: (Income) loss from continuing operations allocated to unvested shares			(74	)			---								(370	)			---
Income from continuing operations allocated to common shares		$	3,496				42,674			$	0.08			$	19,879				42,190			$	0.47
Dilutive Securities:
Plus: Income from continuing operations allocated to unvested shares			74				---								370				---
Less: (Income) loss from continuing operations re-allocated to unvested shares			(74	)			---								(368	)			---
Stock Options			---				200								---				319
Diluted EPS:
Income from continuing operations allocated to common shares, and assumed share conversions		$	3,496				42,874			$	0.08			$	19,881				42,509			$	0.47

Options to purchase approximately 1.7 million shares at an average exercise price of $32.56 were outstanding at March 31, 2012, while options to purchase approximately 1.5 million shares at an average exercise price of $32.93 were outstanding at March 31, 2011. Approximately 0.9 million and 0.6 million stock options to purchase shares were not included in the computation of Diluted EPS for the three months ended March 31, 2012 and 2011, respectively, because these stock options were antidilutive, in that the sum of the stock option price, unrecognized compensation expense and excess tax benefits recognized as proceeds in the treasury stock method was greater than the average closing market price for the common shares during those periods.

 

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(5)           Long-Term Debt

Our long-term debt as of March 31, 2012 and December 31, 2011, was as follows (in thousands):

		March 31,				December 31,
		2012				2011
7-1/8% senior notes due 2017		$	250,000			$	250,000
8-7/8% senior notes due 2020 (1)			221,940				221,873
7-7/8% senior notes due 2022 (1)			247,935				247,902
Bank Borrowings			---				---
Long-Term Debt (1)		$	719,875			$	719,775
(1) Amounts are shown net of debt discount

The maturities on our long-term debt are $250.0 million in 2017, $225.0 million in 2020 and $250.0 million in 2022.

We have capitalized interest on our unproved properties in the amount of $2.0 million and $1.9 million for the three months ended March 31, 2012 and 2011, respectively.

Bank Borrowings>. In May 2011, we renewed and extended our $500 million credit facility with a syndicate of ten banks through May 12, 2016, which may be increased by up to $200 million to a maximum aggregate facility amount of $700 million, subject to additional lender commitments and other terms of the credit agreement. As of March 31, 2012, our borrowing base was $325 million and our commitment amount was $300 million. In May 2012, in conjunction with our regularly scheduled borrowing base redetermination, which occurs every six months, our borrowing base was increased to $375 million and we elected to keep our commitment amount at $300 million.

At March 31, 2012 and December 31, 2011 we had no borrowings under our credit facility. The interest rate on our credit facility is either (a) the lead bank’s prime plus an applicable margin or (b) Eurodollar rate plus an applicable margin. However with respect to (a), if the lead bank’s prime rate is not higher than each of the federal funds rate plus ½%, and the adjusted London Interbank Offered Rate (“LIBOR”) plus 1%, the greatest of these three rates will then apply. The applicable margins vary depending on the level of outstanding debt with escalating rates of 50 to 150 basis points above the Alternative Base Rate and escalating rates of 150 to 250 basis points for Eurodollar rate loans. The commitment fee associated with the unfunded portion of the borrowing base is set at 50 basis points. At March 31, 2012, the lead bank’s prime rate was 3.25%.

The terms of our credit facility include, among other restrictions, a limitation on the level of cash dividends (not to exceed $15.0 million in any fiscal year), a remaining aggregate limitation on purchases of our stock of $50.0 million, requirements as to maintenance of certain minimum financial ratios (principally pertaining to adjusted working capital ratios and EBITDAX) and limitations on incurring other debt. Since inception, no cash dividends have been declared on our common stock. As of March 31, 2012 we were in compliance with the provisions of this agreement. The credit facility is secured by our domestic oil and natural gas properties. Under the terms of the credit facility, we can increase the commitment amount to the total amount of the borrowing base with unanimous consent of the bank group as it might change from time to time.

Interest expense on the credit facility, including commitment fees and amortization of debt issuance costs, totaled $0.6 million and $0.6 million for the three months ended March 31, 2012 and 2011, respectively. The amount of commitment fees included in interest expense, net was $0.4 million for the three month periods ended March 31, 2012 and 2011, respectively.

Senior Notes Due 2022. >These notes consist of $250 million of 7-7/8% senior notes issued at 99.156% of par, which equates to an effective yield to maturity of 8%. The notes were issued on November 30, 2011 with an original discount of $2.1 million and will mature on March 1, 2022. The original discount of $2.1 million is recorded in “Long-Term Debt” on our condensed consolidated balance sheet and will be amortized over the life of the note. The notes are senior unsecured obligations that rank equally with all of our existing and future senior unsecured indebtedness, are effectively subordinated to all our existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness, including borrowing under our bank credit facility, and will rank senior to any future subordinated indebtedness of Swift Energy. Payment of interest on these notes is payable semi-annually on March 1 and September 1 and commenced on March 1, 2012. On or after March 1, 2017, we may redeem some or all of these notes, with certain restrictions, at a redemption price, plus accrued and unpaid interest, of 103.938% of principal, declining  in twelve-month intervals to 100% in 2020 and thereafter. In addition, prior to March 1, 2015, we may redeem up to 35% of the principal amount of the notes with the net proceeds of qualified offerings of our equity at a redemption price of 107.875% of the principal amount of the notes, plus accrued and unpaid interest. We incurred approximately $4.8 million of debt issuance costs related to these notes, which is included in “Other Long–Term Assets” on the accompanying condensed consolidated balance sheet and will be amortized to interest expense, net over the life of the notes using the effective interest method. In the event of certain changes in control of Swift Energy, each holder of notes will have the right to require us to repurchase all or any part of the notes at a purchase price in cash equal to 101% of the principal amount, plus accrued and unpaid interest to the date of purchase. The terms of these notes include, among other restrictions, a limitation on how much of our own common stock we may repurchase. We were in compliance with the provisions of the indenture governing these senior notes as of March 31, 2012.

 

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Under the terms of the sale of the Senior Notes due 2022, Swift was required to offer to exchange these notes for registered notes with the same terms. In April 2012 we commenced the exchange offer for all of the Senior Notes due 2022, and expect the exchange to be completed by May 2012.

Interest expense on the 7-7/8% senior notes due 2022, including amortization of debt issuance costs and debt discount, totaled $5.0 million for the three months ended March 31, 2012.

Senior Notes Due 2020>. These notes consist of $225 million of 8-7/8% senior notes issued at 98.389% of par, which equates to an effective yield to maturity of 9-1/8%. The notes were issued on November 25, 2009 with an original discount of $3.6 million and will mature on January 15, 2020. The original discount of $3.6 million is recorded in “Long-Term Debt” on our condensed consolidated balance sheets and will be amortized over the life of the note. The notes are senior unsecured obligations that rank equally with all of our existing and future senior unsecured indebtedness, are effectively subordinated to all our existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness, including borrowing under our bank credit facility, and will rank senior to any future subordinated indebtedness of Swift Energy. Payment of interest on these notes is payable semi-annually on January 15 and July 15 and commenced on November 25, 2009. On or after January 15, 2015, we may redeem some or all of these notes, with certain restrictions, at a redemption price, plus accrued and unpaid interest,  of 104.438% of principal, declining  in twelve-month intervals to 100% in 2018 and thereafter. In addition, prior to January 15, 2013, we may redeem up to 35% of the principal amount of the notes with the net proceeds of qualified offerings of our equity at a redemption price of 108.875% of the principal amount of the notes, plus accrued and unpaid interest. We incurred approximately $5.0 million of debt issuance costs related to these notes, which is included in “Other Long–Term Assets” on the accompanying condensed consolidated balance sheets and will be amortized to interest expense, net over the life of the notes using the effective interest method. In the event of certain changes in control of Swift Energy, each holder of notes will have the right to require us to repurchase all or any part of the notes at a purchase price in cash equal to 101% of the principal amount, plus accrued and unpaid interest to the date of purchase. The terms of these notes include, among other restrictions, a limitation on how much of our own common stock we may repurchase. We were in compliance with the provisions of the indenture governing these senior notes as of March 31, 2012.

Interest expense on the 8-7/8% senior notes due 2020, including amortization of debt issuance costs and debt discount, totaled $5.2 million and $5.1 million for the three months ended March 31, 2012 and 2011, respectively.

Senior Notes Due 2017>. These notes consist of $250.0 million of 7-1/8% senior notes due 2017, which were issued on June 1, 2007 at 100% of the principal amount and will mature on June 1, 2017. The notes are senior unsecured obligations that rank equally with all of our existing and future senior unsecured indebtedness, are effectively subordinated to all our existing and future secured indebtedness to the extent of the value of the collateral securing such indebtedness, including borrowing under our bank credit facility, and will rank senior to any future subordinated indebtedness of Swift Energy. Payment of interest on these notes is payable semi-annually on June 1 and December 1, and commenced on December 1, 2007. On or after June 1, 2012, we may redeem some or all of these notes, with certain restrictions, at a redemption price, plus accrued and unpaid interest,  of 103.563% of principal, declining  in twelve-month intervals to 100% in 2015 and thereafter. We incurred approximately $4.2 million of debt issuance costs related to these notes, which is included in “Other Long-Term Assets” on the accompanying condensed consolidated balance sheets and will be amortized to interest expense, net over the life of the notes using the effective interest method. In the event of certain changes in control of Swift Energy, each holder of notes will have the right to require us to repurchase all or any part of the notes at a purchase price in cash equal to 101% of the principal amount, plus accrued and unpaid interest to the date of purchase. The terms of these notes include, among other restrictions, a limitation on how much of our own common stock we may repurchase. We were in compliance with the provisions of the indenture governing these senior notes as of March 31, 2012.

 

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Interest expense on the 7-1/8% senior notes due 2017, including amortization of debt issuance costs, totaled $4.6 million and $4.5 million for the three months ended March 31, 2012 and 2011, respectively.

(6)           Discontinued Operations

In August 2008, we completed the sale of our remaining New Zealand permit for $15.0 million; with three $5.0 million payments to be received nine months after the sale, 18 months after the sale, and 30 months after the sale. The Company initially deferred the gain on the sale due to legal claims around the transfer of this property. In July 2011, a settlement was reached and all legal claims were dismissed. As a result, in the second quarter of 2011, the Company recognized sale proceeds of $15.0 million, net of $0.6 million in capitalized costs in assets held for sale, relating to our remaining New Zealand permit. In accordance with guidance contained in FASB ASC 360-10, the results of operations for the New Zealand operations have been excluded from continuing operations and reported as discontinued operations for the current and prior periods. As of December 31, 2011, all payments under this sale agreement had been received. There is essentially no income tax expense on this gain as the Company has offsetting New Zealand tax losses that were previously unrecognized due to a valuation allowance. The Company has written off its remaining unused New Zealand tax losses.

Our loss from discontinued operations, net of taxes was less than $0.1 million for the three months ended March 31, 2011, which equated to $0.00 per basic and diluted share for the same period. Our cash provided by operating activities – discontinued operations was less than $0.1 million for the three months ended March 31, 2011.

(7)           Acquisitions and Dispositions

There were no material acquisitions or dispositions in the three months ended March 31, 2012 and 2011, respectively.

(8)           Fair Value Measurements

FASB ASC 820-10 defines fair value, establishes guidelines for measuring fair value and expands disclosure about fair value measurements. It does not create or modify any current GAAP requirements to apply fair value accounting. However, it provides a single definition for fair value that is to be applied consistently for all prior accounting pronouncements.

Our financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, bank borrowings, and senior notes. The carrying amounts of cash and cash equivalents, accounts receivable, and accounts payable approximate fair value due to the highly liquid or short-term nature of these instruments.

The fair value of the bank borrowings approximate the carrying amounts as of March 31, 2012 and December 31, 2011, and was determined based upon variable interest rates currently available to us for borrowings with similar terms.

 

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Based upon quoted market prices as of March 31, 2012 and December 31, 2011, the fair value and carrying value of our senior notes was as follows (in millions):

		March 31, 2012								December 31, 2011
		Fair Value				Carrying Value				Fair Value				Carrying Value
7-1/8% senior notes due 2017		$	257.5			$	250.0			$	254.8			$	250.0
8-7/8% senior notes due 2020		$	243.6			$	221.9			$	239.6			$	221.9
7-7/8% senior notes due 2022		$	255.0			$	247.9			$	252.8			$	247.9

Our senior notes due 2017, 2020 and 2022 are stated at cost on our financial statements and are traded in an active market with observable inputs. If we recorded these notes at fair value they would be level 2 in our fair value hierarchy since their value is based on similar assets and they are in a market with limited trading.

The following table presents our assets that are measured at fair value as of March 31, 2012 and December 31, 2011 and are categorized using the fair value hierarchy. The fair value hierarchy has three levels based on the reliability of the inputs used to determine the fair value (in millions):

		Fair Value Measurements at
		Total				Quoted Prices in Active markets for Identical Assets (Level 1)				Significant Other Observable Inputs  (Level 2)				Significant Unobservable Inputs (Level 3)
March 31, 2012
Oil Floors		$	0.8			$	---			$	0.8			$	---
December 31, 2011
Oil Floors		$	0.1			$	---			$	0.1			$	---

Our derivatives, measured at fair value in the table above, are recorded in “Other current assets” on the accompanying condensed consolidated balance sheet.

Level 1 – Uses quoted prices in active markets for identical, unrestricted assets or liabilities. Instruments in this category include money market funds as they have comparable fair values for identical assets.

Level 2 – Uses quoted prices for similar assets or liabilities in active markets or observable inputs for assets or liabilities in non-active markets. Instruments in this category include our commodity derivatives that we value using commonly accepted industry-standard models (such as Black-Scholes) which contain inputs such as contract prices, risk-free rates, volatility measurements and other observable market data that are obtained from independent third-party sources.

Level 3 – Uses unobservable inputs for assets or liabilities that are in non-active markets. We do not have any assets or liabilities in this category that are not supported by market activity and have significant unobservable inputs.

 

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(9)           Condensed Consolidating Financial Information

Swift Energy Company is the issuer and Swift Energy Operating, LLC (a wholly owned indirect subsidiary of Swift Energy Company) is a guarantor of our senior notes due 2017, 2020 and 2022. The guarantees on our senior notes due 2017, 2020 and 2022 are full and unconditional. The following is condensed consolidating financial information for Swift Energy Company, Swift Energy Operating, LLC, and other subsidiaries:

Condensed Consolidating Balance Sheets

 

(in thousands)		March 31, 2012
		Swift Energy Company (Issuer)				Swift Energy Operating, LLC (Guarantor)				Other Subsidiaries				Eliminations				Swift Energy Company Consolidated
ASSETS
Current assets		$	---			$	200,004			$	21			$	---			$	200,025
Property and equipment			---				1,987,848				---				---				1,987,848
Investment in subsidiaries (equity method)			1,005,643				---				920,195				(1,925,838	)			---
Other assets			---				15,752				85,429				(85,429	)			15,752
Total assets		$	1,005,643			$	2,203,604			$	1,005,645			$	(2,011,267	)		$	2,203,625
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities		$	---			$	192,675			$	2			$	---			$	192,677
Long-term liabilities			---				1,090,734				---				(85,429	)			1,005,305
Stockholders’ equity			1,005,643				920,195				1,005,643				(1,925,838	)			1,005,643
Total liabilities and stockholders’ equity		$	1,005,643			$	2,203,604			$	1,005,645			$	(2,011,267	)		$	2,203,625

(in thousands)		December 31, 2011
		Swift Energy Company (Issuer)				Swift Energy Operating, LLC (Guarantor)				Other Subsidiaries				Eliminations				Swift Energy Company Consolidated
ASSETS
Current assets		$	---			$	328,130			$	21			$	---			$	328,151
Property and equipment			---				1,867,766				---				---				1,867,766
Investment in subsidiaries (equity method)			996,509				---				911,061				(1,907,570	)			---
Other assets			---				16,552				85,429				(85,429	)			16,552
Total assets		$	996,509			$	2,212,448			$	996,511			$	(1,992,999	)		$	2,212,469
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities		$	---			$	211,792			$	2			$	---			$	211,794
Long-term liabilities			---				1,089,595				---				(85,429	)			1,004,166
Stockholders’ equity			996,509				911,061				996,509				(1,907,570	)			996,509
Total liabilities and stockholders’ equity		$	996,509			$	2,212,448			$	996,511			$	(1,992,999	)		$	2,212,469

 

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Condensed Consolidating Statements of Income

(in thousands)		Three Months Ended March 31, 2012
		Swift Energy Company (Issuer)				Swift Energy Operating, LLC (Guarantor)				Other Subsidiaries				Eliminations				Swift Energy Company Consolidated
Revenues		$	---			$	135,878			$	---			$	---			$	135,878
Expenses			---				129,996				---				---				129,996
Income before the following:			---				5,882				---				---				5,882
Equity in net earnings of subsidiaries			3,570				---				3,570				(7,140	)			---
Income from continuing operations, before income taxes			3,570				5,882				3,570				(7,140	)			5,882
Income tax provision			---				2,312				---				---				2,312
Net income		$	3,570			$	3,570			$	3,570			$	(7,140	)		$	3,570
Total comprehensive income		$	3,831			$	3,831			$	---			$	(3,831	)		$	3,831

(in thousands)		Three Months Ended March 31, 2011
		Swift Energy Company (Issuer)				Swift Energy Operating, LLC (Guarantor)				Other Subsidiaries				Eliminations				Swift Energy Company Consolidated
Revenues		$	---			$	144,078			$	---			$	---			$	144,078
Expenses			---				111,585				---				---				111,585
Income before the following:			---				32,493				---				---				32,493
Equity in net earnings of subsidiaries			20,181				---				20,249				(40,430	)			---
Income from continuing operations, before income taxes			20,181				32,493				20,249				(40,430	)			32,493
Income tax provision			---				12,244				---				---				12,244
Income from continuing operations			20,181				20,249				20,249				(40,430	)			20,249
Loss from discontinued operations, net of taxes			---				---				(68	)			---				(68	)
Net income		$	20,181			$	20,249			$	20,181			$	(40,430	)		$	20,181
Total comprehensive income		$	20,087			$	20,087			$	---			$	(20,087	)		$	20,087

 

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Condensed Consolidating Statements of Cash Flows

 

(in thousands)		Three Months Ended March 31, 2012
		Swift Energy Company (Issuer)				Swift Energy Operating, LLC (Guarantor)				Other Subsidiaries				Eliminations				Swift Energy Company Consolidated
Cash flow from operations		$	---			$	63,783			$	--			$	--			$	63,783
Cash flow from investing activities			---				(187,383	)			---				---				(187,383	)
Cash flow from financing activities			---				(1,307	)			---				---				(1,307	)
Net decrease in cash			---				(124,907	)			---				--				(124,907	)
Cash, beginning of period			---				251,677				19				---				251,696
															---
Cash, end of period		$	---			$	126,770			$	19			$	--			$	126,789

(in thousands)

Three Months Ended March 31, 2011

Swift Energy Company (Issuer)

Swift Energy Operating, LLC (Guarantor)

Other Subsidiaries