Comstock Resources, Inc.
Q1 2008 Earnings Call Transcript

Published: 19 May 2008

[Operator:]

Good day, ladies and gentlemen, and welcome to the first quarter 2008 Comstock Resources earnings conference call. My name is [Latasha] and I will be your coordinator for today. (Operator Instructions) I would now like to turn the call over to Jay Allison, Chief Executive Officer. Please proceed.

[Jay Allison:]

Thank you, Latasha, and I guess I should start out and say, you know, what a day. It's been a wonderful day. Welcome to the Comstock Resources 2008 first quarter financial and operating results conference call. You can view a slide presentation during or after this call by going to our website at www.ComstockResources.com and clicking Presentations. There you will find a presentation entitled "First Quarter 2008 Results." I am Jay Allison, President of Comstock, and with me this morning is Roland Burns, our Chief Financial Officer, and Mack Good, our Chief Operating Officer. During this call I will review our 2008 first quarter financial and operating results as well as results to date of our 2008 drilling program. Our discussions today will include forward-looking statements within the meaning of securities laws. While we believe the expectations in such statements to be reasonable, there can be no assurance that such expectations will prove to be correct. You know, before we go to Slide 2, I'd like to make the following comments. During this conference call we will review about 25 pages of slides, but before we do that I'd like for you to know that in my 20 years with Comstock, I mean, I've gone through some quarterly conference calls that have ranged from very disappointing to very positive. However, I have really never had a quarterly conference call like this one, that truly is transformational to Comstock. We are pleased to report to you in the following 25 pages you're going to find nine big items

[Roland Burns:]

Thanks, Jay. On Slide 23 we present a pro forma income statement for the sale of our stake in Bois d'Arc and the sale of the East Texas and South Texas net profits interest properties. We've taken our reported results for the first quarter and removed the effect of consolidated Bois d'Arc. We have also excluded the operating results of the NPI properties in a separate column on the slide. We've assumed the proceeds from the sales were used to reduce amounts outstanding under our revolving bank credit facility. Excluding Bois d'Arc and the NPI properties to be sold, our production would have been 13.8 Bcfe or 152 million per day in the first quarter. Our sales would have been $122 million, operating income would be $68 million, and our net income, without counting the substantial gains that we're recognizing from these divestiture transactions, would have been $29.4 million from continuing operations or $0.65 per share. On the cost side, our lifting costs come down to $1.44 per Mcfe as compared to the consolidated $1.46 rate. Our DD&A per Mcfe produced increases to $2.87 per Mcfe from the $2.80 that we reported for the first quarter. Our effective income tax rate improves substantially to 36.4% as compared to our consolidated tax rate this quarter that we had of 51.7%. We expect to account for Bois d'Arc as a discontinued operation starting in the second quarter of this year, depending on the status of the merger. The gain will be recognized in the quarter that the merger actually closes in. On Slide 24 we have a pro forma balance sheet to show the impact of these transactions. We started with the reported March 31, 2008 balance sheet and removed the consolidated Bois d'Arc Energy accounts and subtracted the book value of the net profits interest properties. We've used the cash proceeds received after paying the current tax liability to reduce the amounts outstanding under our bank credit facility. The stock in Stone Energy is included as an asset on the new balance sheet as marketable securities. We expect to use the cost or fair value method to account for this investment and, accordingly, will not be reflecting Stone's operations in any of our reported numbers. After the sales, our assets on a pro forma basis are $1.7 billion compared to the $2.4 billion at the end of the first quarter. Our debt falls from $736 million to $269 million on a pro forma basis. Our book value of our stockholders equity increases from $807 million at the end of the first quarter to $1.1 billion on a pro forma basis. Debt to total book capitalization falls substantially from 48%, where it was at the end of the first quarter, to 20% on a pro forma basis. I'll now turn it back over to Jay.

[Jay Allison:]

Well, like I said early, you know, what a day. If you look on Slide 25, it's the 2008 outlook. As Roland pointed out, Comstock will be well positioned to continue to grow and add value for our stockholders. Our expanded onshore drilling program will be funded exclusively from operating cash flow and will position us for continued growth in 2009. We now expect to spend $322 million on our onshore drilling program, with the increased spending in our East Texas/North Louisiana region. We are targeting to have 20% to 25% onshore production growth in 2008, and are on track with a very solid first quarter. Our position in the emerging Haynesville Shale play exposes us to somewhere between 1.7 and 2.5 trillion cubic feet equivalent of reserve potential. And unlike many of our peers, our substantial unhedged production provides us exposure to higher cash flow and higher earnings in the current strong oil and gas price environment as opposed to having to explain away a large loss created by derivative trading activity. And lastly, our upcoming divestitures of our stake in Bois d'Arc Energy and, to a lesser extent, the net profits interest properties provides us an extremely strong balance sheet that will allow us to aggressively support the continued growth of our onshore operations. And I can tell you that the management at Comstock really looks forward toward continuing to add shareholder value by focusing our growth exclusively onshore. With that, Latasha, let me open it up for questions, please.

[Operator:]

(Operator Instructions) Your first question comes from Wayne Andrews - Raymond James.

[Wayne Andrews:]

I have a couple of questions for you. Let's just first start with your Haynesville Shale acreage position, which is substantially more than we were estimating just a few weeks ago. And maybe you could comment a little bit on how much of that acreage exists under your previously held Cotton Valley [trend] acreage and how much have you acquired since then and maybe what are your plans for additional acreage going forward? And I have a followup question as well.

[Jay Allison:]

Wayne, I have those numbers but I think Mack is the one - he leads that program, and he is involved daily with it. And it's a madhouse out there, as you know, so I'm going to let Mack go over that, Wayne.

[Mack Good:]

We have legacy deep rights that total about 15,000 acres, and we've acquired about 35,000 acreages, net acreages, of new leases. And we have several additional targeted areas of leasing that's ongoing now. And I can't comment on the total acreage there that we're targeting, but it is substantial. We're quite happy with our position. We don't think that all the acreage is the same. Based on current information and analysis, we think there's a core and we think we have a very nice position within that core region.

[Wayne Andrews:]

And maybe, Mack, this is probably also a question for you. You seem to have provided some pretty significant detail on your expectations for Haynesville productivity, resource potential, without having drilled many well. Maybe you could point to some of the things that you're seeing that encourage you to provide such bullish information and outlook on the play.

[Mack Good:]

Sure. We've drilled three wells, and we're drilling a fourth. We've taken some core samples from one of our wells. We've run diagnostic logs in detail throughout the shale. We have logs on all of the - almost all - of the wells that have penetrated the shale, the Haynesville, through the Bossier. We've subjected those logs to rigorous analysis as well. We have reported production rates from a number of wells that have been tested, and the bottom line is, as some of the other operators, it's kind of interesting that we're all coming up independently of one another with numbers that are very similar. On a per section basis we're calculating that the gas in place in the Haynesville could approach around 90 Bcfe. That's an in place number. Now the trick is what's your recovery going to be. And in the Barnett and in some of the other shale plays, the recovery on horizontal wells approaches 40%. So if you just do the arithmetic based on all of the data that we have available, the numbers that Jay mentioned is what reveals themselves when you use a recovery factor between 30% and 40%.

[Wayne Andrews:]

And a question for Roland. It sounds like, Jay and Roland, you're both anticipating sort of 15% to 20% growth onshore and now it sounds like you're talking more like 20% to 25%, and I'm also assuming that that's after accounting for the sale of the non-operated interest. Is that correct?

[Roland Burns:]

Yeah, that's correct, Wayne. The properties being sold were probably, you know, if they sold in the month of June, they might be in the second quarter but they would not be in the third or fourth quarter if the transactions close. But we're taking that into account when setting our growth target for 20% to 25% for our onshore properties.

[Jay Allison:]

And one key thing about that, Wayne, you know, we don't have to borrow a penny to do that, and we don't have to issue any equity to fund that growth.

[Wayne Andrews:]

Well that sort of leads me to my next and last question. I'll let some others get in the queue. By our estimates you'd still be generating free cash flow even with the increase in the capital spending budget. What would be your plans given that you now have very little outstanding debt in the form of your senior notes?

[Roland Burns:]

That's correct, Wayne. We would still, especially with the very high oil and gas prices that we have, with our substantially unhedged position that we're going to still have substantial free cash flow even after increasing our budget. I think that we're looking at a lot of acquisition opportunities and fighting the land grab wars in East Texas. And so, you know, we would hope to invest the funds mostly in that region, either through acquisitions, additional drilling and acreage acquisitions.

[Operator:]

Your next question comes from Ronald Mills - Johnson Rice.

[Ronald Mills:]

Mack, maybe for you, just a follow up on more technical information. Have you all, based on the logs you've seen, any estimate in terms of what your expectations from a porosity standpoint are in the play? And as you move toward your acreage particularly in Logansport and even further south, it looks like that Haynesville Shale thicken a little bit. Are there similar porosity characteristics from a log standpoint as you move south on your acreage in Louisiana?

[Mack Good:]

Ron, that's what we're seeing. It's a really interesting setup. There's several benches of porosity within the Haynesville. Those benches can be separated from one another by 150 feet or so and depending on which bench you're targeting. Now, all of our numbers are just focusing on a single bench although there are others that we haven't evaluated as thoroughly. So that's the upside that gets very little press just simply because so little is known about it, meaning those other benches. But to specifically answer your question about porosity, we're seeing porosity varying between 10% and 14% in the bench that we're targeting within the Haynesville. And we're seeing that distribution on porosity to hold through the data points that we've collected via the well bore logs that we've got.

[Ronald Mills:]

And did you say you were looking mostly at the lowest bench at this point?

[Mack Good:]

Yes.

[Ronald Mills:]

And the three wells that you drilled, as I recall from February, the first well was drilled more in the Logansport area. Have you drilled across different areas or has most of your activity been focused in one area?

[Mack Good:]

We've drilled in multiple areas, and we're keeping some of that information tight for obvious reasons just simply because of the competitive nature of the play. But we have tested more than just Logansport.

[Ronald Mills:]

And then, at least on you all's presentation you have a potential, I guess, expected outline of the Haynesville Shale which includes portions of East Texas. Is that some of that related to old well control you have from East Texas as well?

[Mack Good:]

Yes, sir.

[Ronald Mills:]

And so some of that Haynesville potentially starts to thin out as you move further into East Texas, is that part of the expectation for your wedge?

[Mack Good:]

Right. That's the way we see it, Ron.

[Ronald Mills:]

And then just to clarify, of the acreage, the 50,400 acres, does that include the acreage, looking at that same slide, just within what you consider the primary activity area or does that also include the stuff in the [Woodlawn] and [Booker] fields which is more within the gray wedge, which is the overall activity area?

[Mack Good:]

We think Woodlawn is on the very edge, but 98% of our acreage is within the primary activity area.

[Ronald Mills:]

And Roland, just from a prospectivity standpoint, I'm assuming that that 1.7 to 2.5 Ts is [own risk] so no real acreage prospectivity factor in there, but does it include a royalty?

[Roland Burns:]

Yes, Ron. We took about 25% out just as a kind of average type royalty in that calculation, but have not tried to risk it at all.

[Ronald Mills:]

And then it sounds like - the nine horizontal wells, it sounds like some of those, at least beginning in the third quarter, will become Haynesville. Is there a potential for your, original plans for seven Lower Cotton Valley horizontals, to shift to fewer Lower Cotton Valley and more Haynesville? Is that one way to look at the shift in drilling?

[Mack Good:]

Right, Ron. We're extremely flexible. Results will dictate what we do.

[Operator:]

Your next question comes from Jack Aydin - KeyBanc Capital Markets.

[Jack Aydin:]

The two wells that you drilled in December, did you give any indication of what the [IPs] were and what the cost was besides what is on that chart on Page 18?

[Mack Good:]

No. Those tests were vertical, and they were held tight for obvious reasons, Jack.

[Jack Aydin:]

Okay. In terms of ROE going forward and DD&A going forward for modeling purposes, should we use the numbers, you know, what you give on the pro forma basis for the onshore going forward, Roland?

[Roland Burns:]

Yes, Jack, that would be a good indication of what we'd expect for the onshore properties only.

[Jack Aydin:]

Again, onshore was up 44% year-over-year and then you're talking about 20% to 25%. Isn't that a little bit on the conservative side or sandbagging us a little bit here? It was a nice way to ask.

[Mack Good:]

Let me give you my answer, Jack.

[Jack Aydin:]

Yeah, I'd like to hear your answer.

[Mack Good:]

My answer is we're going to be drilling some horizontals in the third and fourth quarter. They take longer to drill. They'll take longer to get to production because especially on the Haynesville we're going to be testing running every log and coring, etc., so the timelines on those wells will get stretched a little bit. And that will have an impact on our production profile pushing into next year. If things go as we certainly expect them to, we'll have a nice production ramp coming into the first quarter of next year. But obviously going forward we're going to be drilling a lot of horizontal wells.

[Roland Burns:]

And Jack, this is Roland, I'd also comment the first quarter to first quarter shows the dramatic increase in production, but you remember we had a very large increase in production during the year and that really started to show up in the second quarter of last year. So the 44%, that's a very large target for us to try to reach when we get to the later quarter's comparison. The upside to our production forecast is probably the South Texas wells, especially on the Shell properties, where we haven't really looked at exploration wells to support the forecast. So some success there, and then we can maybe have more aggressive forecasts. But right now we're just really looking at the developmental activity and realizing that a lot of the increase in our capital budget that we're just putting in now really won't contribute to production until 2009.

[Jack Aydin:]

Well on that note, you care to venture 2009 for modeling purposes in terms of production growth?

[Roland Burns:]

It's a little early but our goal is always to make sure that we have a sound 15% production increase from the drill bit activities. But I think as the year progresses and we can see how Mack pulls together the development of the horizontal wells we'll get a better feel for what type of results we can achieve in 2009.

[Operator:]

Your next question comes from Kim Pacanovsky - Collins Stewart.

[Kim Pacanovsky:]

A couple of questions. I know you're not going to say exactly where you drilled the second and third Haynesville wells, but could you give us an idea of what the geographical spread is between the wells and also the consistency and thickness of pay?

[Mack Good:]

I won't give you the geographical spread just simply because there's a lot of smart people listening.

[Kim Pacanovsky:]

I know how to use a compass.

[Mack Good:]

But I can tell you that the distribution between the wells, the distribution meaning the shale thickness, the porosity, and the potential that we've evaluated for each of those points are very similar.

[Kim Pacanovsky:]

And on your Slide 16 you have pay thickness of 190 to 250 feet, and then your tests came in at 303, the one that you reported.

[Mack Good:]

Right. And we're seeing thicknesses between 250 to 350 feet.

[Kim Pacanovsky:]

And what percent of the acreage is held by production, the total acreage?

[Mack Good:]

Well we have some leases that are new, and so they're not HBP. They're three-year clock leases. They're the typical setup, Kim.

[Kim Pacanovsky:]

What percent was that? I'm sorry.

[Mack Good:]

Probably about two-thirds of our - about half, pardon me - of our acreage position.

[Kim Pacanovsky:]

About half? Okay.

[Mack Good:]

Are new leases.

[Kim Pacanovsky:]

And can you maybe just, I don't know what you could say on this but talk about your thinking on the Stone stock and maybe your long-term plans for that? I mean, obviously you -

[Jay Allison:]

Well what we did, Kim, with Stone is we - from the Bois d'Arc side, I mean, it is an unbelievably excellent company  as you know, quarter by quarter by quarter the company's grown over the least three years from $13 now to the sale price is almost $25 - but it was transitioning to a more deepwater exploration type of story. And we really enjoyed the Bois d'Arc people. You know, our goal is we think that we've made a great investment in what we think is the premier Gulf of Mexico company with Stone. We're going to own 13% of it, and I think that Dave Welch and Ken and the management group there, coupled with Gary, I think they'll grow it. And we're extremely pleased with it.

[Kim Pacanovsky:]

And any thinking going forward on the acquisition market right now, corporate versus property acquisitions? Give us a little bit more detail on what kind of things you might be looking at?

[Jay Allison:]

Well, we're looking at a lot of, of course, East Texas/North Louisiana, some acreage purchases, maybe some smaller companies that are private that have acreage or maybe deeper rights. We have some companies that in this heated area of Haynesville, they want to spread their leases around and have maybe two or three different companies committed to drill. So we have seen, you might not think in this environment that you'd see a lot of opportunities, but we have seen just a ton of opportunities in our core area to grow. And it's mainly in East Texas/North Louisiana; not so much in South Texas.

[Kim Pacanovsky:]

They're just getting more expensive, that's all.

[Jay Allison:]

Well, it is getting more expensive. But I guess the good thing, Kim, about that is that our base acreage which, you know, Mack says anywhere from a third to a half of our acreage, our cost basis is pretty nominal. And then we got in it early enough that most of our acreage has not been that expensive. Some of that is relationships that we've built up with some of the parties that we've received leases from, you know, relationships that we had 10 or 12 years ago. And they've been successful dealing with us, and they continue to believe they will be. And I think a lot of that is, you know, as we visit with you in person and do road shows and stuff, it all goes back, Kim, to the people that we have here within the company. I mean, the head of G&G, the head of our reservoir, our engineering, all of those people now, really, we transitioned to have a much more predictable company on a quarterly basis. And it just so happened that the transaction with Stone appeared in a very timely manner, and I think we'll now continue to focus - which we tried to do last year - we'll focus creating value onshore with this new group that we have here at Comstock that has really performed.

[Operator:]

Your next question comes from Rehan Rashid - Friedman, Billings, Ramsey & Co.

[Rehan Rashid:]

Maybe this is for Mack. Looking at your Haynesville, any thoughts as to what a horizontal completion could look like, maybe the lateral length? And also kind of from what we're hearing it seems like shale is more closer to kind of silly putty. How would you complete something like that? And is your core indeed kind of telling you that?

[Mack Good:]

The research that we've done and what other operators, how they completed the horizontal sections, it's a liner completion, a cemented liner. The perforating is done in the typical fashion. You frac stages approximately 500 feet in interval, source point perforating. We're acquiring additional reservoir data that will give us greater detail on how exactly we want to approach the frac designs, but that's our initial setup. As to the lateral length, anywhere from 3,000 to 4,000 feet would be the targeted length on that.

[Rehan Rashid:]

And other attributes of a shale play, maybe total organic content or something along those lines, any other information from the core?

[Mack Good:]

I can't release numbers, but I can tell you that the thermal maturity, the total organic carbon content, the vitrinite reflectance, free gas and the in situ gas all are within the window, in the middle of the window, of what is expected of a prospective shale play.

[Operator:]

Your next question comes from Dan McSpirit - BMO Capital Markets.

[Dan McSpirit:]

At what point do you stop participating in the land grab in North Louisiana/East Texas, and whether that's a function of time or price, and move that capital to drilling?

[Jay Allison:]

I think right now the way we look at that is there are a lot of opportunities out there that we think are too pricey. And we have management meetings maybe once or twice a week with the whole land group and the G&G people and the reservoir people. And there's probably 20 of us in a room and we look at our footprint and we say, "Does this complement our existing footprint? Do we feel like we know more about this area or not?" And then as a group we say, "Here's the amount of money we think we'll have in '08. What should we be doing with it, and can we spend it somewhere to create greater value somewhere else?" And I think, based upon that, a lot of that is what the lease commitment might look like. A lot of it is, is it kind of in the wheelhouse of another peer company out there that they would bid up a higher price for it? And we won't chase that. But if it's contiguous around where we are and it's a decent size, not just scattered acreage, then we look at it. And a lot of this stuff we've turned down. We could have had, I think, a much bigger footprint here had we wanted to spend a lot of money, extra money. And we've decided not to do that. I think you've got to be a good steward of your money, and I think you can chase it upwards too high.

[Dan McSpirit:]

And does that imply or suggest that the estimate that you're putting out here in terms of a net acre footprint is a very clean estimate and is very well scrubbed in terms of it being prospective for the Haynesville?

[Jay Allison:]

Yes. Yes, it is.

[Dan McSpirit:]

And then the last question, if I could, outside of your formal guidance here I wonder if you couldn't give us more of a window on the future here in terms of what Comstock's onshore asset portfolio might look like a year from now? And I ask that in light of maybe more divestitures in an effort to high grade the asset base maybe and to raise capital for drilling purposes.

[Jay Allison:]

Well, in our other regions you'll notice that we're spending less than $7 million, let's say. And I do think that we do have properties within that, quote, Other Regions category, that the later part of this year, the first of next year  which is mainly the Mississippi area - would be great divestiture candidates for us because we've not focused there. And that could be quite a few dollars for us. We think it's a great region, but it's just not where we focus.

[Operator:]

Your last question comes from [Kyle Wade] - Copia Capital.

[Kyle Wade:]

My questions have been answered.

[Operator:]

I show no further questions in the queue. I'd now like to turn the call over [break in audio].

[Jay Allison:]

I'd like to say that we really want to say thank you for participating in the conference call today, and we want you to know that we're very thankful to be able to deliver excellent news today to you. I mean, we never walk away without being thankful for that. And, you know, the news is delivered to you, the stockholder, and that's why we do what we do. So Latasha, that should conclude our first quarter conference call. Thanks.