COMSTOCK RESOURCES INC 10-Q

ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report contains forward-looking statements that involve risks, uncertainties and assumptions that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 including those described under the heading "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2022 (the "Annual Report"). Actual results may differ materially from those anticipated in our forward-looking statements due to many factors. The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included in this report and in our Annual Report. Results of Operations Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 (In thousands except per unit amounts) Net Production Data: Natural gas (MMcf) 130,528 128,902 383,902 367,758 Oil (MBbls) 17 21 57 66 Natural gas equivalent (MMcfe) 130,629 129,025 384,241 368,152 Revenues: Natural gas sales $ 304,141 $ 994,979 $ 911,065 $ 2,376,774 Oil sales 1,309 1,936 4,111 6,324 Total natural gas and oil sales $ 305,450 $ 996,915 $ 915,176 $ 2,383,098 Expenses: Production and ad valorem taxes $ 25,386 $ 24,531 $ 59,891 $ 60,080 Gathering and transportation $ 47,012 $ 44,740 $ 137,981 $ 113,797 Lease operating $ 31,664 $ 28,608 $ 100,525 $ 79,873 Exploration $ — $ — $ 1,775 $ 3,363 Average Sales Price: Natural gas (per Mcf) $ 2.33 $ 7.72 $ 2.37 $ 6.46 Oil (per Bbl) $ 77.00 $ 92.19 $ 72.12 $ 95.82 Average equivalent (Mcfe) $ 2.34 $ 7.73 $ 2.38 $ 6.47 Expenses ($ per Mcfe): Production and ad valorem taxes $ 0.20 $ 0.19 $ 0.16 $ 0.16 Gathering and transportation $ 0.36 $ 0.35 $ 0.36 $ 0.31 Lease operating $ 0.24 $ 0.22 $ 0.26 $ 0.22 Gas Services: Gas services revenue $ 71,287 $ 193,090 $ 239,350 $ 322,575 Gas services expense $ 67,632 $ 181,818 $ 224,317 $ 305,271 Revenues – Natural gas and oil sales of $305.5 million for the third quarter of 2023 decreased by $691.5 million (69%) as compared to $996.9 million for the third quarter of 2022. The decrease was primarily due to lower natural gas prices in the third quarter of 2023 as compared with 2022 prices. Our natural gas production for the third quarter of 2023 increased 1% to 130.5 billion cubic feet ("Bcf") (1.4 Bcf per day), and was sold at an average price of $2.33 per thousand cubic feet ("Mcf"). Our natural gas production for the third quarter of 2022 was 128.9 Bcf (1.4 Bcf per day) and was sold at an average price of $7.72 per Mcf. Natural gas and oil sales of $915.2 million for the nine months ended September 30, 2023 decreased by $1.5 billion (62%) as compared to $2.4 billion for the nine months ended September 30, 2022, which was also primarily due to lower natural gas prices during the first nine months of 2023 as compared with 2022 prices. Our natural gas production for the first nine months of 2023 increased 4% to 383.9 Bcf (1.4 Bcf per day), and was sold at an average price of $2.37 per Mcf as compared to 367.8 Bcf (1.3 Bcf per day) sold at an average price of $6.46 in the first nine months of 2022. 19 COMSTOCK RESOURCES, INC. We utilize natural gas price derivative financial instruments to manage our exposure to changes in prices of natural gas and to protect returns on investment from our drilling activities. The following table presents our natural gas prices before and after the effect of cash settlements of our derivative financial instruments: Three Months Ended September 30, Nine Months Ended September 30, 2023 2022 2023 2022 Average Realized Natural Gas Price: Natural gas, per Mcf $ 2.33 $ 7.72 $ 2.37 $ 6.46 Cash settlements on derivative financial instruments, per Mcf 0.08 (2.36 ) 0.20 (1.84 ) Price per Mcf, including cash settlements on derivative financial instruments $ 2.41 $ 5.36 $ 2.57 $ 4.62 Gas service revenues of $71.3 million decreased $121.8 million (63%) for the third quarter of 2023 from $193.1 million in the third quarter of 2022. Gas service revenues of $239.4 million decreased $83.2 million (26%) for the first nine months of 2023 from $322.6 million for the first nine months of 2022. Gas service activities commenced in April 2022 with the acquisition of a pipeline and gas treating plant and the opportunity to utilize our excess transport capacity in North Louisiana. Gas services revenues decreased for the three and nine months ended September 30, 2023 as compared to 2022 due to lower natural gas prices on sales of natural gas purchased to utilize our excess transport capacity. Costs and Expenses – Our production and ad valorem taxes increased $0.9 million (3%) to $25.4 million for the third quarter of 2023 from $24.5 million in the third quarter of 2022. The increase was primarily related to increases in Louisiana production tax and ad valorem tax rates, partially offset by lower natural gas and oil sales during 2023. Production and ad valorem taxes decreased $0.2 million to $59.9 million for the first nine months of 2023 from $60.1 million in the first nine months of 2022. The decrease was primarily related to lower natural gas and oil sales during 2023. Gathering and transportation costs for the third quarter of 2023 increased $2.3 million (5%) to $47.0 million as compared to $44.7 million in the third quarter of 2022. Gathering and transportation costs for the first nine months of 2023 increased $24.2 million (21%) to $138.0 million as compared to $113.8 million for the first nine months of 2022. The increase is due to production growth in areas with higher average gathering and transportation rates. Our lease operating expense of $31.7 million ($0.24 per Mcfe) for the third quarter of 2023 increased $3.1 million (11%) from lease operating expense of $28.6 million ($0.22 per Mcfe) for the third quarter of 2022. Lease operating expense of $100.5 million ($0.26 per Mcfe) for the first nine months of 2023 increased $20.7 million (26%) from lease operating expense of $79.9 million ($0.22 per Mcfe) for the first nine months of 2022. The increase was due primarily to increased water disposal and other production costs. Gas service expenses of $67.6 million decreased $114.2 million (63%) for the third quarter of 2023 from $181.8 million in the third quarter of 2022. Gas service expenses of $224.3 million decreased $81.0 million (27%) for the first nine months of 2023 from $305.3 million for the first nine months of 2022. The decrease is due primarily to lower natural gas prices realized on purchases of third party natural gas for resale. Depreciation, depletion and amortization ("DD&A") increased $19.1 million to $148.2 million in the third quarter of 2023 from $129.1 million in the third quarter of 2022. Our DD&A per equivalent Mcf produced was $1.13 per Mcfe for the quarter ended September 30, 2023 as compared to $1.00 for the quarter ended September 30, 2022. DD&A increased $67.4 million to $422.4 million for the first nine months of 2023 from $355.0 million during the first nine months of 2022. Our DD&A per equivalent Mcf produced was $1.10 per Mcfe for the nine months ended September 30, 2023 as compared to $0.96 for the nine months ended September 30, 2022. The increase in the DD&A rate was primarily due to higher drilling and completion costs incurred for wells turned to sales in the three months and nine months ended September 30, 2023. General and administrative expenses, which are reported net of overhead reimbursements, decreased to $9.6 million for the third quarter of 2023 as compared to $10.2 million in the third quarter of 2022. The decrease was primarily related to lower personnel costs. General and administrative expenses increased to $32.0 million for the first nine months of 2023 as compared to $27.5 million during the first nine months of 2022. The increase was primarily related to higher personnel costs. We use derivative financial instruments as part of our price risk management program to protect our capital investments. During the quarter ended September 30, 2023, we had net gains related to our derivative financial instruments of $14.3 million, as compared to net losses on derivative financial instruments of $271.3 million during the quarter ended September 30, 2022. Realized net gains from our price risk management program were $10.3 million for the quarter ended September 30, 2023 as compared to realized net losses of 20 COMSTOCK RESOURCES, INC. $304.5 million for the quarter ended September 30, 2022. Net gains on derivative financial instruments were $76.2 million for the first nine months of 2023 as compared to net losses of $781.7 million for the first nine months of 2022. Realized net gains from our price risk management program were $76.2 million for the first nine months of 2023 as compared to realized net losses of $679.0 million for the first nine months of 2022. Interest expense was $43.6 million and $41.4 million for the quarters ended September 30, 2023 and 2022, respectively, and $121.1 million and $132.2 million for the nine months ended September 30, 2023 and 2022, respectively. The increase in interest expense for the quarters ended September 30, 2023 and 2022 was due primarily to borrowings under the bank credit facility. The decrease in interest expense for the nine months ended September 30, 2023 and 2022 was due primarily to the early retirements of senior notes in May and June 2022 and the repayment of outstanding borrowings under the bank credit facility in 2022. Loss on extinguishment of debt was $46.8 million for the nine months ended September 30, 2022. In May and June 2022, we retired $244.4 million and $26.1 million, respectively, principal amount of our 7.5% senior notes due in 2025 and 6.75% senior notes due in 2029. Income taxes for the quarter ended September 30, 2023 and 2022 were a provision of $3.6 million and $102.8 million, respectively. Income taxes for the nine months ended September 30, 2023 and 2022 were a provision of $28.9 million and $179.6 million, respectively. Income tax expense for the quarters ended September 30, 2023 and 2022 reflect an effective tax rate of 19.7% and 22.4%, respectively. Income tax expense for the nine months ended September 30, 2023 and 2022 reflect an effective tax rate of 21.8% and 22.5%, respectively. The difference between the federal statutory tax rate of 21% and our effective rate is primarily attributable to the impact of state income taxes and revisions to the estimated future utilization of federal and state net operating loss carryforwards. We reported net income available to common stockholders of $14.7 million or $0.05 per share, for the quarter ended September 30, 2023. Income from operations for the third quarter of 2023 was $47.3 million. We reported net income available to common stockholders of $351.2 million or $1.28 per diluted share for the quarter ended September 30, 2022. In the first nine months of 2023, we reported net income available to common stockholders of $103.5 million or $0.37 per diluted share. Income from operations for the first nine months of 2023 was $175.8 million. We reported net income available to common stockholders of $608.0 million or $2.24 per diluted share for the nine months ended September 30, 2022. Cash Flows, Liquidity and Capital Resources Cash Flows The following table summarizes sources and uses of cash and cash equivalents: Nine Months Ended September 30, 2023 2022 (In thousands) Sources of cash and cash equivalents: Operating activities $ 788,639 $ 1,230,056 Borrowings on bank credit facility, net of repayments 345,000 (135,000 ) Proceeds from asset sales 41,295 93 Total $ 1,174,934 $ 1,095,149 Uses of cash and cash equivalents: Capital expenditures $ 1,103,527 $ 793,900 Retirement of senior notes — 273,920 Common stock dividends 104,181 — Preferred stock dividends — 13,089 Other 2,043 6,255 Total $ 1,209,751 $ 1,087,164 Cash flows from operating activities. Net cash provided by our operating activities decreased $441.4 million (36%) to $788.6 million in the first nine months of 2023 from $1,230.1 million in the same period in 2022. The decrease was due primarily to lower natural gas and oil sales. Proceeds from asset sales. In the second quarter of 2023, we sold our interest in certain non-operated properties for net proceeds of $41.3 million. 21 COMSTOCK RESOURCES, INC. Retirement of senior notes. In May 2022, we retired all of our outstanding 7.5% senior notes due in 2025 for $248.9 million, which included premiums paid over face value of $4.5 million. During June 2022, we retired $26.1 million principal amount of our 6.75% senior notes for $24.9 million. Common stock dividends. During the first nine months of 2023, we paid quarterly cash dividends of $0.125 per common share to stockholders of record as of March 1, 2023, June 1, 2023 and September 1, 2023, respectively. Capital expenditures. The increase in capital expenditures of $309.6 million is primarily due to our higher drilling and completion activity in the first nine months of 2023 and $76.6 million of unproved property acquisitions. Our capital expenditures are summarized in the following table: Nine Months Ended September 30, 2023 2022 (In thousands) Acquisitions: Proved property $ — $ 205 Unproved property 76,646 37,396 Exploration and development: Development leasehold costs 19,087 8,298 Exploratory drilling and completion costs 179,049 49,003 Development drilling and completion costs 740,808 619,373 Other development costs 18,868 52,500 Asset retirement obligations 71 1,223 Total exploration and development 1,034,529 767,998 Other property and equipment 22,076 18,815 Total capital expenditures $ 1,056,605 $ 786,813 Change in accrued capital expenditures and other 32,441 (16,231 ) Prepaid drilling costs 14,594 25,752 Change in asset retirement obligations (113 ) (2,434 ) Total cash capital expenditures $ 1,103,527 $ 793,900 We drilled 52 (41.3 net) wells and completed 57 (43 net) Haynesville and Bossier shale operated wells during the first nine months of 2023. We currently expect to spend an additional $300 million to $400 million in the remaining three months of 2023 on drilling, completion, infrastructure and other activity. Liquidity and Capital Resources As of September 30, 2023, we had $1.2 billion of liquidity, comprised of unused borrowing capacity under our bank credit facility and $19.8 million of cash and cash equivalents on hand. Our short and long-term capital requirements consist primarily of funding our development and exploration activities, acquisitions, payments of contractual obligations and debt service. We expect to fund our future development and exploration activities with future operating cash flow and borrowings under our bank credit facility. The timing of most of our future capital expenditures is discretionary because of the limited number of material long-term capital expenditure commitments. Consequently, we have a significant degree of flexibility to adjust the level of our capital expenditures as circumstances warrant. We believe that our cash provided by operations and borrowings available under our bank credit facility will be sufficient to satisfy our foreseeable liquidity needs and capital expenditure requirements for at least the next twelve months. If our plans or assumptions change or our assumptions prove to be inaccurate, we may be required to seek additional capital, including debt or equity financing. We cannot provide any assurance that we will be able to obtain such capital, or if such capital is available, that we will be able to obtain it on acceptable terms. We do not have a specific acquisition budget for the remainder of 2023 because the timing and size of acquisitions are unpredictable. We intend to use our cash flows from operations, borrowings under our bank credit facility, or other debt or equity financings to the extent available, to finance such acquisitions. The availability and attractiveness of these sources of financing will depend upon a number of factors, some of which will relate to our financial condition and performance and some of which will be beyond our control, such as prevailing interest rates, natural gas and oil prices and other market conditions. Lack of access to the debt or equity markets due to general economic conditions could impede our ability to complete acquisitions. 22 COMSTOCK RESOURCES, INC. At September 30, 2023, we had $345.0 million of borrowings outstanding under our bank credit facility. Aggregate commitments under our bank credit facility are $1.5 billion, which matures on November 15, 2027. Borrowings under the bank credit facility are subject to a borrowing base, which was redetermined on October 27, 2023 and currently set at $2.0 billion. The borrowing base is re-determined on a semi-annual basis and upon the occurrence of certain other events. Borrowings under the bank credit facility are secured by substantially all of our assets and those of our subsidiaries and bear interest at our option, at either adjusted SOFR plus 1.75% to 2.75% or an alternate base rate plus 0.75% to 1.75%, in each case depending on the utilization of the borrowing base. We also pay a commitment fee of 0.375% to 0.50% on the unused portion of the borrowing base. The bank credit facility places certain restrictions upon our and our subsidiaries' ability to, among other things, incur additional indebtedness, pay cash dividends, repurchase common stock, make certain loans, investments and divestitures and redeem the senior notes. The only financial covenants are the maintenance of a leverage ratio of less than 3.5 to 1.0 and an adjusted current ratio of at least 1.0 to 1.0. We were in compliance with the covenants as of September 30, 2023. Income Taxes At September 30, 2023, we had $767.5 million in U.S. federal net operating loss ("NOL") carryforwards and $1.5 billion in certain state NOL carryforwards. As a result of the change of control in August 2018, our ability to use NOLs to reduce taxable income is generally limited to an annual amount based on the fair market value of our stock immediately prior to the ownership change multiplied by the long-term tax-exempt interest rate. Our NOLs are estimated to be limited to $3.3 million a year as a result of this limitation. In addition to this limitation, IRC Section 382 provides that a corporation with a net unrealized built-in gain immediately before an ownership change may increase its limitation by the amount of recognized built-in gain recognized during a recognition period, which is generally the five-year period immediately following an ownership change. Based on the fair market value of our common stock immediately prior to the ownership change, we believe that we have a net unrealized built-in gain which will increase the Section 382 limitation during the five-year recognition period from 2018 to 2023 by $147.7 million. NOLs that exceed the Section 382 limitation in any year continue to be allowed as carryforwards until they expire and can be used to offset taxable income for years within the carryover period subject to the limitation in each year. NOLs incurred prior to 2018 generally have a 20-year life until they expire. NOLs generated in 2018 and after would be carried forward indefinitely. Our use of new NOLs arising after the date of an ownership change would not be affected by the 382 limitation. If we do not generate a sufficient level of taxable income prior to the expiration of the pre-2018 NOL carryforward periods, then we will lose the ability to apply those NOLs as offsets to future taxable income. We estimate that $766.2 million of the U.S. federal NOL carryforwards and $1.3 billion of the estimated state NOL carryforwards will expire unused.