Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2011

 

Commission File Number 001-31539

 

 

SM ENERGY COMPANY

(Exact name of registrant as specified in its charter)

 

Delaware		41-0518430
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

 

(303) 861-8140

(Registrant’s telephone number, including area code)

 

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

 

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

 

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

 

Large accelerated filer x		Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

 

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

 

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

 

As of July 26, 2011 the registrant had 63,734,209 shares of common stock, $0.01 par value, outstanding.

 

 

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SM ENERGY COMPANY

IND EX

 

			PAGE
Part I.	FINANCIAL INFORMATION
	Item 1.	Financial Statements (Unaudited)
		Condensed Consolidated Balance Sheets June 30, 2011, and December 31, 2010	3
		Condensed Consolidated Statements of Operations Three and Six Months Ended June 30, 2011, and 2010	4
		Condensed Consolidated Statements of Stockholders’ Equity and Comprehensive Income Six Months Ended June 30, 2011, and 2010	5
		Condensed Consolidated Statements of Cash Flows Six Months Ended June 30, 2011, and 2010	6
		Notes to Condensed Consolidated Financial Statements	8
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk (included within the content of Item 2)	46
	Item 4.	Controls and Procedures	46
Part II.	OTHER INFORMATION
	Item 1.	Legal Proceedings	46
	Item 1A.	Risk Factors	46
	Item 6.	Exhibits	47

 

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PART I.  FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

 

SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands, except share amounts)

 

		June 30,			December 31,
		2011			2010
ASSETS
Current assets:
Cash and cash equivalents		$	101,080		$	5,077
Accounts receivable		173,557			163,190
Refundable income taxes		3,134			8,482
Prepaid expenses and other		32,281			45,522
Derivative asset		28,985			43,491
Deferred income taxes		7,086			8,883
Total current assets		346,123			274,645
Property and equipment (successful efforts method), at cost:
Land		1,526			1,491
Proved oil and gas properties		3,799,844			3,389,158
Less - accumulated depletion, depreciation, and amortization		(1,532,670		)	(1,326,932		)
Unproved oil and gas properties		89,317			94,290
Wells in progress		245,650			145,327
Materials inventory, at lower of cost or market		15,915			22,542
Oil and gas properties held for sale (note 3)		130,077			86,811
Other property and equipment, net of accumulated depreciation of $17,550 in 2011 and $15,480 in 2010		61,831			21,365
		2,811,490			2,434,052
Other noncurrent assets:
Derivative asset		10,624			18,841
Other noncurrent assets		51,656			16,783
Total other noncurrent assets		62,280			35,624
Total Assets		$	3,219,893		$	2,744,321
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable and accrued expenses		$	413,048		$	417,654
Derivative liability		70,100			82,044
Deposit associated with oil and gas properties held for sale		—			2,355
Total current liabilities		483,148			502,053
Noncurrent liabilities:
Long-term credit facility		—			48,000
3.50% Senior Convertible Notes, net of unamortized discount of $7,209 in 2011 and $11,827 in 2010		280,291			275,673
6.625% Senior Notes		350,000			—
Asset retirement obligation		72,273			69,052
Asset retirement obligation associated with oil and gas properties held for sale (note 3)		92			2,119
Net Profits Plan liability		133,419			135,850
Deferred income taxes		496,405			443,135
Derivative liability		38,233			32,557
Other noncurrent liabilities		16,866			17,356
Total noncurrent liabilities		1,387,579			1,023,742
Commitments and contingencies (note 7)
Stockholders’ equity:
Common stock, $0.01 par value - authorized: 200,000,000 shares; issued: 63,764,421 shares in 2011 and 63,412,800 shares in 2010; outstanding, net of treasury shares: 63,683,354 shares in 2011 and 63,310,165 shares in 2010		638			634
Additional paid-in capital		215,704			191,674
Treasury stock, at cost: 81,067 shares in 2011 and 102,635 shares in 2010		(1,544		)	(423		)
Retained earnings		1,144,972			1,042,123
Accumulated other comprehensive loss		(10,604		)	(15,482		)
Total stockholders’ equity		1,349,166			1,218,526
Total Liabilities and Stockholders’ Equity		$	3,219,893		$	2,744,321

 

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

 

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SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In thousands, except per share amounts)

 

 

		For the Three Months						For the Six Months
		Ended June 30,						Ended June 30,
		2011			2010			2011			2010
Operating revenues and other income:
Oil, gas, and NGL production revenue		$	333,934		$	175,887		$	610,247		$	388,774
Realized hedge gain (loss) (note 10)		(6,330		)	9,329			(7,705		)	11,924
Gain on divestiture activity (note 3)		30,019			7,021			54,934			127,999
Marketed gas system and other operating revenue		20,250			19,460			35,726			43,135
Total operating revenues and other income		377,873			211,697			693,202			571,832
Operating expenses:
Oil, gas, and NGL production expense		53,342			45,168			119,154			93,508
Depletion, depreciation, amortization, and asset retirement obligation liability accretion		115,382			79,770			220,738			157,535
Exploration		9,603			14,498			22,315			28,396
Abandonment and impairment of unproved properties		1,237			2,375			4,316			3,279
General and administrative		27,310			25,398			53,171			48,884
Change in Net Profits Plan liability		(13,984		)	(6,599		)	211			(33,871		)
Unrealized and realized derivative (gain) loss (note 10)		(43,876		)	(2,087		)	44,553			(9,822		)
Marketed gas system and other expense		17,152			16,385			37,009			39,383
Total operating expenses		166,166			174,908			501,467			327,292
Income from operations		211,707			36,789			191,735			244,540
Nonoperating income (expense):
Interest income		227			54			355			183
Interest expense		(14,550		)	(6,343		)	(24,264		)	(13,130		)
Income before income taxes		197,384			30,500			167,826			231,593
Income tax expense		(72,851		)	(12,432		)	(61,796		)	(87,347		)
Net income		$	124,533		$	18,068		$	106,030		$	144,246
Basic weighted-average common shares outstanding		63,638			62,917			63,543			62,855
Diluted weighted-average common shares outstanding		66,909			64,566			66,695			64,493
Basic net income per common share		$	1.96		$	0.29		$	1.67		$	2.29
Diluted net income per common share		$	1.86		$	0.28		$	1.59		$	2.24

 

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

 

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SM ENERGY COMPANY AND SUBSIDIARIES

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

(In thousands, except share amounts)

 

																		Accumulated
							Additional											Other			Total
		Common Stock					Paid-in			Treasury Stock					Retained			Comprehensive			Stockholders’
		Shares		Amount			Capital			Shares		Amount			Earnings			Income (Loss)			Equity
Balances, January 1, 2011		63,412,800		$	634		$	191,674		(102,635	)	$	(423	)	$	1,042,123		$	(15,482	)	$	1,218,526
Comprehensive income, net of tax:
Net income		—		—			—			—		—			106,030			—			106,030
Reclassification to earnings		—		—			—			—		—			—			4,878			4,878
Total comprehensive income																					110,908
Cash dividends, $ 0.05 per share		—		—			—			—		—			(3,181		)	—			(3,181		)
Issuance of common stock under Employee Stock Purchase Plan		22,373		1			1,121			—		—			—			—			1,122
Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings, including income tax benefit of RSUs		18,836		—			(644		)	—		—			—			—			(644		)
Sale of common stock, including income tax benefit of stock option exercises		310,412		3			10,595			—		—			—			—			10,598
Stock-based compensation expense		—		—			12,958			21,568		(1,121		)	—			—			11,837
Balances, June 30, 2011		63,764,421		$	638		$	215,704		(81,067	)	$	(1,544	)	$	1,144,972		$	(10,604	)	$	1,349,166
Balances, January 1, 2010		62,899,122		$	629		$	160,516		(126,893	)	$	(1,204	)	$	851,583		$	(37,954	)	$	973,570
Comprehensive income, net of tax:
Net income		—		—			—			—		—			144,246			—			144,246
Change in derivative instrument fair value		—		—			—			—		—			—			53,765			53,765
Reclassification to earnings		—		—			—			—		—			—			(782		)	(782		)
Minimum pension liability adjustment		—		—			—			—		—			—			4			4
Total comprehensive income																					197,233
Cash dividends, $ 0.05 per share		—		—			—			—		—			(3,144		)	—			(3,144		)
Issuance of common stock under Employee Stock Purchase Plan		27,456		—			799			—		—			—			—			799
Issuance of common stock upon vesting of RSUs, net of shares used for tax withholdings, including income tax cost of RSUs		34,588		1			(545		)	—		—			—			—			(544		)
Sale of common stock, including income tax benefit of stock option exercises		148,902		1			3,054			—		—			—			—			3,055
Stock-based compensation expense		—		—			11,149			24,258		715			—			—			11,864
Balances, June 30, 2010		63,110,068		$	631		$	174,973		(102,635	)	$	(489	)	$	992,685		$	15,033		$	1,182,833

 

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

 

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SM ENERGY COMPANY AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

 

		For the Six Months
		Ended June 30,
		2011			2010
Cash flows from operating activities:
Net income		$	106,030		$	144,246
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on divestiture activity		(54,934		)	(127,999		)
Depletion, depreciation, amortization, and asset retirement obligation liability accretion		220,738			157,535
Exploratory dry hole expense		49			327
Abandonment and impairment of unproved properties		4,316			3,279
Stock-based compensation expense		11,837			11,864
Change in Net Profits Plan liability		211			(33,871		)
Unrealized derivative (gain) loss		24,160			(9,822		)
Amortization of debt discount and deferred financing costs		11,294			6,657
Deferred income taxes		52,241			78,820
Plugging and abandonment		(1,430		)	(6,222		)
Other		(5,888		)	2,937
Changes in current assets and liabilities:
Accounts receivable		(10,370		)	7,628
Refundable income taxes		5,348			9,558
Prepaid expenses and other		15,692			(148		)
Accounts payable and accrued expenses		(2,530		)	26,299
Excess income tax benefit from the exercise of stock awards		(6,791		)	(938		)
Net cash provided by operating activities		369,973			270,150
Cash flows from investing activities:
Net proceeds from sale of oil and gas properties		97,952			247,998
Capital expenditures		(662,372		)	(304,627		)
Deposits to restricted cash		—			(19,595		)
Other		(2,355		)	(6,492		)
Net cash used in investing activities		(566,775		)	(82,716		)
Cash flows from financing activities:
Proceeds from credit facility		102,000			204,059
Repayment of credit facility		(150,000		)	(392,059		)
Debt issuance costs related to credit facility		(8,525		)	—
Net proceeds from 6.625% Senior Notes		341,435			—
Proceeds from sale of common stock		4,929			2,916
Dividends paid		(3,181		)	(3,144		)
Excess income tax benefit from the exercise of stock awards		6,791			938
Other		(644		)	(544		)
Net cash provided by (used in) financing activities		292,805			(187,834		)
Net change in cash and cash equivalents		96,003			(400		)
Cash and cash equivalents at beginning of period		5,077			10,649
Cash and cash equivalents at end of period		$	101,080		$	10,249

 

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

 

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SM ENERGY COMPANY AND SUBSIDIARIES

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

 

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

 

		For the Six Months Ended June 30,
		2011			2010
		(In thousands)
Cash paid for interest		$	(6,378	)	$	(8,152	)
Net cash refunded for income taxes		$	2,543		$	2,392

 

As of June 30, 2011, and 2010, $237.9 million, and $105.4 million, respectively, are included as additions to oil and gas properties and accounts payable and accrued expenses.  These oil and gas property additions are reflected in cash used in investing activities in the periods that the payables are settled.

 

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

 

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SM ENERGY COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 1 - The Company and Business

 

SM Energy Company (“SM Energy” or the “Company”) is an independent energy company engaged in the acquisition, exploration, exploitation, development, and production of crude oil, natural gas, and natural gas liquids (“NGLs”) in North America, with a focus on oil and liquids-rich resource plays.

 

Note 2 - Basis of Presentation, Significant Accounting Policies, and Recently Issued Accounting Standards

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of SM Energy have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Regulation S-X.  They do not include all information and notes required by generally accepted accounting principles for complete financial statements.  However, except as disclosed herein, there has been no material change in the information disclosed in the notes to consolidated financial statements included in SM Energy’s Annual Report on Form 10-K for the year ended December 31, 2010,  (the “2010 Form 10-K”).  In the opinion of management, all adjustments, consisting of normal recurring accruals that are considered necessary for a fair presentation of interim financial information, have been included.  Operating results for the periods presented are not necessarily indicative of expected results for the full year.  In connection with the preparation of its condensed consolidated financial statements, the Company evaluated subsequent events after the balance sheet date of June 30, 2011, through the filing date of this report.

 

Other Significant Accounting Policies

 

The accounting policies followed by the Company are set forth in Note 1 to the Company’s consolidated financial statements in the 2010 Form 10-K, and are supplemented throughout the notes to condensed consolidated financial statements in this report.  It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes included in the 2010 Form 10-K.  As discussed in Note 10 - Derivative Financial Instruments, as of January 1, 2011, the Company elected to discontinue cash flow hedge accounting on a prospective basis.

 

Recently Issued Accounting Standards

 

In May 2011, the Financial Accounting Standards Board (“FASB”) issued new fair value measurement authoritative guidance that clarifies the application of fair value measurement and disclosure requirements and changes particular principles or requirements for measuring fair value.  This guidance is effective for annual periods beginning after December 15, 2011.  The Company is currently evaluating the provisions of this guidance and assessing the impact, if any, it may have on the Company’s fair value disclosures.

 

In June 2011, the FASB issued new authoritative guidance that states an entity that reports items of other comprehensive income has the option to present the components of net income and comprehensive income in either one continuous financial statement, or two consecutive financial statements. This guidance is effective for annual periods beginning after December 15, 2011.  The Company is currently evaluating the provisions of this guidance and assessing the impact it will have on the Company’s comprehensive income disclosures.

 

Note 3 - Divestitures and Assets Held for Sale

 

Mid-Continent Divestiture

 

In June 2011, the Company completed the divestiture of certain non-strategic Constitution Field assets located in its Mid-Continent region that were classified as assets held for sale at March 31, 2011.   Total cash received, before marketing costs and Net Profits Interest Bonus Plan (“Net Profits Plan”) payments, was $35.7 million.  The final sale price is subject to post-closing adjustments and is expected to be finalized during the second half of 2011.  The estimated gain on this divestiture was approximately $28.5 million and may be impacted by the post-closing adjustments mentioned above.  The Company determined that the sale did not qualify for discontinued operations accounting under financial statement presentation authoritative guidance.

 

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Rocky Mountain Divestiture

 

In January 2011, the Company completed the divestiture of certain non-strategic assets located in its Rocky Mountain region that were classified as assets held for sale at December 31, 2010.   Total cash received, before marketing costs and Net Profits Plan payments, was $45.5 million.  The final gain on sale related to the divestiture was $27.2 million.  The Company determined that the sale did not qualify for discontinued operations accounting under financial statement presentation authoritative guidance.

 

Assets Held for Sale

 

Assets are classified as held for sale when the Company commits to a plan to sell the assets and there is reasonable certainty that the sale will take place within one year.  Upon classification as held for sale, long-lived assets are no longer depreciated or depleted and a measurement for impairment is performed to expense any excess of carrying value over fair value less costs to sell.  Subsequent changes to estimated fair value less the cost to sell will impact the measurement of assets held for sale for assets for which fair value is determined to be less than the carrying value of the assets.

 

As of June 30, 2011, the accompanying condensed consolidated balance sheets (“accompanying balance sheets”) include $130.1 million in book value of assets held for sale, net of accumulated depletion, depreciation and amortization and a corresponding asset retirement obligation liability is also separately presented.  The above assets held for sale and asset retirement obligation liability amounts include certain assets located in Pennsylvania and the Company’s South Texas & Gulf Coast region, including our gathering assets as described in Note 12 – Acquisition and Development Agreement.  The Company determined that these planned asset sales do not qualify for discontinued operations accounting under financial statement presentation authoritative guidance.

 

In July 2011, the Company entered into an agreement to divest its Marcellus shale assets located in Pennsylvania that were classified as held for sale at June 30, 2011, for $80.0 million in cash, subject to normal closing and post-closing adjustments.  The agreement has an effective date of April 1, 2011, and is anticipated to close in the third quarter of 2011.  The closing of this transaction is subject to the satisfaction of certain closing conditions, including the resolution of any title and environmental defects exceeding specified levels.

 

On August 2, 2011, the Company divested its operated LaSalle and Dimmitt County assets located in its South Texas & Gulf Coast region that were classified as assets held for sale at June 30, 2011.  Total cash received, before marketing costs, was $227.4 million.  The final sales price is subject to post-closing adjustments and is expected to be finalized in the fourth quarter of 2011.  The estimated gain on this divestiture is approximately $196.1 million and may be impacted by the post-closing adjustments mentioned above.

 

Note 4 - Income Taxes

 

Income tax expense for the six-month periods ended June 30, 2011, and 2010, differs from the amounts that would be provided by applying the statutory U.S. federal income tax rate to income before income taxes as a result of the estimated effect of the domestic production activities deduction, percentage depletion, the effect of state income taxes, and other permanent differences.

 

The provision for income taxes consists of the following:

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2011			2010			2011			2010
		(in thousands)
Current portion of income tax (expense) benefit:
Federal		$	(2,212	)	$	1,759		$	(9,156	)	$	(8,216	)
State		(224		)	21			(399		)	(311		)
Deferred portion of income tax (expense)		(70,415		)	(14,212		)	(52,241		)	(78,820		)
Total income tax (expense)		$	(72,851	)	$	(12,432	)	$	(61,796	)	$	(87,347	)
Effective tax rate		36.9		%	40.8		%	36.8		%	37.7		%

 

On a year-to-date basis, a change in the Company’s effective tax rate between reported periods will generally reflect differences in its estimated highest marginal state tax rate due to changes in the composition of income from Company activities among state tax jurisdictions.  The cumulative effects of state rate changes are reflected in the period legislation is enacted.  Changes in the effective tax rate between periods also occur due to estimates for the domestic production activities deduction, percentage depletion, and for potential permanent state tax items that affect the presented periods differently due to oil and gas price variability and the impact of non-core asset sales. The quarterly rate can also be impacted by the proportion of income earned in reported periods.

 

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The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and in various states.  With few exceptions, the Company is no longer subject to U.S. federal or state income tax examinations by these tax authorities for years before 2007.  In the first quarter of 2011, the Company received the anticipated $5.5 million refund from its 2006 tax year as a result of a net operating loss carryback claim from the 2008 tax year.  In the fourth quarter of 2010, the Internal Revenue Service initiated an audit of the Company for the 2009 tax year.   The audit was concluded in the second quarter of 2011 with a $110,000 decrease to the total 2005 refund claim of $25 million.  A quick refund claim of $22.9 million from 2005 was received in the third quarter of 2010.  The Company’s remaining refundable income tax balance at June 30, 2011, includes the remaining $2 million 2005 amount.

 

Note 5 - Long-Term Debt

 

Revolving Credit Facility

 

The Company executed a Fourth Amended and Restated Credit Agreement on May 27, 2011.  This amended revolving credit facility replaced the Company’s previous facility.  The Company incurred $8.5 million of deferred financing costs in association with the amended credit facility.  Borrowings under the facility are secured by substantially all of the Company’s proved oil and gas properties.  The credit facility has a maximum loan amount of $2.5 billion, with current aggregate lender commitments of $1.0 billion, and a maturity date of May 27, 2016.  The borrowing base under the credit facility as of the filing date of this report is $1.3 billion, and is subject to regular semi-annual redeterminations.  The borrowing base redetermination process considers the value of the Company’s oil and gas properties and other assets, as determined by the bank syndicate.

 

The Company must comply with certain financial and non-financial covenants under the terms of its credit facility agreement, including the limitation of the Company’s dividends to no more than $50.0 million per year.  The Company was in compliance with all financial and non-financial covenants under the credit facility as of June 30, 2011, and through the filing date of this report.  Interest and commitment fees are accrued based on the borrowing base utilization grid below.  Eurodollar loans accrue interest at the London Interbank Offered Rate plus the applicable margin from the utilization table below, and Alternative Base Rate (“ABR”) and swingline loans accrue interest at Prime plus the applicable margin from the utilization table below.  Commitment fees are accrued on the unused portion of the aggregate commitment amount and are included in interest expense in the accompanying condensed consolidated statements of operations (“accompanying statements of operations”).

 

Borrowing Base Utilization Grid

 

Borrowing Base Utilization Percentage		<25%		³ 25% <50%		³ 50% <75%		³ 75% <90%		³ 90%
Eurodollar Loans		1.500	%	1.750	%	2.000	%	2.250	%	2.500	%
ABR Loans or Swingline Loans		0.500	%	0.750	%	1.000	%	1.250	%	1.500	%
Commitment Fee Rate		0.375	%	0.375	%	0.500	%	0.500	%	0.500	%

 

The Company had no outstanding borrowings under its credit facility as of June 30, 2011.  The Company had $48.0 million of outstanding borrowings under its previous credit facility as of December 31, 2010.  The Company had $999.4 million available borrowing capacity under this facility as of June 30, 2011.  The Company had $629.5 million available borrowing capacity under its previous facility as of December 31, 2010, when the aggregate commitment amount was $678.0 million.  The Company has two letters of credit outstanding for a total of $608,000 as of June 30, 2011.  The Company had a single letter of credit outstanding in the amount of $483,000 at December 31, 2010.  These letters of credit reduce the amount available under the commitment amount on a dollar-for-dollar basis.

 

6.625% Senior Notes Due 2019

 

On February 7, 2011, the Company issued $350.0 million in aggregate principal amount of 6.625% Senior Notes Due 2019 (the “6.625% Senior Notes”).  The 6.625% Senior Notes were issued at par and mature on February 15, 2019.  The Company received net proceeds of approximately $341.4 million after deducting fees of approximately $8.6 million, which will be amortized as deferred financing costs over the life of the 6.625% Senior Notes.  The net proceeds were used to repay all borrowings under the Company’s credit facility, with the remainder to be used for the Company’s ongoing capital expenditure program and general corporate purposes.

 

Prior to February 15, 2014, the Company may redeem up to 35 percent of the aggregate principal amount of the 6.625% Senior Notes with the net cash proceeds of one or more equity offerings at a redemption price of 106.625% of the principal amount thereof, plus accrued and unpaid interest.  The Company may redeem the 6.625% Senior Notes, in whole or part, at any time prior to February 15, 2015, at a redemption price equal to 100% of the principal amount, plus a specified make whole premium and accrued and unpaid interest.

 

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The Company may also redeem all or, from time to time, a portion of the 6.625% Senior Notes on or after February 15, 2015, at the prices set forth below, expressed as a percentage of the principal amount redeemed, plus accrued and unpaid interest:

 

2015		103.313	%
2016		101.656	%
2017 and thereafter		100.000	%

 

The 6.625% Senior Notes are unsecured senior obligations and rank equal in right of payment with all of the Company’s existing and any future unsecured senior debt and are senior in right of payment to any future subordinated debt.  There are no subsidiary guarantors of the 6.625% Senior Notes.  The Company is subject to certain covenants under its 6.625% Senior Notes that limit incurring additional indebtedness, issuing preferred stock, and making restricted payments in excess of specified amounts.  The restricted payment covenant limits the payment of dividends on the Company’s common stock, provided however, the Company may pay dividends of up to $6.5 million for any given year during the eight - year term of the notes.  The Company is in compliance with all covenants under its 6.625% Senior Notes as of June 30, 2011, and through the filing date of this report.

 

Additionally, on February 7, 2011, the Company entered into a registration rights agreement that provides holders of the 6.625% Senior Notes certain registration rights for the 6.625% Senior Notes under the Securities Act of 1933, as amended (the “Securities Act”).  Pursuant to the registration rights agreement, the Company will file an exchange offer registration statement with the Securities and Exchange Commission (the “SEC”) with respect to an offer to exchange the 6.625% Senior Notes for substantially identical notes that are registered under the Securities Act.  Under certain circumstances, in lieu of a registered exchange offer, the Company has agreed to file a shelf registration statement relating to the resale of the 6.625% Senior Notes.  If the exchange offer is not completed on or before February 7, 2012, or the shelf registration statement, if required, is not declared effective within the time periods specified in the registration rights agreement, then the Company has agreed to pay additional interest with respect to the 6.625% Senior Notes in an amount not to exceed one percent of the principal amount of the 6.625% Senior Notes until the exchange offer is completed or the shelf registration statement is declared effective.

 

3.50% Senior Convertible Notes Due 2027

 

On April 4, 2007, the Company issued $287.5 million in aggregate principal amount of 3.50% Senior Convertible Notes Due 2027 (the “3.50% Senior Convertible Notes”).  The 3.50% Senior Convertible Notes mature on April 1, 2027, unless converted prior to maturity, redeemed, or purchased by the Company.

 

Holders of the 3.50% Senior Convertible Notes may elect to surrender all or a portion of their notes for conversion under certain circumstances, including during a calendar quarter if the closing price of the Company’s common stock was more than 130 percent of the conversion price of $54.42 per share for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter.  As of December 31, 2010, the 3.50% Senior Convertible Notes were not convertible.  The closing price of the Company’s common stock was more than the conversion trigger price of $70.75 per share for at least 20 trading days in the 30 consecutive trading days ending on the last trading day during the first quarter of 2011.  Therefore the holders of the 3.50% Senior Convertible Notes had the right to convert all or a portion of their notes during the second quarter of 2011.  If holders elect to convert all or a portion of their notes during a calendar quarter that they are eligible to do so, they will receive cash, shares of the Company’s common stock, or any combination thereof as may be elected by the Company under the indenture for the 3.50% Senior Convertible Notes.  No holders elected to convert their notes during the second quarter of 2011.  The closing price of the Company’s common stock was not more than the conversion trigger price of $70.75 per share for at least 20 trading days in the 30 consecutive trading days ending on the last trading day in the second quarter of 2011.  Therefore, the 3.50% Senior Convertible Notes will not be convertible during the third quarter of 2011.

 

Note 6 - Earnings per Share

 

Basic net income per common share of stock is calculated by dividing net income available to common stockholders by the basic weighted-average common shares outstanding for the respective period.  The Company’s earnings per share calculations reflect the impact of any repurchases of shares of common stock made by the Company.

 

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

 

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The PSAs represent the right to receive, upon settlement of the PSAs after the completion of the three-year performance period, a number of shares of the Company’s common stock that may range from zero to two times the number of PSAs granted on the award date.  The number of potentially dilutive shares related to PSAs is based on the number of shares, if any, which would be issuable at the end of the respective reporting period, assuming that date was the end of the contingency period.  For additional discussion on PSAs, please refer to Note 8 - Compensation Plans under the heading Performance Share Awards Under the Equity Incentive Compensation Plan .

 

The Company’s 3.50% Senior Convertible Notes have a net-share settlement right whereby the Company has the option to irrevocably elect, by notice to the trustee under the indenture for the notes, to settle the Company’s obligation to deliver shares of the Company’s common stock, in the event that holders of the notes elect to convert all or a portion of their notes, by delivering cash in an amount equal to each $1,000 principal amount of notes surrendered for conversion and, if applicable, at the Company’s option, shares of common stock or cash, or any combination of common stock and cash, for the amount of conversion value in excess of the principal amount.  For accounting purposes, the treasury stock method is used to measure the potentially dilutive impact of shares associated with this conversion feature.  Shares of the Company’s common stock traded at an average closing price exceeding the $54.42 conversion price for the three-month and six-month periods ended June 30, 2011.  The 3.50% Senior Convertible Notes had a dilutive impact for the three-month and six-month periods ended June 30, 2011, as calculated in the basic and diluted earnings per share table below.  The 3.50% Senior Convertible Notes were not dilutive for the three-month and six-month periods ended June 30, 2010.

 

The treasury stock method is used to measure the dilutive impact of unvested RSUs, contingent PSAs, and in-the-money stock options, as calculated in the basic and diluted earnings per share table below.

 

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

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2011			2010			2011			2010
		(in thousands, except per share amounts)
Net income		$	124,533		$	18,068		$	106,030		$	144,246
Basic weighted-average common shares outstanding		63,638			62,917			63,543			62,855
Add: dilutive effect of stock options, unvested RSUs, and contingent PSAs		2,182			1,649			2,161			1,638
Add: dilutive effect of 3.50% Senior Convertible Notes		1,089			—			991			—
Diluted weighted-average common shares outstanding		66,909			64,566			66,695			64,493
Basic net income per common share		$	1.96		$	0.29		$	1.67		$	2.29
Diluted net income per common share		$	1.86		$	0.28		$	1.59		$	2.24

 

Note 7 - Commitments and Contingencies

 

During the second quarter of 2011, the Company entered into two natural gas gathering and services agreements whereby it is subject to certain natural gas gathering through-put commitments for up to ten years pursuant to each contract.  The Company may be required to make periodic deficiency payments for any shortfalls in delivering the minimum applicable annual or semi-annual volume commitments.  In the event that no gas is delivered pursuant to the agreements, the aggregate deficiency payments will total approximately $729.4 million.  If a shortfall in the minimum volume commitment arises, the Company can arrange for third party gas to be delivered into the applicable gathering system and applied to the Company’s minimum commitment.

 

During the first quarter of 2011, the Company entered into a hydraulic fracturing services contract.  The total commitment is $180.0 million over a two-year term commencing January 1, 2011.  However, the Company’s liability in the event of early termination of this contract is not to exceed $24.0 million.

 

The Company is subject to litigation and claims that have arisen in the ordinary course of its business.  The Company accrues for such items when a liability is probable and the amount can be reasonably estimated.  The Company currently has no such accruals.  In the opinion of management, any adverse results in any such pending litigation and claims will not have a material effect on the results of operations, the financial position, or cash flows of the Company.

 

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The Company is currently a defendant in litigation where the plaintiffs claim an aggregate overriding royalty interest of 7.46875 percent in production from approximately 22,000 of the Company’s net acres in the Eagle Ford shale play in South Texas.  The plaintiffs seek to quiet title to their claimed overriding royalty interest and seek the recovery of unpaid overriding royalty interest proceeds allegedly due.  The Texas District Court has issued an order granting plaintiffs’ motion for summary judgment, but the Company believes that the summary judgment order is incorrect under the governing agreements and applicable law, and the Company intends to appeal and continue to contest the litigation.  In July 2011, the court entered judgment awarding the plaintiffs damages of approximately $5.2 million.  If the plaintiffs were to ultimately prevail, the overriding royalty interest would reduce the Company’s net revenue interest in the affected acreage.  The Company does not currently believe that an unfavorable ultimate outcome is probable, nor that if the plaintiffs prevail there would be a material effect on the financial position of the Company.  Based on the Company’s current view of the facts and circumstances of the case, no accrual has been made for any loss.

 

Note 8 - Compensation Plans

 

Cash Bonus Plan

 

During the first quarters of 2011 and 2010, the Company paid $21.6 million and $7.7 million for cash bonuses earned in the 2010 and 2009 performance years, respectively.  Within the general and administrative expense and exploration expense line items in the accompanying statements of operations was $3.7 million and $2.9 million of accrued cash bonus plan expense related to the specific performance year for the three-month periods ended June 30, 2011, and 2010, respectively, and $7.5 million and $6.0 million for the six-month periods ended June 30, 2011, and 2010, respectively.

 

Performance Share Awards Under the Equity Incentive Compensation Plan

 

PSAs are the primary form of long-term equity incentive compensation for the Company.  The PSA factor is based on the Company’s performance after completion of a three-year performance period.  The performance criteria for the PSAs are based on a combination of the Company’s annualized total shareholder return (“TSR”) for the performance period and the relative measure of the Company’s TSR compared with the annualized TSR of an index comprised of certain peer companies for the performance period.  In addition, there are separate employment service vesting provisions.  PSAs are recognized as general and administrative and exploration expense over the vesting period of the award.

 

Total stock-based compensation expense related to PSAs for the three-month periods ended June 30, 2011, and 2010, was $4.1 million and $3.8 million, respectively, and $8.4 million and $7.4 million for the six-month periods ended June 30, 2011, and 2010, respectively.  As of June 30, 2011, there was $13.6 million of total unrecognized compensation expense related to unvested PSAs that is being amortized through 2013.

 

A summary of the status and activity of PSAs for the six-month period ended June 30, 2011, is presented in the following table:

 

				Weighted-
				Average Grant-
		PSAs		Date Fair Value
Non-vested, at January 1, 2011		1,110,666		$	39.48
Granted		—		$	—
Vested (1)		(7,682	)	$	36.69
Forfeited		(23,289	)	$	39.41
Non-vested, at June 30, 2011		1,079,695		$	39.50

 

(1)                 The number of awards vested assumes a multiplier of one. The final number of shares vested may vary depending on the ending three-year multiplier, which ranges from zero to two.

 

Subsequent to June 30, 2011, the Company granted 234,308 Performance Stock Units (“PSUs”), which are structurally the same as previously granted PSAs, as part of its regular annual compensation process.  These PSUs will vest 1/7 th  on July 1, 2012, 2/7 ths  on July 1, 2013, and 4/7 ths  on July 1, 2014.   Also subsequent to June 30, 2011, the Company settled 305,351 PSAs that relate to awards granted in 2008 through the issuance of shares of the Company’s common stock in accordance with the terms of the PSA awards.

 

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