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Executives

Jay Allison – Chairman, President and CEO

Roland Burns – SVP and CFO

Mack Good – COO

Analysts

Wayne Andrews – Raymond James

Kim Pacanovsky – Collins Stewart

Ron Mills – Johnson Rice

Dan McSpirit – BMO Capital Markets

David Snow – Energy Equities, Inc.

Matt McGeary – Sentinel Asset Management

Comstock Resources, Inc. (CRK) Q2 2008 Earnings Call Transcript August 5, 2008 11:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the second quarter Comstock Resources, Inc. earnings conference call. My name is Latisha and I will be your coordinator for today. At this time, all participants all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this call. (Operator instructions) I would now like to turn the presentation over to your host for today’s call, Jay Allison, President and Chief Executive Officer of Comstock Resources. Please proceed.

Jay Allison

Thank you, Latisha, and thanks everyone for being present for the conference call. Welcome to the Comstock Resources 2008 second 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 Second 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, we will review our 2008 first quarter financial and operating results as well as the 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.

If you flip over to tab two, you will see the second quarter 2008 highlights. We are pleased to be able to report another exceptional quarter and we are very pleased on how Comstock is now positioned for future growth. In this quarter, we are accounting for our offshore operations, which relate to our investment in Bois d'Arc Energy as discontinued operations given the upcoming merger of Bois d'Arc with Stone Energy. This accounting highlights our continuing onshore operations, which have had tremendous growth this year. Many of the numbers used in this presentation reflect only our onshore operations and exclude the contributions to earnings provided by the offshore operations of Bois d'Arc.

In the second quarter, our revenues were $172 million, and we generated EBITDAX of $145 million and operating cash flow of $134 million. Our net income was very strong for the quarter at $83 million or $1.81 per share. This is almost double our net earnings in the first quarter of $41 million or $0.91 per share. Our continuing operations contributed $71 million or $1.55 per share with Bois d'Arc contributing $12 million or $0.26 per share to this blockbuster quarter.

The strong financial results in the second quarter were driven by 42% onshore production growth and very strong oil and natural gas prices in the quarter. Our onshore drilling activities have been very successful so far in 2008. 61 of the 62 total wells we drilled were successful. Bois d'Arc has drilled six successful wells out of the nine wells drilled to date in 2008. We continue to be very excited about the potential of emerging Haynesville Shale play. We have increased our holdings to 65,802 net acres in this play and have offers to further increase our acreage position this year.

On April 30, we announced that our 49% owned subsidiary Bois d'Arc Energy has agreed to be acquired by Stone Energy. Comstock will recognize a substantial gain on its investment and will become a significant stockholder in Stone Energy with our 13% ownership of the combined company. The cash portion of the consideration combined with the sale of certain non-core properties for $138 million has allowed us to substantially reduce our debt and will fuel increased activity on our onshore properties including the emerging Haynesville Shale play.

I will turn it over to Roland Burns to review the financial results in more detail. Roland?

Roland Burns

Thanks, Jay. Our excellent financial results have been driven by our strong production growth from our onshore operations this quarter, which are shown on slide three of the presentation. In the second quarter of 2008, our production averaged to 168 million cubic feet of natural gas equivalent per day, which was 42% higher than our production in second quarter of 2007.

Our production for the first half of this year was also 42% higher than production for the same period last year. Production this quarter was also up 5% over production from the first quarter of this year. Our successful drilling activities and the South Texas acquisition that we completed at the end of 2007 account for the increase.

On slide three, we break down our production into our operating regions and we also separate out the properties that we are selling. The properties that we were selling were producing about 9 million per day in the first half of 2008. We will now have that production next quarter. So excluding the Gilmer Field, which we sold at our East Texas region, this region averaged 80 million per day, which was 27% higher than it was in the second quarter of last year.

Production in our South Texas region, excluding the fields that we were selling, was up 156% to 64 million per day as compared to the 25 million per day rate we had in 2007. Production in our other regions averaged 15 million per day in the second quarter, which was down from the 18 million a day that we averaged in 2007 second quarter. We expect to produce between 56 to 59 Bcfe in 2008, which would represent about a 25% to 30% growth over our 2007 levels. And this is even after accounting for the properties that we sold.

Also contributing to the strong financial results were the very strong oil and gas prices that we had in the second quarter. On slide four, we cover our oil prices. Our average oil price increased 87% in the second quarter of 2008 to $105.16 per barrel as compared to $56.10 per barrel in the second quarter of 2007. Our oil price in the second quarter averaged 85% of the average NYMEX WTI price in the quarter. For the first half of this year, our realized oil price was $93.90, which was 80% higher than the $52.10 we averaged in the first half of 2007. And also for the first half of the year, our oil price averaged 85% of the NYMEX WTI price.

Slide five shows our average gas price. Our average gas price increased 45% in the second quarter to $10.83 per Mcf as compared to $7.47 in the second quarter of 2007. Our realized gas price was 99% of the average Henry Hub NYMEX gas price in the second quarter. For the first half of 2008, our average gas price increased 35% to $9.56 per Mcf as compared to $7.09 in the same period in 2007. Our realized gas price was 101% of the average Henry Hub NYMEX price for the first half of the year.

We had 11% of our onshore gas production hedged in the second quarter, which reduced our realized gas price for the quarter to $9.39 per Mcf. For the rest of the year, approximately 12% of our onshore gas production is hedged at $8.20 per Mcf, leaving us 88% of our production unhedged.

On slide six, we cover our oil and gas sales. Our sales from our continuing onshore operations increased 107% to $172 million in the second quarter due to the higher production level and the strong oil and gas prices. For the first half of this year, oil and gas sales increased 96% to $300 million as compared to $153 million for the same period in 2007.

Our earnings before interest, taxes, depreciation, amortization and exploration expense and other non-cash expenses, or EBITDAX, from our continuing onshore operations increased 131% in the second quarter to $145 million as compared to $63 million in last year's second quarter as shown on slide seven. For the first six months of this year, EBITDAX increased 115% to $248 million as compared to $115 million for the same period in 2007.

Slide eight covers our operating cash flow. Our cash flow just from our continuing onshore operations increased 147% in the second quarter to $134 million as compared to cash flow of $54 million in 2007 second quarter. For the first half of this year, our operating cash flow was $226 million, 126% higher than cash flow in the first half of 2007 of $100 million.

On slide nine, we outline our earnings. We reported net income of $83 million or $1.81 per share for the second quarter, which is the highest quarterly profit in our corporate history. This compares to $18 million or $0.41 per share for the second quarter of 2007. $71 million or $1.55 per share is attributable to our continuing onshore operations as compared to $13 million or $0.29 per share in the second quarter of 2007. Including in the continuing earnings this quarter is an after-tax gain of about $14 million or $0.31 per share realized on the sale on our net profits interest properties. For the first half of this year we reported net income of $124 million or $2.72 per share as compared to $31 million or $0.69 per share for the same period in 2007. A $100 million or $2.21 per share is attributable to our continuing onshore operations as compared to $22 million or $0.51 per share in 2007’s first half.

We outline our cost structure on slide 10. Our lifting cost in the second quarter improved to $1.53 per Mcfe produced as compared to $1.64 in the second quarter of 2007. The higher production volumes in the quarter account for the lower lifting rate. Our depreciation, depletion and amortization per Mcfe produced increased to $2.89 per Mcfe in the second quarter of 2008 as compared to $2.80 per Mcfe in 2007 second quarter.

On slide 11, we outline our production cost for the first half of this year. Our lifting cost averaged $1.49 per Mcfe in the first half of this year as compared to $1.52 in 2007. Our depreciation, depletion and amortization per Mcfe produced increased to $2.87 per Mcfe in the first half of 2008 as compared to $2.75 in 2007.

On slide 12, we present our capital structure at the end of second quarter. On June 30, we reduced our debt to $494 million out of our excess cash flow and the proceeds from the asset sales. Our onshore bank credit facility now has a borrowing base of $590 million, giving us availability of $270 million at the end of this quarter. We have excluded $18 million dollars of debt from this slide that relates to our discontinued operations. This debt was paid off in full on July by Bois d'Arc.

Our equity at the end of the quarter was up to $892 million. Our percentage of debt to our total booked capitalization decreased to 36% at the end of the quarter as compared to the 50% level that we are at, at the end of 2007. After the Bois d'Arc merger closes, we debt to total booked capitalization is expected to decrease to 17%.

On slide 13, we detail our drilling expenditures during the first half of this year. We spent $146 million for our onshore drilling program as compared to the $170 million that we spent in 2007’s first six months. We spent $104 on our East Texas/North Louisiana drilling program; $37 million in South Texas, and $5 million were spent on our other regions. We announced today that we are increasing our onshore drilling budget to $410 million, which is detailed on slide 14. Much of this increase is for acreage acquisitions in the Haynesville play. We now expect to drill approximately 133 wells or 78.6 wells net to our working interest in our onshore drilling program, 9 of these wells will be horizontal wells drilling our East Texas/North Louisiana region for either the Cotton Valley Taylor or the Haynesville shale formation.

Our East Texas/North Louisiana operating region at $292 million accounts for 71% of our budget and 101 wells, which we plan to drill. We expect to spend $111 million in our South Texas region to drill 24 wells and we have budgeted $7 million to drill 8 wells in our other regions. I will now turn it back over to Jay to review the operating results in each region.

Jay Allison

Thank you, Roland, for the excellent report on the second quarter financials, again, the highest quarterly profit in our corporate history.

If you turn to slide 15, we focus on our East Texas/North Louisiana region. We drilled 52 wells in this region in eight different fields in the first half of this year. All of those wells were successful. We have tested these wells at a per well average rate of 2.6 million cubic feet equivalent per day, which is a substantial improvement from our average rate in 2007 of 1.4 million cubic feet equivalent per day. The prolific wells at (inaudible) and the Taylor Cotton Valley horizontal wells account for the improved per well results. Really our per well rate has almost doubled over what it was in 2007.

On slide 16, we have a map of our Waskom Field in Harrison County, Texas. We have now drilled 3 very successful horizontal wells in this field. In the second quarter, we called drilled Swift #13 well. This well was drilled to a total vertical depth of 9,540 feet with 2,947 feet horizontal leg drilled in Taylor Cotton Valley sands. We completed this well with a seven-stage frac and it tested at an initial production rate of 8.0 million cubic feet equivalent per day of natural gas. We own a 49% working interest in the Swift #13 well.

Our most recent well is the Bouge well #4, which looks to be the best one so far that we drilled. The Bouge was drilled to a total vertical depth of 9600 feet with a 2850-foot horizontal leg drilled. This well was also completed with a seven stage frac and tested at an initial production rate of 10.1 million cubic feet equivalent per day of natural gas. We have a 94% working interest in the Bogue #4 well. We have 8 more identified horizontal drilling sites in this field and we also plan to take the technology over to some of our other 31 [ph] East Texas fields this year.

On slide 17, there is another area we have been very active in which is our Hico Knowles Field in Lincoln Parish in Northern Louisiana as shown on slide 17. This field offsets the very prolific Terryville field that Petrohawk has been developing. We have drilled or participated in 19 wells in the first half of this year, 17 of these wells have been completed and had initial production rates, which have averaged 4 million cubic feet equivalent per day. We still have another 27 locations identified to be drilled on our acreage.

On slide 18, we have our current view of the emerging Haynesville shale play in North Louisiana and East Texas. Our acreage is highlighted in green. We currently have 80, 593 gross acres and 65,802 net acres that we believe are productive for Haynesville development based on 5 test wells that we have drilled and data from wells drilled by other operators that we have reviewed. We are continuing to add to our acreage position and to test other acreage we have in order to see if the shale is perspective.

Our goal is to bring our net acreage up to 75,000 acres by the end of this year. Given expected wells spacing of 80 acres and the expected per well recovery rate of 3.5 to 4 Bcfe per well our acreage could have 2.2 to 2.5 trillion cubic feet equivalent of reserve potential. If other operators are correct with reserve recoveries of over 6 Bcfe per well and the potential is even greater for Comstock. I will now let Mack Good our chief operating officer comment on our Haynesville horizontal well, which we have just started drilling. Mack?

Mack Good

Thanks, Jay. On slide 19, you will see a diagram that will give you a general picture of how we plan to complete of our first horizontal Haynesville well and as Jay mentioned we've already spud this well. This picture shows that we expect to encounter our Haynesville section for 2190 feet to 250 feet thick in our first well and that we plan to pump between 9 to 12 fracture stimulation treatments across the well's horizontal lateral. Our geological work on Haynesville shows that the targeted shale section is found in the lower part of the Bouge shale interval and the depth of this Haynesville shale targeted for development varies between 10,750 to 12,000 feet deep and we believe that the shale is between 180 to 300 feet thick cross the play area.

We have drilled and completed and tested six vertical Haynesville wells in different parts of our Haynesville acreage across the play and this has given us valuable information. Drilling and completing a vertical well to test the Haynesville currently costs approximately $2.1 million. The cost of drilling and completing a horizontal Haynesville well will depend upon exact location and because of this may expect those costs to vary between $6 and $8 million.

The commercial development of the Haynesville definitely requires drilling horizontal wells in order to optimize reserve recovery and economics. Comstock is currently drilling our first Haynesville horizontal well in our Toledo Bin North [ph] or TBN area. Our TBN area is located just south of our Logansport field assets into (inaudible), Louisiana. We will have an approximate 88% working interest in this well. The well name is BSMC LA 7#1. We will drill this well to an estimated vertical depth of 11,400 feet at which point we which point we will drill an estimated 4000 foot horizontal lateral, and we plan to fracture stimulate this horizontal lateral in 9 to 12 stages into simultaneously flow all of the stages to sales.

Comstock plan is to move in a second Haynesville horizontal drilling rig to begin operations during the fourth quarter of 2008. We will drill an estimated 40 horizontal Haynesville wells during 2009 by running 5 rigs for the year. However, our plan is to ramp to a 7 rig program by late third quarter of 2009. I will now turn it back over to Jay.

Jay Allison

Thanks, Mack. And as Mack reported, we actually spudded that well, I believe, yesterday. Our South Texas region has displayed on slide 20. In our South Texas region, we drilled 7 successful wells in the first half of this year and we had one dry hole. These wells have been tested at a per well average rate of 3.8 million cubic feet equivalent per day. Two of the successful wells were drilled in our Las Hermanitas field in Duval County, Texas; three were in the Javelina field in Hildago County; one was in the Ball Ranch field; and one was in the Lorenz Ranch field in McMullen County.

On slide 21, we have a map of our Fandango field. We purchased this well from Shell at the end of last year. We are currently building a location to drill our first well in this field. This well will target 3 potential play sands with a total reserve potential approaching 30 Bcfe. We will have 100 working interest in this well.

On December 28, we covert an acquisition of producing properties from Shell in South Texas as displayed on slide 20. We acquired 70 producing wells in the Fandango, Rosita and Dinn Ranch fields, which are currently producing 22 million cubic feet of natural gas equivalent per day. The acquired properties have net proved reserves of approximately 70 Bcfe. All of the proved reserves are in the developed category. In addition to the proved reserves, we estimate that there are 18 drilling locations, which would add 50 Bcfe of probable and possible reserves, and we have identified 14 prospective drilling locations with 42 Bcfe of reserve potential.

On slide 22, we covered the sale of our net profits interest properties in East and South Texas as well as two other fields in South Texas that we plan to sell in the third quarter and if profits interest properties are non operated properties that we originally acquired when we purchased DevX in 2001. We sold our interest in the J.C. Martin, AWP and East Seven Sisters field in South Texas and the Gilmer field in east Texas to two separate buyers in June. The estimated proved reserves attributable to the properties were around 44.3 Bcfe. This works out to a sale price of $2.75 per Mcfe.

Production in the first half of 2008 attributable to our interest in these properties was 8.4 million cubic feet equivalent per day, and these properties contributed $7.9 million to our operating income before income taxes. We realized a gain of $13.9 million or $0.31 per share after income taxes on these sales in the second quarter. We have also accepted offers to sell our interest in our East White Point and Markham fields for $16.4 million. The sales are expected to close in August of 2008 and in fact one of them closed yesterday. These properties have estimated proved reserves of 15.3 Bcfe and we are producing slightly less than a million cubic feet per day in the first half of 2008. We expect to realize an after-tax gain of $3.9 million in these sales in the third quarter. We have utilized an exchange [ph] structure for these transactions, so we will not have a current tax liability on the sales.

On slide 23, we showed the impact on Comstock of the proposed merger of Bois d'Arc Energy with Stone Energy that we expect to close on August the 28th. And on the terms of the merger agreement Bois d'Arc shareholders including Comstock will receive $13.65 in cash and 0.165 of Stone common stock for each share of Bois d'Arc. Comstock will receive $440 million in cash and 5317,069 shares of the common stock of Stone for its stake in Bois d'Arc using the average market value of Stone's stock during July.

The shares of Stone that Comstock will receive have a value of $307 million making the total consideration paid to Comstar for our shares of Bois d'Arc approximately $747 million. We will recognize a gain of $358 million before income tax and $233 million after income taxes. That equates to a gain of $5.16 per share. The final gain that we recognize would be based on the closing market value of Stone stock on the day the merger closes. The cash portion of the sales will create a current tax liability of $150 million for Comstock. We plan to use the after-tax cash proceeds of $290 million initially to reduce debt and ultimately for onshore acquisitions and increased onshore drilling activity.

Completion of the transaction is subject to approval by the Bois d'Arc Energy and Stone stockholders at special meetings of their respected stockholders to be held on August 27 of 2008. We have entered into a stockholder agreement with Stone, in which we have agreed to vote in favor of the merger.

Slide 24, the 2008 outlook. Really in summary, the company is extremely well positioned right now 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 to continue our growth into 2009. We now expect to spend $410 million on our onshore drilling program with the increased spending in our East Texas/North Louisiana region.

As Roland said, we are targeting to have 25% to 30% onshore production growth in 2008 and are on track with two excellent quarters so far this year. Our position in the emerging Haynesville shale play exposes those to somewhere between 2.2 trillion cubic feet and 2.5 trillion cubic feet of potential reserves. Unlike many of our peers, our substantial non-hedge production provides us exposure to our cash flow and earnings in the current strong oil and gas price environment as opposed to having to explain away a large loss created by derivative trading activities like investors are hearing about this quarter.

The hedges we do here were carefully constructed to qualify for hedge accounting, unlike much of the trading activities that many of our peers have engaged in. And lastly, our upcoming divestitures of our stake in Bois d'Arc Energy and, to a lesser extent, the non-core properties provides us an extremely strong balance sheet that will allow us to aggressively support the continued growth of our onshore operations, which is increasingly important given the tight credit environment that we are all faced in.

We have not had to delude our stockholders with numerous equity or convertible offerings like many of our peers in the Haynesville play. We think that’s an important element to Comstock. As we approach the closing of the Bois d'Arc merger, we look forward to continuing to add shareholder value by being able to focus our growth exclusively onshore.

I will now open the meeting up for questions, Latisha.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Wayne Andrews from Raymond James. Please proceed.

Wayne Andrews – Raymond James

Thank you. And good morning, gentlemen, congratulations on a nice quarter.

Jay Allison

Thank you, Wayne.

Wayne Andrews – Raymond James

Yes. I have a couple of questions for you. The first relates to the timing of your Cotton Valley wells. I mean, those are two very significant wells you announced in the quarter, excellent volumes at, what, 8 million and 10 million a day. And maybe, Roland, you can tell us a little bit on how long they were on in the second quarter so we can get a feel for their contribution to the quarter and what to expect next quarter?

Mack Good

Wayne, this is Mack. The well that came on at 10 million a day has been on for about two weeks. So it really didn’t contribute significantly to the second quarter average. We are drilling a third horizontal well in Woodlawn [ph] Fields now and we expect to get that flowing to sales this quarter. And our current plan is to drill three more horizontal wells for Cotton Valley targets throughout the year.

Wayne Andrews – Raymond James

Very good that if you have continued success like that, it should have a significant impact. Next question just kind of revolves around the Haynesville shale expansion of acreage. Now, has any – I know you’ve started out with some pretty conservative estimates of what portion of your acreage might have Haynesville potential and it’s expanded. Can you elaborate on if any of that expansion was related to just the outline of the play moving and then versus how much was actually acquired as far as additional acreage?

Mack Good

Wayne, we haven’t moved our play boundary significantly, although it has moved certainly. The acreage that we acquired recently has nothing to do with our legacy acreage. And you are right, there may in fact be some legacy acreage that we are not counting, especially on the west side just based on how we’ve mapped it. But the additional acreage that we’ve acquired is non-legacy acreage and it’s in Louisiana.

Wayne Andrews – Raymond James

Well, that certainly sounds encouraging. And can you mention – obviously I’m sure it’s a pretty difficult environment to try to acquire acreage, and what makes you think you’re going to be able to continue to compete in that area if the dollars continue to ramp up?

Mack Good

You’re right again. I mean, the competition is fierce, especially for core acreage. I think the competitive advantage we have is that we have rigs that are available to joint venture with certain groups. We have a number of offers that we are considering to do that. And we are not in a position where we are facing a clock issue with a lot of our leases unlike some others. So we are in a fairly enviable position as far as being able to negotiate with some of these other entities as far as partnering.

Jay Allison

Wayne, one thing. As you know, I mean, over 17 years we’ve got a great network and reputation in East Texas/North Louisiana. We’ve had a lot of smaller companies that have come and said, we’d still like to own some of our mineral rights, can we drill some wells with you. I mean, we’ve got an inventory of – kind of transactions like that that we’ve looked at. We do have a lot of people calling and then have 400 acres or 1,000 acres, maybe even 10,000 acres, and we continue to look at those tracks. Usually those are all on a bid basis and the company that pays the most gets the acreage. We’ve been pretty disciplined on the royalties. I mean, most of the royalties are a quarter or less. We think 30% royalties is too much. So we do have some guidelines there, and even with those guidelines we’ve two things. One, we had gone from 50,000 net acres to 65,000 net acres. And I think we’ve done that with discipline. We’ve done that with free cash flow or from properties that we’ve sold. So that’s one of the important kind of bullet points at Comstock. We have not deluded the potential return of the Haynesville, much less the Cotton Valley Taylor [ph] return by either issuing some kind of convertible instrument or by issuing equity. And I think at the bottom line we can create more shareholder value by staying disciplined like that. And we do think that we can acquire another 10,000 acres between now and year-end or we wouldn’t state that, which is – it’s unusual for us to even give a goal like that, as you know, you’ve known us for 13 years or so. So we’re pretty confident we can do that within our parameters of what we think is acceptable.

Wayne Andrews – Raymond James

Very good. Well, that's one of the benefits of having operated there for so long. Thanks. I’ll let some others ask questions.

Jay Allison

Thank you, Wayne.

Operator

Our next question comes from the line of Kim Pacanovsky from Collins Stewart. Please proceed.

Jay Allison

Hi, Kim.

Kim Pacanovsky – Collins Stewart

Hi there, good morning. Sorry about that. Hi, Jay, how are you?

Jay Allison

I’m good.

Kim Pacanovsky – Collins Stewart

Good. Okay. Couple questions here. First of all, where – what parishes in Louisiana did you acquire that additional acreage in?

Jay Allison

That would be Caddo and Bossier Parish.

Kim Pacanovsky – Collins Stewart

Okay. And Mack, I’m just curious as how you came up with your first location for your horizontal and Toledo North, and if you just kind of go through the process of why you picked this location.

Mack Good

Sure. The geological correlations gave us a real good idea of the Haynesville thickness that we were targeting and the porosity [ph] developments within that thickness. We also have about a 12,000-acre block that this first well will provide good tests, by no means going to test the whole block, but it was a good place to get started. Almost within 45 to 60 days from now, we’re going to be moving into Logansport in drilling our first Haynesville horizontal there.

Kim Pacanovsky – Collins Stewart

Okay. And you said nine wells total for the year between the Cotton Valley Taylor and the Haynesville. So if I do the math right, is that just two Haynesville wells to be drilled in ’08? Is that correct?

Mack Good

No. We’re going to be spudding six actually. We’re going to TD and start completion on four of those six horizontals.

Jay Allison

I think the two would be what we consider would be completed this year.

Mack Good

Right.

Jay Allison

Completed in producing (inaudible) process at year-end.

Kim Pacanovsky – Collins Stewart

Okay, all right. That makes sense. Okay. And if I – have you heard anything new on Shell and BP’s activity in Toledo South?

Mack Good

Yes. Shell has drilled a very nice well to the east and slightly north of our Toledo Bin North acreage block. It’s kind of in between our north and south blocks. And it really supports that region. In Canada, of course, over in Red River Parish announced a very nice well, plus 10 million a day type rate. So, the data is supporting our play boundary outlines, which we like.

Kim Pacanovsky – Collins Stewart

Okay. And if we could just shift over to the Cotton Valley horizontals, you show about eight other locations on your Waskom map in your presentation. Are you going to drill those locations up before you head out of Waskom, and what’s the average interest in those locations?

Mack Good

We’re not going to drill those up before we move out of Waskom with the rig. We are staggering our drilling opportunities there. We plan to drill four in a row.

Kim Pacanovsky – Collins Stewart

Okay. In Waskom?

Mack Good

In Waskom. After we get through with the current well that we are drilling, which is in Woodlawn. And the average interests in those wells, Kim, is about 80% to 100% working interest.

Kim Pacanovsky – Collins Stewart

Okay, great. Thanks guys. Nice quarter.

Mack Good

Thank you.

Jay Allison

Thank you, Kim.

Operator

(Operator instructions) Our next question comes from the line of Ron Mills from Johnson Rice. Please proceed.

Ron Mills – Johnson Rice

Good morning guys.

Jay Allison

Hi, Ron.

Ron Mills – Johnson Rice

Just going back to Haynesville for a couple questions, Jay, you mentioned your lease expirations shouldn’t be an issue. Can you walk through – of your acreage, how much of it is held by production since you have such so much legacy acreage in the area versus how much is on a drilling clock, so to speak?

Mack Good

Ron, this is Mack. About 40% of our acreage is HBP and the remainder are three-year term leases.

Ron Mills – Johnson Rice

All right. And I know it’s been a hot topic with a lot of people in the play. I don’t know, Mack, this may be for you. Can you talk a little bit about takeaway capacity in the area and what Comstock is doing to secure takeaway capacity?

Mack Good

Sure. I can’t go into details about that because we are having negotiations at the moment with a number of purchasers and pipeline operators. But the bottom line to get to your question is certainly that’s something that we are addressing. The takeaway capacity currently is sufficient to handle the anticipated volumes that based on all of the public data from the various operators that are in the play, that we think would be hitting the pipes. But as the play very quickly ramps up and I’m going into – deep into next year, those volumes are obviously going to increase very quickly. So, a number of operators – pipeline operators are planning to loop their lines and lay new lines for the takeaway capacity, increasing their takeaway capacity. So, steps are underway to address that anticipated problem. We’re getting firm capacity, I can tell you that.

Ron Mills – Johnson Rice

Okay. And you talked about you have one rate now, you have second rate coming, I don’t know, probably October/November time frame. And you expect to – it sounds like average five rigs next year with a hope to exit at least seven in 2009. Do you have agreements on those rig deliveries or are you just hoping to line up the access of those rigs just looking at where you stand in that regard?

Mack Good

No, we’ve got contracts on those rigs, Ron. And we should exit this year with four operating and very quickly get to that fifth rig in the first quarter of next year. And then we’ll add rig six and seven moving deeper into the year. But we have all of them on contract.

Ron Mills – Johnson Rice

Okay. And with Hico Knowles being the other real big driver here in terms of onshore production, it looks like – can you talk about what your activity plans are there? I know the operator of a portion of it has been fairly aggressive with their activity in Hico Knowles. And any signs that Petrohawk’s activity will slow down in this play and what your plans are, given the high productivity of those wells?

Mack Good

Yes. We plan to drill an additional six wells in Hico Knowles. Petrohawk’s plans, of course, I hesitate to speak for them, but they have been running between two to four rigs for the majority of the year in the field. They have acquired additional acreage that we also had some interest in to the west. So they very may well move into that acreage next year. Ron, we have not heard what their plans are for next year. I think they will have – as our release indicates, we estimate 27 more locations are available between them and us, and a few of those of course will be drilled throughout the remainder of the year. And then how they plan to allocate their dollars next year given that their activity in the Haynesville, for example, I don’t know yet.

Ron Mills – Johnson Rice

And then lastly for you, Roland – and Jay, you can comment too – but your CapEx increased to $410 million versus the $278 million that you had originally budgeted. It looks like, using your growth targets and assuming the costs going forward remain in line with the second quarter that you should be more than funding that increased budget internally. Is that a fair assumption for my model?

Roland Burns

Ron, that’s a good assumption. We are at least projecting that we’ll have cash flow in excess of what that capital budget is going to require for the remainder of the year. And I think there is still some potential that we could increase the budget some more, especially based on opportunities we have to pick up acreage in Haynesville, because that's been one of the biggest components of the increase has been the acreage that we've acquired and then just additional cost of horizontal wells, which may have displaced some of the other wells that we are drilling.

Ron Mills – Johnson Rice

Do you know about how much of $135 million, $140 million increase is related to acreage versus drilling for Haynesville?

Roland Burns

I would say about $80 million of that increase is on the acreage side, Ron.

Ron Mills – Johnson Rice

All right. Well, congratulations guys. Thanks.

Jay Allison

Thank you, Ron.

Operator

Our next question comes from the line of Dan McSpirit from BMO Capital Markets. Please proceed.

Dan McSpirit – BMO Capital Markets

Thank you. Gentlemen, good morning.

Jay Allison

Hi, Dan.

Dan McSpirit – BMO Capital Markets

I recognize that it’s early innings in the Haynesville shale play and that you will find a distribution of possible values with respect to the recoveries per well and yet other operators are very comfortable with stating 6, 6.5 B per well recoveries. Yet you folks are holding to this title range of 3.5 to 4, 4 Bs. I don’t want to go so far as to say that 3.5 Bs could prove meaningless here over time, but why are you sticking to that range? Why be so conservative versus others?

Mack Good

Dan, I’ll address that quickly. We think that all of the data that we have in our shop more strongly supports 3.5 to 4 Bcf estimate than it does a 6 to 6.5 Bcf estimate. In order to get to the 6.5 Bcf estimate, you have to include an upper bench in Haynesville. And completing that upper bench mechanically and combining it with lower bench mechanically requires a certain completion approach that we think isn’t cost effective. So we are sticking to the 3.5 to 4 Bcf until we get some more data that we think supports a higher number. Now certainly using that upper bench has a basis. You can get to that higher number, but getting the recoveries is the question.

Jay Allison

One thing we do say, Dan, is like we were in New York and Boston about a month ago and had a bunch of meetings. We've always said that the company that maybe has spent the most and has the most information, hopefully has the most accurate numbers. So that is why we put in the presentation that these are our numbers, this is kind of our first blush look at it and the filing costs, of course, are less than $2. And if the kind of peer company numbers are correct, it will be even a more profitable play. So like Mack said, we independently came up with our own numbers and hopefully they are conservative but they are kind of what we're going to stick to right now.

Dan McSpirit – BMO Capital Markets

Got it. I appreciate the fact that these wells are – while they are economic at even at $8 gas believe it or not, but with respect to completing the upper bench what is involved there, could you help me understand I guess the mechanics of that?

Jay Allison

Sure Dan. As you know Haynesville shale is abnormally pressured. It has the higher port pressure. So in order to frac these wells the pump pressures required are quiet high and so in order to get the rate, the pump rate to create the appropriate fracture systems around the targeted shale interval you have got to go to these high pressures. In order to complete two benches you've got to be able to isolate, mechanically pressure isolate once lateral at the lower bench from the upper lateral so you can get an appropriate frac. We think that doing that mechanically is extremely difficult. It can be done but at a very high cost and so I think what is going to happen is it we're going to drill one well drill a lateral into the lower bench and drill a second well with that lateral into that upper bench and that is yet to be done to our knowledge. So that is why we take a more conservative approach to our reserve estimates because not a lot of data is available to us on the upper bench yet.

Operator

Our next question comes from the line of David Snow from Energy Equities, Inc. Please proceed.

David Snow – Energy Equities, Inc.

Yes, hi. I would like to go back to the – those $8 and $10 million a day Cotton Valley wells what acre is facing those horizontal, would that be 80 acres or?

Jay Allison

Yes.

David Snow – Energy Equities, Inc.

And how much of the – you have about 2,000 acres of Cotton Valley, is that right?

Jay Allison

Actually across several fields we have considerably more than that. I can't give you an exact number, but in Waskom we have about that.

David Snow – Energy Equities, Inc.

That was from when you were at the New York IPAA, and it has probably increased as a function of more acreage or that wasn't the full amount that you specified then?

Roland Burns

Yes, we said – we have over 200,000 net acres in this region and all of that his Cotton Valley you know because they – but what you think as Cotton Valley.

Mack Good

We have – I haven't got a total but we have several thousands of acres that have been identified for the horizontal drilling program?

David Snow – Energy Equities, Inc.

Is there any reason that it would be several thousands rather than the whole shooting match?

Jay Allison

Yes, because the targeted section in the Cotton Valley is called the Cotton Valley C interval and it is continuous and bounded by some shale barriers that contain the frac heights growth and you don't find that throughout the entire area.

David Snow – Energy Equities, Inc.

Okay. So the rest of it is done on 20 to 40-acre vertical spacings.

Jay Allison

Yes.

David Snow – Energy Equities, Inc.

And your average recovery on those would be more on the range of 1.3 gross or something like that or how would you–?

Jay Allison

1 to 1.5 (inaudible).

David Snow – Energy Equities, Inc.

And what would be the average of the spacing on that?

Jay Allison

On the verticals?

David Snow – Energy Equities, Inc.

Yes.

Jay Allison

Probably 40 to 60 acres.

David Snow – Energy Equities, Inc.

Okay, all right. And then in your Haynesville, are you in the deeper part of the play, it sounds like you are?

Jay Allison

Actually we're in a shallower portion as well in Northern DeSoto and in Caddo, but we have some deeper acreage positions as you go further – as you probably already know, as we go further south it does deepen, and we have some nice blocks there, and that is just parenthetically that is where Shell and EnCana have drilled some very nice wells in that deeper section. And as you go deeper your pressure also increases in the Haynesville.

David Snow – Energy Equities, Inc.

Your first well is going to be in the south or in the northern end?

Jay Allison

We are going to be in the south end of our acreage block.

David Snow – Energy Equities, Inc.

Do you have – can you give us some idea what the porosity is?

Jay Allison

We're seeing anywhere from 14% to 18%.

David Snow – Energy Equities, Inc.

Okay. Well, it sounds like as a conventional porosity almost.

Jay Allison

Yes, but it is trapped in a shale. That is what makes it very interesting.

David Snow – Energy Equities, Inc.

How much of the – what is the in plays reserves per section resource per section on these two benches that you are looking at?

Jay Allison

Well it depends on how you want to calculate that. We think it could get up to 160 to 200 days per section and what recovery factor you want to apply to it. That it the big question mark – that everyone is focused on right now. I think everybody gets to the – pretty close to the same in place gross numbers what you think you can recover.

David Snow – Energy Equities, Inc.

And that 160 to 200 is for both ventures or what portion of the section is included?

Jay Allison

Well the lower bench is probably about 120 days of that.

David Snow – Energy Equities, Inc.

And the rest is upper bench.

Jay Allison

Yes.

David Snow – Energy Equities, Inc.

Okay, wonderful. Thank you very much.

Jay Allison

You are welcome.

Roland Burns

Thank you.

Operator

Our next question is a follow up question from Ron Mills from Johnson Rice.

Please proceed.

Ron Mills – Johnson Rice

Hi, Mack. You said on the porosity that you threw out there, is that what are seeing in the 6 vertical wells that you have drilled?

Mack Good

Yes.

Ron Mills – Johnson Rice

And where – can you give us an idea as to where those six vertical wells were drilled in terms of Toledo North versus Logansport?

Mack Good

We drilled in Logansport and we drilled in Waskom and we have drilled in Woodlawn. We have other data from other wells to the South.

Ron Mills – Johnson Rice

Okay, and then – well then one question for you, in terms of the operating costs and the DD&A and G&A, is the second quarter a good proxy as to how things should look for the remainder of the year?

Jay Allison

Yes, I think the second quarter Ron, is a good proxy other than maybe production taxes may not be quite as high as gas prices are lower in the third or fourth quarter than they were in the second, but otherwise the cost structure now that they've got it separated between the – with the onshore continuing operations kind of separated, it's a good proxy for how we look.

Ron Mills – Johnson Rice

And then your gas prices being roughly Henry hub despite your activity be in South Texas and East Texas/North Louisiana. Is that a function of the BTU content?

Jay Allison

The BTU content typically has been pretty strong and then they you have got really strong prices in the North Louisiana area on top of that and – but overall we have been averaging very close to Henry hub, sometimes a slight discount to that number.

Ron Mills – Johnson Rice

Great, and then you're hedging, do you still only have the $17 million a day you hedged related to this shell acquisition?

Mark Good

Right. And that acquisition runs through the end of 2009. It is about roughly 12% of the production.

Ron Mills – Johnson Rice

All right, thank you.

Operator

Our next question comes from the line of Matt McGeary from Sentinel Asset Management. Please proceed.

Matt McGeary – Sentinel Asset Management

Good morning, guys. I will say if the current shareholder I do commend you generating all this nice growth and outlook within your cash flow internal estimates. Most of my questions have been answered, I am just curious Jay maybe sort of conceptually given what has happened to the E&P sector, the stock market anyway. At some point does it make sense to use some of your cash to buy back some of your own stock. You know, even with all the nice certain growth avenues you have in front for you?

Jay Allison

Yes, absolutely I think it does. If you look at the company just [ph] as you get through this one-hour conference call, I know the sector hasn't been trading well for maybe a month, but we did report an exceptional quarter, it is the highest quarterly profit in our corporate history $83 million. As Roland had said early we didn't have a mark-to-market issue or derivative issue. We didn't have to explain some kind of mythical loss, remember we had $83 million in profits and for a company our size that is pretty phenomenal. Then going back to your statements, in other words, did we feel comfortable in purchasing stock? Well, let us look at the underlying foundation of the company, East Texas/North Louisiana we've increased our budget maybe $130 or $135 million this year, a lot of that is in East Texas/North Louisiana probably as Roland said 80%, 90% of it and then you say well what about the quality of our wells. We drilled 52, we’ve hit 52, and the IP rates have almost doubled. We were at $2.6 million a day this year. Last year for the year we averaged $1.4 million. So, we are very comfortable with our exposure in East Texas/North Louisiana. We have added another 15,000 net acres and we didn't press releases to tout it. We kind of went under the radar to do it and we kept our discipline. At the same time, we didn't issue equity to everybody to pay for it, because we don't have to. Quite frankly, before we even sold Bois d'Arc and I hope that occurs on the 28th, we were able to create our own internal cash flow because we haven't been hedged and we did these net profits and we reduced our cap, our debt to cap to 36% and hopefully on the 28th, which is not many days from now, we will be at a 17% debt-to-cap, and we are in a very tight credit market, and when you look at our availability we will almost have no commercial bank debt. We will have, I think, a $590 million credit facility and we might have $560 million of availability, which again that goes back to the question of if the stock drop, should we buy shares back? And I think the answer is yes. Do we need those dollars in order to grow our production? I think that we have got this 25% to 30% onshore production growth. I mean, we are well ahead of that. I think we can deliver on that. The question is do we need to issue any equity in order to hit our numbers and to grow? No, we don't have to and we don't even have to do a convertible offering. We have got to turn [ph] the money. It is nice to be able to create shareholder value the old fashioned way and that is instead of issuing equity to buy things, we actually created a company called Bois d'Arc, hopefully it sells on the 28th of this month and we made almost $800 million and you take those dollars and you put it back in to creating shareholder value and I think the one thing that that no one has asked a question on, we thought someone would, it is how about the future of South Texas? I mean, we closed Fandango last year with Shell. I think it added a dollar to cash flow, $0.12 or $0.13 per earnings at a $7 gas price for a 12-month cycle. It was just one sentence, but we said we are going to spud our first well probably in the next 30 days or so and we think that well has free potential sands to add about 30 Bcfe reserves. Well, we are going to produce about 55 Bcfe or so this year. That is a pretty big well that maybe we should focus on a little bit, but we will be a company that is exclusively onshore. So, all those things tell me that I am very comfortable with the treasures that Comstock has. I don't think we have much trash within all the treasures, and we believe that is a management group which is Mack, and Blaine, and Gary, Rol, and me and Mark and you name them, it is the Comstock people. If we believe that and I think we should take a look at buying stock back. Hopefully, it will rebound and go back up, but if it doesn't you know we are in a position where were could do that. That is a long answer, but I am very compassionate about that.

Matt McGeary – Sentinel Asset Management

I appreciate that. Thanks and good job guys.

Jay Allison

Latisha, is that it? It is an hour or so.

Operator

At this time, we are running out of time. I will like to turn the call back over to Jay Allison.

Jay Allison

All right again, I want to thank all of you for especially hanging on to the call to the very end. I know that this sector is not trading very well; there is nothing we could do about that. We did plan on delivering good results and if we don’t it won’t be because we didn’t try. So, thank you again for all the questions. They were good questions and for the support that we have had and continue to receive from each one of you. Thank you.

Operator

Thanks for your participation in today’s conference. This concludes the presentation, you may now disconnect.

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Source: Comstock Resources, Inc. Q2 2008 Earnings Call Transcript
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