UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

ý		Quarterly Report Pursuant To Section 13 or 15(d) of the Securities Exchange Act of 1934
o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Quarterly Period ended September 30, 2004

Commission File No. 001-31446

 

CIMAREX ENERGY CO.

1700 Lincoln Street, Suite 1800

Denver, Colorado 80203-4518

(303) 295-3995

 

Incorporated in the		Employer Identification
State of Delaware		No. 45-0466694

 

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  ý   No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes  ý    No  o

 

The number of shares Cimarex Energy Co. common stock outstanding as of September 30, 2004 was 41,600,675.

 

 

CIMAREX ENERGY CO.

 

Table of Contents

 

PART I
Item 1 – Financial Statements
Consolidated balance sheets (unaudited) as of September 30, 2004 and December 31, 2003
Consolidated statements of operations (unaudited) for the three and nine months ended September 30, 2004 and 2003
Consolidated statements of cash flows (unaudited) for the nine months ended September 30, 2004 and 2003
Consolidated statement of stockholders’ equity (unaudited) for the nine months ended September 30, 2004
Notes to consolidated financial statements
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3 – Qualitative and Quantitative Disclosures About Market Risk
Item 4 – Controls and Procedures
PART II
Item 6 – Exhibits and Reports on Form 8-K

 

In this report, we use terms to discuss oil and gas producing activities as defined in Rule 4-10(a) of Regulation S-X. We express quantities of natural gas in terms of thousand cubic feet (Mcf), million cubic feet (MMcf) or billion cubic feet (Bcf). Oil is quantified in terms of barrels (Bbls), thousands of barrels (MBbls) and millions of barrels (MMBbls). Oil is compared to natural gas in terms of equivalent thousand cubic feet (Mcfe) or equivalent million cubic feet (MMcfe). One barrel of oil is the energy equivalent of six Mcf of natural gas. Information relating to our working interest in wells or acreage, “net” oil and gas wells or acreage is determined by multiplying gross wells or acreage by our working interest therein. Unless otherwise specified, all references to wells and acres are gross.

 

2

 

PART I

 

ITEM 1 — Financial Statements

 

CIMAREX ENERGY CO.

Consolidated Balance Sheets

(Unaudited)

 

		September 30, 2004			December 31, 2003
		(In thousands, except share data)
Assets
Current assets:
Cash and cash equivalents		$	92,197		$	40,420
Receivables, net		81,215			68,293
Inventories		11,322			6,700
Deferred income taxes		1,557			1,631
Other current assets		3,985			6,160
Total current assets		190,276			123,204
Oil and gas properties at cost, using the full cost method of accounting:
Proved properties		1,510,448			1,331,095
Unproved properties and properties under development, not being amortized		70,686			39,370
		1,581,134			1,370,465
Less – accumulated depreciation, depletion and amortization		(832,935		)	(746,161		)
Net oil and gas properties		748,199			624,304
Fixed assets, net		15,934			12,092
Goodwill		44,967			44,967
Other assets, net		2,565			941
		$	1,001,941		$	805,508
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	25,582		$	18,394
Accrued liabilities		62,199			48,339
Revenue payable		33,013			18,776
Total current liabilities		120,794			85,509
Deferred income taxes		194,774			155,293
Other liabilities		35,457			29,966
Stockholders’ equity:
Preferred stock, $0.01 par value, 15,000,000 shares authorized, no shares issued		—			—
Common stock, $0.01 par value, 100,000,000 shares authorized, 41,600,675 and 41,063,653 shares issued and outstanding, respectively		416			411
Paid-in capital		247,685			237,430
Unearned compensation		(9,141		)	(9,540		)
Retained earnings		411,956			306,439
		650,916			534,740
		$	1,001,941		$	805,508

 

See accompanying notes to consolidated financial statements.

 

3

 

CIMAREX ENERGY CO.

Consolidated Statements of Operations

(Unaudited)

 

		For the Three Months Ended September 30,						For the Nine Months Ended September 30,
		2004			2003			2004			2003
		(In thousands, except per share data)
Revenues:
Gas sales		$	91,333		$	61,999		$	256,529		$	192,559
Oil sales		28,299			17,773			73,927			54,471
Marketing sales		49,329			32,822			139,921			101,459
Other, net		1,312			168			6,008			102
		170,273			112,762			476,385			348,591
Costs and expenses:
Depreciation, depletion and amortization		32,048			22,672			89,220			64,676
Asset retirement obligation accretion		319			241			913			737
Production		8,648			8,364			27,536			23,507
Transportation		2,696			2,055			7,544			5,210
Taxes other than income		9,736			6,131			27,565			19,449
Marketing purchases		48,495			32,786			138,081			100,884
General and administrative		5,398			4,181			15,040			12,320
Stock compensation		502			448			1,454			1,350
Financing costs -
Interest expense		290			302			866			998
Capitalized interest		—			—			—			(304		)
Interest income		(232		)	(123		)	(421		)	(205		)
		107,900			77,057			307,798			228,622
Income before income tax expense and cumulative effect of a change in accounting principle		62,373			35,705			168,587			119,969
Income tax expense		23,191			13,164			63,070			45,245
Income before cumulative effect of a change in accounting principle		39,182			22,541			105,517			74,724
Cumulative effect of a change in accounting principle, net of tax		—			—			—			1,605
Net income		$	39,182		$	22,541		$	105,517		$	76,329
Earnings per share:
Basic -
Income before cumulative effect of a change in accounting principle		$	0.94		$	0.54		$	2.55		$	1.80
Cumulative effect of a change in accounting principle, net of tax		—			—			—			0.04
Net income		$	0.94		$	0.54		$	2.55		$	1.84
Diluted -
Income before cumulative effect of a change in accounting principle		$	0.91		0.53			2.47			1.77
Cumulative effect of a change in accounting principle, net of tax		—			—			—			0.04
Net income		$	0.91		$	0.53		$	2.47		$	1.81
Weighted average basic shares outstanding		41,511			41,612			41,399			41,545
Weighted average diluted shares outstanding		42,885			42,297			42,687			42,195

 

See accompanying notes to consolidated financial statements.

 

4

 

CIMAREX ENERGY CO.

Consolidated Statements of Cash Flows

(Unaudited)

 

		For the Nine Months Ended September 30,
		2004			2003
		(In thousands)
Cash flows from operating activities:
Net income		$	105,517		$	76,329
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation, depletion and amortization		89,220			64,676
Amortization of restricted stock compensation		1,454			1,416
Cumulative effect of a change in accounting principle, net of taxes		—			(1,605		)
Deferred income taxes		42,899			24,137
Asset retirement obligation accretion		913			737
Income tax benefit related to stock options exercised		3,345			561
Other		59			236
Changes in operating assets and liabilities:
(Increase) decrease in receivables, net		(12,922		)	1,621
Increase in inventories		(4,622		)	(2,758		)
(Increase) decrease in other current assets		2,175			(615		)
Increase (decrease) in accounts payable		21,425			(5,740		)
Increase in accrued liabilities		7,658			12,308
Increase (decrease) in other non-current liabilities		1,330			(143		)
Net cash provided by operating activities		258,451			171,160
Cash flows from investing activities:
Oil and gas expenditures		(205,925		)	(97,896		)
Acquisition of proved oil and gas properties		(102		)	(2,531		)
Proceeds from sale of assets		766			231
Other expenditures		(8,078		)	(6,691		)
Net cash used by investing activities		(213,339		)	(106,887		)
Cash flows from financing activities:
Payments on long-term debt		—			(32,000		)
Common stock reacquired and retired		(714		)	(8		)
Proceeds from issuance of common stock		7,379			2,266
Net cash provided by (used in) financing activities		6,665			(29,742		)
Net increase in cash and cash equivalents		51,777			34,531
Cash and cash equivalents at beginning of period		40,420			22,327
Cash and cash equivalents at end of period		$	92,197		$	56,858

 

See accompanying notes to consolidated financial statements.

 

5

 

CIMAREX ENERGY CO.

Consolidated Statement of Stockholders’ Equity

For the Nine Months Ended September 30, 2004

(Unaudited)

 

							Paid-in Capital			Unearned Compensation				Retained Earnings				Total Shareholders’ Equity
		Common Stock
		Shares		Amount
							(In thousands)
Balance, December 31, 2003		41,064		$	411		$	237,430		$	(9,540		)	$		306,439		$	534,740
Net income														105,517				105,517
Issuance of restricted stock awards		15		—			400			(400			)	—				—
Issuance of restricted stock units awards		—		—			—			(1,142			)	—				(1,142		)
Common stock reacquired and retired		(22	)	—			(714		)	—				—				(714		)
Shares of restricted stock  exchanged for restricted stock units		(5	)	—			(150		)	—				—				(150		)
Amortization of unearned compensation		—		—			—			1,941				—				1,941
Exercise of stock options		549		5			7,374			—				—				7,379
Tax benefit related to stock options  exercised		—		—			3,345			—				—				3,345
Balance, September 30, 2004		41,601		$	416		$	247,685		$		(9,141	)	$	411,956			650,916

 

See accompanying notes to consolidated financial statements.

 

6

 

CIMAREX ENERGY CO.

Notes to Consolidated Financial Statements

September 30, 2004

(Unaudited)

 

1.                                      Basis of Presentation

 

The accompanying financial statements are unaudited and were prepared from the records of Cimarex Energy Co. (Cimarex or the Company).  We believe these financial statements include all adjustments necessary for a fair presentation of our financial position and results of operations.  We prepared these statements on a basis consistent with the annual audited statements and Regulation S-X. Regulation S-X allows us to omit some of the footnote and policy disclosures required by accounting principles generally accepted in the United States of America and normally included in annual reports on Form 10-K.  These interim financial statements should be read in conjunction with the financial statements and notes in our Annual Report on Form 10-K for the year ended December 31, 2003.

 

Cimarex was formed in February 2002 as a wholly-owned subsidiary of Helmerich & Payne, Inc. (H&P).  As a result of a dividend declared and paid by H&P on September 30, 2002, in the form of Cimarex common stock, Cimarex was spun-off and became a stand-alone company.  Also on September 30, 2002, Cimarex acquired 100 percent of the outstanding common stock of Key Production Company, Inc. (Key) in a tax-free exchange.

 

The accounts of Cimarex and its subsidiaries are presented in the accompanying consolidated financial statements.  All intercompany accounts and transactions were eliminated in consolidation.

 

We make certain estimates and assumptions to prepare our financial statements in conformity with accounting principles generally accepted in the United States of America.  Those estimates and assumptions affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period and in disclosures of commitments and contingencies.  Changes in facts and circumstances may result in revised estimates and actual results could differ from those estimates.

 

The more significant areas requiring the use of management’s estimates and judgments relate to preparation of estimated oil and gas reserves, the use of these oil and gas reserves in calculating depletion, depreciation and amortization, the use of the estimates of future net revenues in computing the ceiling test limitations and estimates of abandonment obligations used in such calculations and in recording asset retirement obligations.  Estimates and judgments are also required in determining the reserves for bad debts, the impairments of undeveloped properties, the assessment of goodwill and the valuation of deferred tax assets.

 

Certain amounts in the accompanying consolidated financial statements for prior periods have been reclassified to conform to the current year presentation.

 

2.                                      Stock Options

 

We apply Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees, and related interpretations to account for all stock option grants and grants of restricted stock.  No compensation cost has been recognized for stock options granted as the option prices are equal to the market price of the underlying common stock on the date of grant.

 

7

 

Statement of Financial Accounting Standard (SFAS) No. 123, Accounting for Stock Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, requires us to provide pro forma information regarding net income as if the compensation cost for our stock option plans had been determined in accordance with the fair value based method prescribed in SFAS No. 123.  In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.  To provide the required pro forma information, Cimarex estimated the theoretical fair value of each stock option at the grant date by using the Black Scholes option-pricing model.

 

Had compensation cost for the plan been determined based on the fair value at the grant dates for awards to employees under the plan, consistent with the methodology of SFAS No. 123, pro forma net income would have been as indicated below:

 

		Three Months Ended September 30,							Nine Months Ended September 30,
		2004				2003			2004			2003
Net income, as reported		$	39,182			$	22,541		$	105,517		76,329
Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(536			)	(592		)	(1,611		)	(1,775		)
Pro forma net income		$		38,646		21,949			$	103,906		$	74,554
Earnings per share:
Basic - as reported		$		0.94		0.54			$	2.55		$	1.84
Basic - pro forma		$		0.93		0.53			$	2.51		$	1.79
Diluted - as reported		$		0.91		0.53			$	2.47		$	1.81
Diluted - pro forma		$		0.90		0.52			2.43			1.77

 

These pro forma amounts may not be representative of future disclosures since the estimated fair value of stock options is amortized to expense over the vesting period and additional options may be granted in future years.

 

8

 

The following summary reflects the status of stock options granted to employees and directors as of September 30, 2004, and changes during the period:

 

		Options Outstanding		Weighted Average Exercise Price			Options Exercisable
Outstanding as of January 1, 2004		3,321,299		$	14.39
Exercised		(549,477	)	13.45
Granted		30,300		33.28
Outstanding as of September 30, 2004		2,802,122		$	14.78		1,450,874

 

The following table summarizes information about Cimarex stock options held by employees and directors at September 30, 2004:

 

		Outstanding Stock Options							Exercisable Stock Options
Range of Exercise Prices		Options		Weighted- Average Remaining Contractual Life		Weighted- Average Exercise Price			Options		Weighted- Average Exercise Price
$ 6.11 to $8.14		147,017		4.0 Years		$	7.84		147,017		$	7.84
$ 8.15 to $10.17		77,500		4.9 Years		9.69			77,500		9.69
$ 10.18 to $12.21		462,068		3.4 Years		11.51			462,068		11.51
$ 12.22 to $14.25		461,968		6.7 Years		13.80			262,124		13.63
$ 14.26 to $16.28		306,158		6.2 Years		15.20			201,982		15.20
$ 16.29 to $18.32		1,268,111		8.1 Years		16.71			270,383		16.83
$ 18.33 to $20.36		49,000		7.7 Years		19.54			29,800		19.02
$ 20.37 to $33.28		30,300		10.0 Years		33.28			—		—

 

3.                                      Asset Retirement Obligations

 

On January 1, 2003, we adopted SFAS No. 143, Accounting for Asset Retirement Obligations.  This Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs.  The Statement requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made, and that the associated asset retirement costs be capitalized as part of the carrying amount of the long-lived asset.  Oil and gas producing companies incur this liability upon acquiring or drilling a well.

 

9

 

The adoption of the Statement resulted in our recording income reported as a cumulative effect of a change in accounting principle of approximately $1.6 million net of income taxes of $1.0 million.

 

The following table reflects the components of the change in the carrying amount of the asset retirement obligation for the nine months ended September 30, 2004 (in thousands):

 

Balance as of January 1, 2004		$	16,463
Liabilities incurred in the current period		1,957
Liabilities settled in the current period		—
Accretion expense		913
Balance as of September 30, 2004		$	19,333

 

4.                                      Long-Term Debt

 

At September 30, 2004, we had no debt outstanding.  We have the capability to borrow on our Senior Secured Revolving Credit Facility led by Bank One, N.A.  At September 30, 2004, the Facility had a borrowing base of $275 million and commitments from our lenders totaling $200 million.  The borrowing base is subject to redetermination each April and October.

 

Borrowings under this Facility bore interest at a LIBOR rate plus 1.25 to 2.00 percent, based on borrowing base usage.  Unused borrowings were subject to a commitment fee of 0.375 to 0.50 percent, also depending on the borrowing base usage.

 

The Credit Facility is secured by mortgages on certain of our oil and gas properties and the stock of our operating subsidiaries.  We are also subject to customary financial and non-financial covenants and are in compliance with those covenants.  The term of the Credit Facility was to expire in October 2005.

 

On October 1, 2004 the Facility has been amended with substantially the same terms.  The amendment maintains a $200 million commitment amount; however it increases the borrowing base from $275 million to $300 million.  Also, the amendment extends the term to October 2009 and does not require any additional mortgages unless outstanding borrowings exceed 50 percent of the borrowing base.  Borrowings under the amended facility bear interest at a LIBOR rate plus 1.125 percent to 1.75 percent, based on borrowing base usage.  Unused borrowings under the amendment are subject to a commitment fee of 0.25 percent to 0.50 percent, also depending on borrowing base usage.

 

10

 

5.                                      Income Taxes

Federal income tax expense for the three and nine months ended September 30, 2004 and 2003 differ from the amounts that would be provided by applying the U.S. Federal income tax rate due to the effect of state income taxes and percentage depletion.

 

The components of the provision for income taxes are as follows (in thousands):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
Current taxes		$	7,591		$	6,754		$	20,171		$	21,108
Deferred taxes		15,600			6,410			42,899			24,137
		$	23,191		$	13,164		$	63,070		$	45,245

 

6.                          Supplemental Disclosure of Cash Flow Information (in thousands):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
Cash paid during the period for:
Interest (net of amounts capitalized)		$	239		$	184		$	714		$	591
Income taxes (net of refunds received)		$	3,820		$	9,958		$	16,872		$	14,733

 

11

 

7.                                      Earnings Per Share

 

The calculations of basic and diluted net earnings per common share are presented below:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
		(in thousands, except per share data)
Income before cumulative effect of a change in accounting principle		$	39,182		$	22,541		$	105,517		$	74,724
Cumulative effect of a change in accounting principle		—			—			—			1,605
Net income available to common stockholders for basic and diluted		$	39,182		$	22,541		$	105,517		$	76,329
Basic weighted-average shares outstanding		41,511			41,612			41,399			41,545
Incremental shares from assumed exercise of stock options and vesting of restricted stock units		1,374			685			1,288			650
Diluted weighted-average shares outstanding		42,885			42,297			42,687			42,195
Basic:
Before cumulative effect of a change in accounting principle		$	0.94		$	0.54		$	2.55		$	1.80
Cumulative effect of a change in accounting principle		—			—			—			0.04
Earnings per share		$	0.94		$	0.54		$	2.55		$	1.84
Diluted:
Before cumulative effect of a change in accounting principle		$	0.91		$	0.53		$	2.47		$	1.77
Cumulative effect of a change in accounting principle		—			—			—			0.04
Earnings per share		$	0.91		$	0.53		$	2.47		$	1.81

 

There were stock options outstanding for 2,802,122 and 3,427,705 shares of Cimarex common stock at September 30, 2004 and 2003, respectively.  All stock options were considered potentially dilutive securities for the three and nine months ended September 30, 2004 and 2003.

 

12

 

8.                                      Segment Information

 

Cimarex operates in the oil and gas industry, and is comprised of an exploration and production segment and a natural gas marketing segment.  Exploration and production activities are located primarily in Oklahoma, Kansas, Texas, Louisiana and California.  We have a wholly owned subsidiary, Cimarex Energy Services, Inc. (CESI) through which we conduct a majority of our gas marketing activity.  Information presented for our natural gas marketing segment represents business conducted with third parties, usually incidental to sales of our own production.

 

Summarized financial information of Cimarex’s reportable segments for the three and nine months ended September 30, 2004 and 2003 is shown in the following table:

 

		External Sales			Operating Profit Before Income Taxes			Depreciation, Depletion and Amortization			Total Assets			Additions to Long- Lived Assets
		(In thousands)
Three Months Ended September 30, 2004:
Exploration and Production		$	119,632		$	60,360		$	31,976		$	966,172		$	63,232
Natural Gas Marketing		49,329			759			72			35,769			97
Total		$	168,961		$	61,119		$	32,048		$	1,001,941		$	63,329
Three Months Ended September 30, 2003:
Exploration and Production		$	79,772		$	35,750		$	22,613		$	747,613		$	36,302
Natural Gas Marketing		32,822			(34		)	59			24,952			(101		)
Total		$	112,594		$	35,716		$	22,672		$	772,565		$	36,201
Nine Months Ended September 30, 2004:
Exploration and Production		$	330,456		$	161,418		$	89,025		$	966,172		$	216,473
Natural Gas Marketing		139,921			1,606			195			35,769			491
Total		$	470,377		$	163,024		$	89,220		$	1,001,941		$	216,964
Nine Months Ended September 30, 2003:
Exploration and Production		$	247,030		$	119,965		$	64,511		$	747,613		$	110,810
Natural Gas Marketing		101,459			391			165			24,952			177
Total		$	348,489		$	120,356		$	64,676		$	772,565		$	110,987

 

13

 

The following table reconciles segment operating profit per the above table to income before taxes as reported on the consolidated statements of operations (in thousands).

 

		ThreeMonthsEnded September 30,								NineMonthsEnded September 30,
		2004				2003				2004			2003
Segment operating profit, including depreciation, depletion and amortization		$	61,119			$	35,716			$	163,024		$	120,356
Unallocated amounts:
Other revenue		1,312				168				6,008			102
Interest expense, net		(58			)	(179			)	(445		)	(489		)
Income before income tax expense and cumulative effect of a change in accounting principle		$		62,373		$		35,705		$	168,587		$	119,969

 

9.                                      Commitments and Contingencies

 

Litigation

 

Cimarex is a defendant to certain claims relating to drainage of gas from two properties that it operates. The royalty owner plaintiffs have filed suit on behalf of themselves and a class of allegedly similar situated royalty owners in two 640-acre-spacing units. The plaintiffs allege that the two units have suffered approximately 20 Bcf of gross gas drainage. Cimarex denies that the drainage, if any, was in an amount that significant.  The plaintiffs have stated that the royalty owner class has sustained actual damages of approximately $20 million exclusive of interest and costs. We estimate that the share of such alleged damages attributable to our working interest ownership would total approximately $3.0 million exclusive of interests and costs. Plaintiffs further allege that, as a former operator, Cimarex is liable for all damages attributable to the drainage. We believe that our liability, if any, should not exceed our working interest share of any actual damages attributable to the alleged drainage.  In this regard, the court granted our request to assert third-party claims against all of the other working interest owners.  Our contention is that the other working interest owners should bear responsibility for their respective pro rata shares of damages, if any.  We cannot predict the outcome of this litigation, and accordingly, no accrual has been recorded in connection with this action.

 

Cimarex has other various litigation related matters in the normal course of business, none of which are material, individually or in aggregate.  We are also party to certain litigation as plaintiffs that could result in potential gains.  Net settlements of $3.5 million have been received in the first nine months of 2004 related to this type of litigation for which we were plaintiffs.  Such amounts were recorded as other income.  Any future potential gains are not deemed material at this time.

 

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Transportation and Gas Deliveries

 

We have one firm transportation contract to transport 10,000 MMBtus per day, at $0.09 per MMBtu through December 31, 2004.  We have a right to extend this contract annually.  The maximum amount that would be payable if deliveries are not made would be $83 thousand.

 

We have also guaranteed delivery of 8.1 Bcf of natural gas from 16 wells over a three-year period as reimbursement for connection costs to a pipeline.  If the minimum delivery is not met, our maximum exposure is approximately $0.6 million.  We have agreed to reimburse another gatherer for connection costs to its pipeline via delivery of 1 Bcf of natural gas per well or a prorated payment based on the total reserves on 26 wells.  The maximum amount that would be payable if no gas is delivered would be $0.9 million.

 

Additionally, we have firm sales contracts to deliver fixed volumes of gas based on an index price.  These contracts are typically one year in length.  As of September 30, 2004, we had an obligation to deliver approximately 0.3 Bcf of natural gas.  If this gas is not delivered our financial commitment would approximate $1.7 million based on index prices as of September 30, 2004.  This commitment will fluctuate due to price volatility and actual volumes delivered.  We believe no financial commitment will be due based on our proved reserves and current production levels.

 

Parental Guarantees

 

As of September 30, 2004, Cimarex had $10 million of parental guarantees outstanding.  These guarantee the credit of certain CESI agreements and are for the benefit of certain counterparties.

 

Drilling Commitments

 

The Company has contractual commitments on oil and gas wells approved for drilling or in the process of being drilled at September 30, 2004 of approximately $10.1 million. All of the noted commitments were routine and made in the normal course of our business.

 

Tax Sharing Agreement

 

On September 30, 2002, Cimarex entered into an agreement with H&P that imposes certain restrictions on Cimarex’s ability to redeem or issue a material number of shares of its common stock or to undergo a change of control.  These restrictions expire on October 1, 2004.  Such actions by Cimarex could cause the spin off of Cimarex by H&P to be deemed a taxable event, potentially resulting in a substantial amount of taxable income to H&P.  Under the terms of the agreement, if Cimarex takes or permits an action to be taken that causes the spin off to be taxable, Cimarex would generally be liable for all or a portion of the resultant tax liability.  It is expected that any such taxes allocated to Cimarex would be material.

 

Cimarex has also provided indemnification of H&P in connection with any future tax claims that may be made relating to the oil and gas exploration and production assets contributed to Cimarex by H&P.

 

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ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Throughout this Form 10-Q, we make statements that may be deemed “forward-looking” statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934.  These forward-looking statements include, among others, statements concerning Cimarex’s outlook with regard to timing and amount of future production of oil and gas, price realizations, amounts, nature and timing of capital expenditures for exploration and development, plans for funding operations and capital expenditures, drilling of wells, operating costs and other expenses, marketing of oil and gas and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts.  The forward-looking statements in this report are subject to risks and uncertainties that could cause actual results to differ materially from those expressed in or implied by the statements.

 

These risks and uncertainties include, but are not limited to, fluctuations in the price we receive for our oil and  gas production, reductions in the quantity of oil and gas sold due to decreased industry-wide demand and/or curtailments in production from specific properties due to mechanical, marketing or other problems, operating and capital expenditures that are either significantly higher or lower than anticipated because the actual cost of identified projects varied from original estimates and/or from the number of exploration and development opportunities being greater or fewer than currently anticipated, and increased financing costs due to a significant increase in interest rates. In addition, exploration and development opportunities pursued by Cimarex may not result in productive oil and gas properties.  There are also numerous uncertainties inherent in estimating quantities of proved reserves, projecting future rates of production and the timing of development expenditures.  These and other risks and uncertainties affecting Cimarex are discussed in greater detail in this report and in other filings by Cimarex with the Securities and Exchange Commission.

 

INTRODUCTION

 

Cimarex Energy Co. is an independent oil and gas exploration and production company.  Our primary focus is to explore for and discover new reserves.  To supplement our growth, from time to time we also consider acquisitions and mergers.  Our operations are presently focused in Oklahoma, Texas, Kansas, Louisiana and California.

 

Industry and Economic Factors

 

In managing our business, we must deal with many factors inherent in our industry.  First and foremost is wide fluctuation of oil and gas prices. Historically, oil and gas markets have been cyclical and volatile, with future price movements difficult to predict.  While our revenues are a function of both production and prices, it is wide swings in prices that have most often had the greatest impact on our results of operations.

 

Our operations entail significant complexities.  Advanced technologies requiring highly trained personnel are utilized in both exploration and production.  Even when the technology is properly used, the interpreter still may not know conclusively if hydrocarbons will be present or the rate at which they will be produced.  Exploration is a high-risk activity, often times resulting in no commercially productive reservoirs being discovered.  Moreover, costs associated with operating within the industry are substantial.

 

The oil and gas industry is highly competitive.  We compete with major and diversified energy companies, independent oil and gas businesses, and individual operators.  In addition, the industry as a whole competes with other businesses that supply energy to industrial and commercial end users.

 

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