Form 10-Q -- March 31, 2006
 


SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)

þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the Quarterly Period Ended March 31, 2006

OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the Transition Period from ____________to____________.
 
Commission File Number: 1-12534

NEWFIELD EXPLORATION COMPANY
(Exact name of Registrant as specified in its charter)

Delaware
72-1133047
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification Number)

363 North Sam Houston Parkway East
Suite 2020
Houston, Texas 77060
(Address and Zip Code of principal executive offices)

(281) 847-6000
(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 þ No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
            Large accelerated filer þ       Accelerated filer ¨     Non-accelerated filer ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
 
Yes ¨ No þ
 
As of April 27, 2006, there were 128,609,519 shares of the Registrant's Common Stock, par value $0.01 per share, outstanding.
 


 

 
TABLE OF CONTENTS


   
Page
PART I
     
Item 1.
Unaudited Financial Statements:
 
     
 
1
     
 
2
     
 
3
     
 
4
     
 
5
     
Item 2.
18
     
Item 3.
26
     
Item 4.
27
     
     
PART II
     
Item 1.
28
     
Item 2.
28
     
Item 6.
28

 

 

NEWFIELD EXPLORATION COMPANY
CONSOLIDATED BALANCE SHEET
(In millions, except share data)
(Unaudited)
 
 
   
March 31,
 
December 31,
 
   
2006
 
2005
 
ASSETS
Current assets:
             
Cash and cash equivalents 
 
$
41
 
$
39
 
Accounts receivable 
   
329
   
370
 
Inventories 
   
31
   
22
 
Derivative assets 
   
94
   
10
 
Deferred taxes 
   
26
   
46
 
Other current assets 
   
47
   
53
 
Total current assets 
   
568
   
540
 
Oil and gas properties (full cost method, of which $941 at March 31, 2006 and $901 at December 31, 2005
were excluded from amortization) 
   
7,433
   
7,042
 
Less—accumulated depreciation, depletion and amortization 
   
(2,760
)
 
(2,632
)
     
4,673
   
4,410
 
               
Furniture, fixtures and equipment, net 
   
20
   
20
 
Derivative assets 
   
8
   
17
 
Other assets 
   
22
   
23
 
Deferred taxes 
   
10
   
9
 
Goodwill 
   
62
   
62
 
Total assets 
 
$
5,363
 
$
5,081
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
             
Accounts payable 
 
$
53
 
$
41
 
Accrued liabilities 
   
457
   
454
 
Advances from joint owners 
   
39
   
29
 
Asset retirement obligation 
   
44
   
47
 
Derivative liabilities 
   
126
   
99
 
Total current liabilities 
   
719
   
670
 
               
Other liabilities 
   
22
   
21
 
Derivative liabilities 
   
236
   
209
 
Long-term debt 
   
868
   
870
 
Asset retirement obligation 
   
217
   
213
 
Deferred taxes 
   
772
   
720
 
Total long-term liabilities 
   
2,115
   
2,033
 
               
Commitments and contingencies (Note 5) 
   
   
 
               
Stockholders' equity:
             
Preferred stock ($0.01 par value; 5,000,000 shares authorized; no shares issued) 
   
   
 
Common stock ($0.01 par value; 200,000,000 shares authorized at March 31, 2006 and December 31, 2005; 130,459,329
and 129,356,162 shares issued and outstanding at March 31, 2006 and December 31, 2005, respectively) 
   
1
   
1
 
Additional paid-in capital 
   
1,159
   
1,186
 
Treasury stock (at cost; 1,876,310 and 1,815,594 shares at March 31, 2006 and December 31, 2005, respectively) 
   
(31
)
 
(27
)
Unearned compensation 
   
   
(34
)
Accumulated other comprehensive income (loss):              
Foreign currency translation adjustment
    (4    (4 
Commodity derivatives
      (41    (40 )
Retained earnings 
   
1,445
   
1,296
 
Total stockholders' equity 
   
2,529
   
2,378
 
Total liabilities and stockholders' equity 
 
$
5,363
 
$
5,081
 
 

The accompanying notes to consolidated financial statements are an integral part of this statement.

1

 

NEWFIELD EXPLORATION COMPANY
CONSOLIDATED STATEMENT OF INCOME
(In millions, except per share data)
(Unaudited)


   
Three Months Ended
March 31,
 
   
2006
 
2005
 
           
Oil and gas revenues 
 
$
431
 
$
413
 
               
Operating expenses:
             
Lease operating 
   
52
   
46
 
Production and other taxes 
   
16
   
11
 
Depreciation, depletion and amortization 
   
131
   
136
 
General and administrative 
   
30
   
23
 
Business interruption insurance benefit 
   
(30
)
 
 
Total operating expenses
   
199
   
216
 
               
Income from operations 
   
232
   
197
 
               
Other income (expenses):
             
Interest expense 
   
(18
)
 
(18
)
Capitalized interest 
   
12
   
12
 
Commodity derivative income (expense) 
   
6
   
(109
)
Other 
   
1
   
 
     
1
   
(115
)
               
Income before income taxes 
   
233
   
82
 
               
Income tax provision:
             
Current 
   
11
   
16
 
Deferred 
   
73
   
6
 
     
84
   
22
 
               
Net income
 
$
149
 
$
60
 
               
Earnings per share:
             
Basic 
 
$
1.18
 
$
0.48
 
Diluted 
 
$
1.17
 
$
0.47
 
               
Weighted average number of shares outstanding for basic earnings per share 
   
126
   
124
 
               
Weighted average number of shares outstanding for diluted earnings per share 
   
128
   
127
 


The accompanying notes to consolidated financial statements are an integral part of this statement.
 
2

 

NEWFIELD EXPLORATION COMPANY
CONSOLIDATED STATEMENT OF CASH FLOWS
(In millions)
(Unaudited)


   
Three Months Ended
March 31,
 
   
2006
 
2005
 
Cash flows from operating activities:
             
Net income 
 
$
149
 
$
60
 
               
Adjustments to reconcile net income to net cash provided by operating activities:
             
Depreciation, depletion and amortization 
   
131
   
136
 
Deferred taxes 
   
73
   
6
 
Stock-based compensation 
   
7
   
1
 
Unrealized commodity derivative (income) expense 
   
(8
)
 
107
 
               
Changes in operating assets and liabilities:
             
Decrease in accounts receivable 
   
41
   
3
 
Increase in inventories 
   
(7
)
 
(8
)
Decrease in other current assets 
   
5
   
11
 
Decrease in other assets 
   
   
1
 
Decrease in accounts payable and accrued liabilities 
   
(45
)
 
(52
)
Decrease in commodity derivative liabilities 
   
(16
)
 
(5
)
Increase in advances from joint owners 
   
9
   
1
 
Increase in other liabilities 
   
1
   
 
Net cash provided by operating activities 
   
340
   
261
 
               
Cash flows from investing activities:
             
Additions to oil and gas properties 
   
(337
)
 
(245
)
Additions to furniture, fixtures and equipment 
   
(2
)
 
(1
)
Net cash used in investing activities 
   
(339
)
 
(246
)
               
Cash flows from financing activities:
             
Proceeds from borrowings under credit arrangements 
   
229
   
258
 
Repayments of borrowings under credit arrangements 
   
(229
)
 
(315
)
Proceeds from issuances of common stock 
   
2
   
15
 
Stock-based compensation excess tax benefit 
   
1
   
 
Purchases of treasury stock 
   
(3
)
 
 
Net cash used in financing activities 
   
   
(42
)
               
Effect of exchange rate changes on cash and cash equivalents  
   
1
   
 
               
Increase (decrease) in cash and cash equivalents 
   
2
   
(27
)
Cash and cash equivalents, beginning of period 
   
39
   
58
 
Cash and cash equivalents, end of period 
 
$
41
 
$
31
 


The accompanying notes to consolidated financial statements are an integral part of this statement.

3

 

NEWFIELD EXPLORATION COMPANY
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(In millions)
(Unaudited)
 
 
                               
Accumulated
     
                   
Additional
         
Other
 
Total
 
   
Common Stock
 
Treasury Stock
 
Paid-in
 
Unearned
 
Retained
 
Comprehensive
 
Stockholders'
 
   
Shares
 
Amount
 
Shares
 
Amount
 
Capital
 
Compensation
 
Earnings
 
Income (Loss)
 
Equity
 
Balance, December 31, 2005 
   
129.4
 
$
1
   
(1.8
)
$
(27
)
$
1,186
 
$
(34
)
$
1,296
 
$
(44
)
$
2,378
 
Issuance of common and restricted stock 
   
1.1
                     
2
                     
2
 
Stock-based compensation 
                           
4
                     
4
 
Treasury stock, at cost 
               
(0.1
)
 
(4
)
                         
(4
)
Tax benefit from stock-based compensation 
                           
1
                     
1
 
Adoption of SFAS No. 123(R) 
                           
(34
)
 
34
               
 
Comprehensive income:
                                                       
Net income 
                                       
149
         
149
 
Reclassification adjustments for settled
hedging positions, net of tax of $9 
                                             
(16
)
 
(16
)
Changes in fair value of outstanding
hedging positions, net of tax of ($8)
                                             
15
   
15
 
Total comprehensive income 
                                                   
148
 
Balance, March 31, 2006 
   
130.5
 
$
1
   
(1.9
)
$
(31
)
$
1,159
 
$
 
$
1,445
 
$
(45
)
$
2,529
 

 
The accompanying notes to consolidated financial statements are an integral part of this statement.
 
4

 

NEWFIELD EXPLORATION COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.  Organization and Summary of Significant Accounting Policies:

Organization and Principles of Consolidation
 
We are an independent oil and gas company engaged in the exploration, development and acquisition of crude oil and natural gas properties. Our company was founded in 1989 and initially focused on the shallow waters of the Gulf of Mexico. Today, we have a diversified asset base. Our domestic areas of operation include the onshore Gulf Coast, the Anadarko and Arkoma Basins of the Mid-Continent, the Uinta Basin of the Rocky Mountains and the Gulf of Mexico. Internationally, we are active offshore Malaysia and China and in the U.K. North Sea.

Our financial statements include the accounts of Newfield Exploration Company, a Delaware corporation, and its subsidiaries. We proportionately consolidate our interests in oil and gas exploration and production ventures and partnerships in accordance with industry practice. All significant intercompany balances and transactions have been eliminated. Unless otherwise specified or the context otherwise requires, all references in these notes to “Newfield,” “we,” “us” or “our” are to Newfield Exploration Company and its subsidiaries.

These unaudited consolidated financial statements reflect, in the opinion of our management, all adjustments, consisting only of normal and recurring adjustments, necessary to state fairly our financial position as of, and results of operations for, the periods presented. These financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all disclosures required for financial statements prepared in conformity with accounting principles generally accepted in the United States of America. Interim period results are not necessarily indicative of results of operations or cash flows for a full year.

These financial statements and notes should be read in conjunction with our audited consolidated financial statements and the notes thereto included in our annual report on Form 10-K for the year ended December 31, 2005.

Common Stock Split
 
Following the close of trading on May 25, 2005, we completed a two-for-one split of our common stock. The split was effected by a common stock dividend. The stated par value per share of our common stock was not changed from $0.01. The financial statements and notes as of and for the quarter ended March 31, 2005 have been restated to retroactively reflect the stock split.

Dependence on Oil and Gas Prices
 
As an independent oil and gas producer, our revenue, profitability and future rate of growth are substantially dependent on prevailing prices for natural gas and oil. Historically, the energy markets have been very volatile and it is likely that oil and gas prices will continue to be subject to wide fluctuations in the future. A substantial or extended decline in oil or gas prices could have a material adverse effect on our financial position, results of operations, cash flows and access to capital and on the quantities of oil and gas reserves that we can economically produce.

Use of Estimates
 
The preparation of our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, the reported amounts of revenues and expenses during the reporting period and the reported amounts of proved oil and gas reserves. Actual results could differ from these estimates. Our most significant financial estimates are related to our proved oil and gas reserves.

Reclassifications
 
Certain reclassifications have been made to prior years’ reported amounts in order to conform with the current year presentation. These reclassifications did not impact our net income, stockholders’ equity or cash flows.
 
 
5

 

NEWFIELD EXPLORATION COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Insurance Recoveries
 
During the first quarter of 2006, we recognized a $30 million benefit related to our business interruption insurance coverage as a result of Hurricanes Katrina and Rita.

Inventories
 
Inventories consist primarily of tubular goods and well equipment held for use in our oil and gas operations and oil produced but not sold. Inventories are carried at the lower of cost or market. Crude oil from our operations offshore Malaysia is produced into a floating production, storage and off-loading vessel and sold periodically as a barge quantity is accumulated. The product inventory consisted of approximately 172,000 barrels of crude oil valued at $4 million at March 31, 2006 and 36,000 barrels of crude oil valued at $1 million at December 31, 2005. Cost for purposes of the carrying value of oil inventory is a sum of production costs and depreciation, depletion and amortization expense.

Foreign Currency
 
The British pound is the functional currency for our operations in the United Kingdom. Translation adjustments resulting from translating our United Kingdom subsidiaries’ British pound financial statements into U.S. dollars are included as accumulated other comprehensive income on our consolidated balance sheet and statement of stockholders’ equity. The functional currency for all other foreign operations is the U.S. dollar. Gains and losses incurred on currency transactions in other than a country’s functional currency are recorded under the caption “Other” on our consolidated statement of income.

Accounting for Asset Retirement Obligations
 
If a reasonable estimate of the fair value of an obligation to perform site reclamation, dismantle facilities or plug and abandon wells can be made, we record a liability (an “asset retirement obligation” or “ARO”) on our consolidated balance sheet and capitalize the asset retirement cost in oil and gas properties in the period in which the retirement obligation is incurred. In general, the amount of an ARO and the costs capitalized will be equal to the estimated future cost to satisfy the abandonment obligation using current prices that are escalated by an assumed inflation factor up to the estimated settlement date, which is then discounted back to the date that the abandonment obligation was incurred using an assumed cost of funds for our company. After recording these amounts, the ARO is accreted to its future estimated value using the same assumed cost of funds and the additional capitalized costs are depreciated on a unit-of-production basis within the related full-cost pool. Both the accretion and the depreciation are included in depreciation, depletion and amortization on our consolidated statement of income.

The change in our ARO for the three months ended March 31, 2006 is set forth below (in millions):

Balance as of January 1, 2006 
 
$
260
 
Accretion expense 
   
4
 
Settlements 
   
(3
)
Balance as of March 31, 2006 
   
261
 
Less: Current portion 
   
44
 
Noncurrent ARO 
 
$
217
 

 
 
6

 

NEWFIELD EXPLORATION COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
 
Stock-Based Compensation
 
On January 1, 2006, we adopted SFAS No. 123 (revised 2004), "Share-Based Payment,'' (SFAS No. 123 (R)) to account for stock-based employee compensation. Among other items, SFAS No. 123(R) eliminates the use of APB 25 and the intrinsic value method of accounting and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant date fair value of those awards in their financial statements. We elected to use the modified prospective method for adoption, which requires compensation expense to be recorded for all unvested stock options and other equity-based compensation beginning in the first quarter of adoption. For all unvested options outstanding as of January 1, 2006, the previously measured but unrecognized compensation expense, based on the fair value at the original grant date, will be recognized in our financial statements over the remaining vesting period. For equity-based compensation awards granted or modified subsequent to January 1, 2006, compensation expense, based on the fair value on the date of grant, will be recognized in our financial statements over the vesting period. We utilize the Black-Scholes option pricing model to measure the fair value of stock options and a lattice-based model for our performance based restricted shares. Prior to the adoption of SFAS No. 123(R), we followed the intrinsic value method in accordance with APB 25 to account for employee stock-based compensation. Prior period financial statements have not been restated.

It is our policy to use unissued shares of stock when stock options are exercised. At March 31, 2006, we had approximately 2.6 million additional shares available for issuance pursuant to our existing employee and director plans. Of the shares available at March 31, 2006, only 1.2 million could be granted as restricted shares. Grants of restricted stock under the 2004 Omnibus Stock Plan reduce the total number of shares available under that plan by two times the number of shares issued as restricted stock.

The modified prospective method requires us to estimate forfeitures in calculating the expense related to stock-based compensation as opposed to our prior policy of recognizing the forfeitures as they occurred. We recorded a cumulative effect gain of a change in accounting principle of $1 million as a result of the adoption of this standard. Because the amount was immaterial, we included it in general and administrative expense on our consolidated statement of income.

The modified prospective method precludes changes to the grant date fair value of equity awards granted before the required effective date of adoption of SFAS No. 123(R). Any unearned compensation recorded under APB 25 related to these awards should be eliminated against the appropriate equity accounts. As a result, upon adoption we eliminated $34 million of unearned compensation cost and reduced by a like amount additional paid-in capital on our consolidated balance sheet.

For the three months ended March 31, 2006, we recorded stock-based compensation of $7 million for all plans. Of that amount, $3 million has been included in general and administrative expense on our consolidated statement of income and $4 million has been capitalized. The impact to net income of adopting SFAS No. 123(R) for this period was $2 million, or $0.02 per basic and diluted share. SFAS No. 123(R) also requires tax benefits relating to excess stock-based compensation deductions to be prospectively presented in our statement of cash flows as financing cash inflows. Accordingly, for the quarter ended March 31, 2006, we reported $1 million of excess tax benefits from stock-based compensation as cash provided by financing activities on our statement of cash flows, which reduced cash flows provided by operating activities by the same amount.

As of March 31, 2006 there was approximately $77 million of total unrecognized compensation expense related to unvested share-based compensation plans. This compensation expense is expected to be recognized on a straight-line basis over the remaining vesting period, approximately 5 years.

Stock Options. We have granted stock options under several employee stock option and omnibus stock plans. Options generally expire ten years from the date of grant and become exercisable at the rate of 20% per year. The exercise price of options cannot be less than the fair market value per share of our common stock on the date of grant.
  
The fair value of the stock options granted prior to and remaining outstanding at January 1, 2006 was determined using the Black-Scholes option valuation method assuming: no dividends, a weighted average risk-free interest rate of 4.09%, expected life of 6.5 years and a weighted average volatility of 37.52%.

 
7

 

NEWFIELD EXPLORATION COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


The following table provides information related to stock option activity for the three months ended March 31, 2006:

   
Number of
Shares
Underlying
Options
(In millions)
 
Weighted
Average
Exercise
Price
Per Share
 
Weighted
Average
Grant Date
Fair Value
Per Share
 
 
Weighted
Average
Contractual
Life in Years
 
 
Aggregate
Intrinsic
Value
(In millions) (1)
 
                       
Outstanding at December 31, 2005 
   
6.5
 
$
23.60
 
$
10.64
   
7.4
 
$
118
 
                                 
Granted 
   
   
   
   
   
 
Exercised 
   
(0.1
)
 
17.00
   
7.43
   
   
(2
)
Forfeited 
   
(0.1
)
 
24.82
   
11.40
   
   
(1
)
Outstanding at March 31, 2006 
   
6.3
 
$
23.71
 
$
10.70
   
7.1
 
$
115
 
                                 
Exercisable at March 31, 2006 
   
2.6
 
$
19.23
 
$
8.62
   
5.8
 
$
59
 
 
                            
 
(1)  
The intrinsic value of a stock option is the amount by which the current market value of the underlying stock exceeds the exercise price of the option. 
 
 
 
The aggregate intrinsic value of stock options exercised during the three month period ended March 31, 2005 was approximately $20 million.

Restricted Shares. At March 31, 2006, our employees held 0.5 million restricted shares of our common stock that vest equally over the service period of nine years, but vesting may be accelerated if certain targets are met. The vesting of these shares is dependant upon the employees continued service with the company.
 
At March 31, 2006, 1.6 million restricted shares of our common stock were outstanding that are subject to performance-based vesting criteria (substantially all of which are considered market-based restricted stock under SFAS No. 123(R)). During February 2006, certain employees received 974,000 restricted performance-based shares of our common stock. The number of these shares that ultimately vest is based upon established performance targets that will be assessed on March 1, 2009. The expense will be recognized ratably over the service period from February 2006 to March 2009. The grant date fair value of these shares was $23.20 per share for a total value of $23 million. Under the grants to our executive officers, they are permitted to retire on or after March 1, 2008 if certain other conditions are met, without forfeiting the shares granted. Substantially all of the remaining performance based shares may vest in whole or in part in 2008, 2009 and 2010. The percentage of the shares vesting, if any, in each respective year is subject to the achievement of certain targets as identified in the respective agreements.

Under our non-employee director restricted stock plan as in effect on March 31, 2006, immediately after each annual meeting of our stockholders, each of our non-employee directors then in office received a number of restricted shares determined by dividing $30,000 by the fair market value of one share of our common stock on the date of the annual meeting. In addition, new directors elected after an annual meeting received a number of restricted shares determined by dividing $30,000 by the fair market value of one share of our common stock on the date of their election. The forfeiture restrictions lapse on the day before the first annual meeting of stockholders following the date of issuance of the shares if the holder remains a director until that time. At March 31, 2006, 27,436 shares remained available for grants under the plan. In March 2006, our Board adopted the First Amendment to the plan and the amendment was submitted to our stockholders for approval at our May 4, 2006 annual meeting. The amendment would increase the value of the restricted stock grants from $30,000 to $75,000 and would increase the total number of shares of our common stock available for grant under the plan by 100,000 shares.
 
 
8

 

NEWFIELD EXPLORATION COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Status of the restricted shares as of March 31, 2006 and the changes during the three months ended March 31, 2006 is presented below:
 
   
Service Based
 
Performance/
Market
Based
 
 
 
Total
 
   
 (In thousands, except per share data)
 
                     
Non-vested shares outstanding at December 31, 2005 
   
549
   
801
   
1,350
 
                     
Granted
   
23
   
974
   
997
 
Forfeited
   
(5
)
 
(1
)
 
(6
)
Vested
   
(40
)
 
(167
)
 
(207
)
                     
Non-vested shares outstanding at March 31, 2006  
   
527
   
1,607
   
2,134
 
Weighted average grant date fair value of shares granted during the period
 
$
43.91
 
$
23.20
 
$
23.68
 
Total fair value of shares vesting during the period 
 
$
726
 
$
2,772
 
$
3,498
 
 
Employee Stock Purchase Plan. Pursuant to our employee stock purchase plan, for each six month period beginning on January 1 or July 1 during the term of the plan, each eligible employee has the opportunity to purchase our common stock for a purchase price equal to 85% of the lesser of the fair market value of our common stock on the first day of the period or the last day of the period. No employee may purchase common stock under the plan valued at more than $25,000 in any calendar year. Employees of our foreign subsidiaries are not eligible to participate.

During the three months ended March 31, 2006, 23,742 options to purchase shares of our common stock with a grant date weighted average fair value of $13.14 per share were outstanding. In accordance with APB 25 and related interpretations, we did not recognize any compensation expense with respect to the plan prior to the adoption of SFAS No. 123(R). The fair value of the options granted to purchase shares in the first quarter of 2006 was determined using the Black-Scholes option valuation method assuming: no dividends, a risk-free interest rate of 4.35%, expected life of 6 months and volatility of 37.6%. At March 31, 2006, 110,059 shares of our common stock were available for issuance pursuant to the plan.

UK Bonus Plan. We have a cash bonus plan for the employees of our UK North Sea operations. The value of the bonus is determined based on the value of the shares of our UK subsidiary as determined by our Board of Directors. This plan is accounted for as a liability plan under SFAS No. 123(R) and is not material to our financial statements.

Pro forma Disclosures. Prior to January 1, 2006, we accounted for our employee stock options using the intrinsic value method prescribed by APB 25. As required by SFAS No. 123(R), we have disclosed below the effect on net income and earnings per share that would have been recorded using the fair value based method for the three months ended March 31, 2005. The weighted average fair value of the options granted in the first three months of 2005 was determined using the Black-Scholes option valuation method assuming: no dividends, a weighted average risk-free interest rate of 3.71%, expected life of 6.5 years and weighted average volatility of 38.55%.

 
9

 

NEWFIELD EXPLORATION COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
   
Three Months
Ended
March 31, 2005
 
   
(In millions, except per
share data)
 
Net income:
       
As reported (1) 
 
$
60
 
Pro forma (2) 
   
58
 
         
Basic earnings per common share —
       
As reported 
 
$
0.48
 
Pro forma 
   
0.46
 
         
Diluted earnings per common share —
       
As reported 
 
$
0.47
 
Pro forma 
   
0.46
 
                        _____
 
(1)  
Includes stock-based compensation costs, net of related tax effects, of $1 million.
 
(2)  
Includes $3 million of stock-based compensation costs, net of related tax effects, that would have been included in the determination of net income had the fair value based method been applied.

2.  Earnings Per Share:

Basic earnings per share (EPS) is calculated by dividing net income (the numerator) by the weighted average number of shares of common stock (other than unvested restricted stock) outstanding during the period (the denominator). Diluted earnings per share incorporates the dilutive impact of outstanding stock options (using the treasury stock method) and unvested restricted stock.

The following is the calculation of basic and diluted weighted average shares outstanding and EPS for the indicated periods:

   
Three Months Ended
March 31,
 
   
2006
 
2005
 
   
(In millions, except per
share data)
 
Income (numerator):
             
Net income — basic 
 
$
149
 
$
60
 
Net income — diluted 
 
$
149
 
$
60
 
               
Weighted average shares (denominator):
             
Weighted average shares — basic 
   
126
   
124
 
Dilution effect of stock options and unvested restricted stock outstanding at end of period 
   
2
   
3
 
Weighted average shares — diluted 
   
128
   
127
 
               
Earnings per share:
             
Basic 
 
$
1.18
 
$
0.48
 
Diluted 
 
$
1.17
 
$
0.47
 

There were no antidilutive shares for the three months ended March 31, 2006. The calculation of shares outstanding for diluted EPS for the three months ended March 31, 2005 does not include the effect of outstanding stock options to purchase 0.1 million shares because to do so would be antidilutive.
 
10

 

NEWFIELD EXPLORATION COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

3.  Oil and Gas Assets:

Oil and Gas Properties
 
Oil and gas properties consisted of the following at:

   
March 31,
 
December 31,
 
   
2006
 
2005
 
   
(In millions)
 
           
Subject to amortization 
 
$
6,492
 
$
6,141
 
Not subject to amortization:
             
Exploration wells in progress 
   
87
   
56
 
Development wells in progress 
   
111
   
107
 
Capitalized interest 
   
78
   
71
 
Fee mineral interests 
   
23
   
23
 
Other capital costs:
             
Incurred in 2006 
   
17
   
 
Incurred in 2005 
   
105
   
110
 
Incurred in 2004 
   
408
   
413
 
Incurred in 2003 and prior 
   
112
   
121
 
Total not subject to amortization
   
941
   
901
 
Gross oil and gas properties 
   
7,433
   
7,042
 
Accumulated depreciation, depletion and amortization 
   
(2,760
)
 
(2,632
)
Net oil and gas properties 
 
$
4,673
 
$
4,410
 

We believe that substantially all of the properties associated with costs not currently subject to amortization will be evaluated within four years except the Monument Butte Field. Because of its size, evaluation of the Monument Butte Field in its entirety will take significantly longer than four years. At March 31, 2006 and December 31, 2005, $312 million and $316 million, respectively, of costs associated with the Monument Butte Field were not subject to amortization.

4.  Debt:

As of the indicated dates, our long-term debt consisted of the following:

   
March 31,
2006
 
December 31,
2005
 
   
(In millions)
 
Senior unsecured debt:
             
Bank revolving credit facility:
             
Prime rate based loans 
 
$
 
$
 
LIBOR based loans 
   
   
 
Total bank revolving credit facility
   
   
 
               
7.45% Senior Notes due 2007 
   
125
   
125
 
Fair value of interest rate swaps (1) 
   
(3
)
 
(2
)
7 5/8% Senior Notes due 2011 
   
175
   
175
 
Fair value of interest rate swaps (1) 
   
(3
)
 
(2
)
Total senior unsecured notes
   
294
   
296
 
               
Total senior unsecured debt
   
294
   
296
 
               
8 3/8% Senior Subordinated Notes due 2012 
   
249
   
249
 
6 5/8% Senior Subordinated Notes due 2014 
   
325
   
325
 
Total long-term debt
 
$
868
 
$
870
 
 
                            
 
(1)  
We have hedged $50 million principal amount of our 7.45% Senior Notes due 2007 and $50 million principal amount of our 7 5/8% Senior Notes due 2011. The hedges provide for us to pay variable and receive fixed interest payments.
 
 
11

 
 
NEWFIELD EXPLORATION COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


In April 2006, we closed the sale of $550 million aggregate principal amount of our 6 5/8% Senior Subordinated Notes due 2016. See Note 10, “Subsequent Events.”

Credit Arrangements
 
In December 2005, we entered into a revolving credit facility that matures in December 2010. The terms of the credit facility provide for initial loan commitments of $1 billion from a syndication of participating banks, led by JPMorgan Chase as the agent bank. The loan commitments under the credit facility may be increased to a maximum aggregate amount of $1.5 billion if the lenders increase their loan commitments or new financial institutions are added to the credit facility. Loans under the credit facility bear interest, at the option of the Company, based on (a) a rate per annum equal to the higher of the prime rate announced from time to time by JPMorgan Chase Bank or the weighted average of the rates on overnight federal funds transactions with members of the Federal Reserve System during the last preceding business day plus 50 basis points or (b) a base Eurodollar rate, substantially equal to the London Interbank Offered Rate (“LIBOR”), plus a margin that is based on a grid of our debt rating (100 basis points per annum at March 31, 2006). At March 31, 2006, we had no borrowings under the credit facility.

The credit facility has restrictive covenants that include the maintenance of a ratio of total debt to book capitalization not to exceed 0.6 to 1.0; maintenance of a ratio of total debt to earnings before gain or loss on the disposition of assets, interest expense, income taxes, depreciation, depletion and amortization expense, exploration and abandonment expense and other noncash charges and expenses to consolidated interest expense of at least 3.5 to 1.0; and as long as our debt rating is below investment grade, the maintenance of an annual ratio of the calculated net present value of our oil and gas properties to total debt of at least 1.75 to 1.00. At March 31, 2006, we were in compliance with all of our debt covenants.

As of March 31, 2006, we had $64 million of undrawn letters of credit under our credit facility. The letters of credit outstanding under the credit facility are subject to annual fees, based on a grid of our debt rating (87.5 basis points at March 31, 2006), plus an issuance fee of 12.5 basis points.

We also have a total of $110 million of borrowing capacity under money market lines of credit with various banks. At March 31, 2006, we had no borrowings under our money market lines.

5.  Contingencies:

We have been named as a defendant in a number of lawsuits arising in the ordinary course of our business. While the outcome of these lawsuits cannot be predicted with certainty, we do not expect these matters will have a material adverse effect on our financial position, cash flows or results of operations.
 

 
12

 

NEWFIELD EXPLORATION COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


6.  Segment Information:

While we only have operations in the oil and gas exploration and production industry, we are organizationally structured along geographic operating segments. Our operating segments are the United States, the United Kingdom, Malaysia, China and Other International. The accounting policies of each of our operating segments are the same as those described in Note 1, “Organization and Summary of Significant Accounting Policies.”

The following tables provide the geographic operating segment information required by SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” as well as results of operations of oil and gas producing activities required by SFAS No. 69, “Disclosures about Oil and Gas Producing Activities,” as of and for the three months ended March 31, 2006 and 2005. Income tax allocations have been determined based on statutory rates in the applicable geographic segment.
 
   
United
States
 
United Kingdom
 
 
Malaysia
 
 
China
 
Other
International
 
 
Total
 
           
(In millions)
         
Three Months Ended March 31, 2006:
                                     
                                       
Oil and gas revenues 
 
$
423
 
$
 
$
8
 
$


 
$

 
$
431
 
                                       
Operating expenses:
                                     
Lease operating 
   
50
   
   
2
   
   
   
52
 
Production and other taxes 
   
15
   
   
1
   
   
   
16
 
Depreciation, depletion and amortization 
   
130
   
 
   
1
   
   
   
131
 
General and administrative 
   
27
   
2
   
1
   
   
   
30
 
Business interruption insurance benefit 
   
(30
)
 
   
   
   
   
(30
)
Allocated income taxes 
   
81
   
(1
)
 
1
   
   
       
Net income (loss) from oil and
gas properties
 
$
150
 
$
(1
)
$
2
 
$
 
$

       
                                       
Total operating expenses 
                                 
199
 
Income from operations 
                                 
232
 
Interest expense, net of interest income,
capitalized interest and other 
                                 
(5
)
Commodity derivative income 
                                 
6
 
Income before income taxes 
                               
$
233
 
                                       
Total long-lived assets 
 
$
4,429
 
$
88
 
$
100
 
$
50
 
$
6
 
$
4,673
 
                                       
Additions to long-lived assets 
 
$
328
 
$
42
 
$
15
 
$
5
 
$
 
$
390
 

 
13

 

NEWFIELD EXPLORATION COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


 
 
United
States
 
United
Kingdom
 
 
Malaysia
 
 
China
 
Other
International
 
 
Total
 
           
(In millions)
         
Three Months Ended March 31, 2005:
                                     
                                       
Oil and gas revenues 
 
$
403
 
$
 
$
10
 
$
$
$
413
 
                                       
Operating expenses:
                                     
Lease operating 
   
43
   
   
3
   
   
   
46
 
Production and other taxes 
   
11
   
   
 
 
   
   
11
 
Depreciation, depletion and amortization 
   
134
   
   
2
   
   
   
136
 
General and administrative 
   
22
   
1
   
   
   
   
23
 
Allocated income taxes 
   
68
   
   
2
   
   
       
Net income (loss) from oil and
gas properties
 
$
125
 
$
(1
)
$
3
 
$
 
$

       
                                       
Total operating expenses 
                                 
216
 
Income from operations 
                                 
197
 
Interest expense, net of interest income,
capitalized interest and other 
                                 
(6
)
Commodity derivative expense 
                                 
(109
)
Income before income taxes 
                               
$
82
 
                                       
Total long-lived assets 
 
$
3,745
 
$
46
 
$
56
 
$
37
 
$
13
 
$
3,897
 
                                       
Additions to long-lived assets 
 
$
231
 
$
20
 
$
2
 
$
 
$
1
 
$
254
 

7. Commodity Derivative Instruments and Hedging Activities:

We utilize swap, floor, collar and three-way collar derivative contracts to hedge against the variability in cash flows associated with the forecasted sale of our future oil and gas production. While the use of these derivative instruments limits the downside risk of adverse price movements, their use also may limit future revenues from favorable price movements.

With respect to a swap contract, the counterparty is required to make a payment to us if the settlement price for any settlement period is less than the swap price for such contract, and we are required to make payment to the counterparty if the settlement price for any settlement period is greater than the swap price for such contract. For a floor contract, the counterparty is required to make a payment to us if the settlement price for any settlement period is below the floor price for such contract. We are not required to make any payment in connection with the settlement of a floor contract. For a collar contract, the counterparty is required to make a payment to us if the settlement price for any settlement period is below the floor price for such contract, we are required to make payment to the counterparty if the settlement price for any settlement period is above the ceiling price for such contract and neither party is required to make a payment to the other party if the settlement price for any settlement period is equal to or greater than the floor price and equal to or less than the ceiling price for such contract. A three-way collar contract consists of a standard collar contract plus a put sold by us with a price below the floor price of the collar. This additional put requires us to make a payment to the counterparty if the settlement price for any settlement period is below the put price. Combining the collar contract with the additional put results in us being entitled to a net payment equal to the difference between the floor price of the standard collar and the additional put price if the settlement price is equal to or less than the additional put price. If the settlement price is greater than the additional put price, the result is the same as it would have been with a standard collar contract only. This strategy enables us to increase the floor and the ceiling price of the collar beyond the range of a traditional no cost collar while defraying the associated cost with the sale of the additional put.

Substantially all of our oil and gas derivative contracts are settled based upon reported prices on the NYMEX. The estimated fair value of these contracts is based upon various factors, including closing exchange prices on the NYMEX, over-the-counter quotations, volatility and, in the case of collars and floors, the time value of options. The calculation of the fair value of collars and floors requires the use of an option-pricing model.

 
14

 

NEWFIELD EXPLORATION COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
 
Cash Flow Hedges
 
Prior to the fourth quarter of 2005, all derivatives that qualified for hedge accounting were designated on the date we entered into the contract as a hedge of the variability in cash flows associated with the forecasted sale of our future oil and gas production. All open contracts that were designated as cash flow hedges as of September 30, 2005 will continue to be accounted for under hedge accounting until the contract expires or is otherwise settled. After-tax changes in the fair value of a derivative that is highly effective and is designated and qualifies as a cash flow hedge, to the extent that the hedge is effective, are recorded under the caption “Accumulated other comprehensive income (loss) — Commodity derivatives” on our consolidated balance sheet until the sale of the hedged oil and gas production. Upon the sale of the hedged production, the net after-tax change in the fair value of the associated derivative recorded under the caption “Accumulated other comprehensive income (loss) — Commodity derivatives” is reversed and the gain or loss on the hedge, to the extent that it is effective, is reported in “Oil and gas revenues” on our consolidated statement of income. At March 31, 2006, we had a net $41 million after-tax loss recorded under the caption “Accumulated other comprehensive income (loss) — Commodity derivatives.” We expect hedged production associated with commodity derivatives accounting for a net loss of approximately $42 million to be sold within the next 12 months and hedged production associated with a remaining net gain of approximately $1 million to be sold thereafter. The actual gain or loss on these commodity derivatives could vary significantly as a result of changes in market conditions and other factors.

For those contracts designated as a cash flow hedge, we formally document all relationships between the derivative instruments and the hedged production, as well as our risk management objective and strategy for the particular derivative contracts. This process includes linking all derivatives that are designated as cash flow hedges to the specific forecasted sale of oil or gas at its physical location. We also formally assess (both at the derivative’s inception and on an ongoing basis) whether the derivatives being utilized have been highly effective at offsetting changes in the cash flows of hedged production and whether those derivatives may be expected to remain highly effective in future periods. If it is determined that a derivative has ceased to be highly effective as a hedge, we will discontinue hedge accounting prospectively. If hedge accounting is discontinued and the derivative remains outstanding, we will carry the derivative at its fair value on our consolidated balance sheet and recognize all subsequent changes in its fair value on our consolidated statement of income for the period in which the change occurs.

Other Derivative Contracts
 
Although our three-way collar contracts are effective as economic hedges of our commodity price exposure, they do not qualify for hedge accounting under SFAS No. 133. Beginning in the fourth quarter of 2005 we elected not to designate any additional swap, collar and floor contracts that were entered into subsequent to October 1, 2005 as accounting hedges under SFAS No. 133. Our three-way collar contracts as well as the other derivative contracts that are not designated as cash flow hedges are carried at their fair value on our consolidated balance sheet under the captions “Derivative assets” and “Derivative liabilities.” We recognize all unrealized and realized gains and losses related to these contracts on our consolidated statement of income under the caption “Commodity derivative income (expense).” We recognized realized losses on these contracts of $1 million and $2 million in the first quarter of 2006 and 2005, respectively.

Natural Gas

As of March 31, 2006, we had entered into derivative contracts that qualify as cash flow hedges with respect to our future natural gas production as follows:

           
Estimated
 
       
NYMEX Contract Price Per MMBtu
 
Fair Value
 
       
Floor Contracts
 
Asset
 
   
Volume in
     
Weighted
 
(Liability)
 
Period and Type of Contract
 
MMMBtus
 
Range
 
Average
 
(In millions)
 
                   
April 2006 - June 2006
                         
Floor contracts
   
4,800
 
 
$7.35
 
 
$7.35
 
$
2
 
July 2006 - September 2006
                         
Floor contracts
   
4,800
   
7.35
   
7.35
   
3
 
October 2006 - December 2006
                         
Floor contracts
   
1,600
   
 7.35
   
7.35
   
1
 
                     
$
6
 

15

 

NEWFIELD EXPLORATION COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


As of March 31, 2006, we also had entered into other contracts with respect to our future natural gas production as set forth in the table below. These contracts do not qualify for hedge accounting.

       
NYMEX Contract Price Per MMBtu
 
Estimated
 
           
Collars
 
Fair Value
 
       
Swaps
 
Floors
 
Ceilings
 
Asset
 
   
Volume in
 
(Weighted
     
Weighted
     
Weighted
 
(Liability)
 
Period and Type of Contract
 
MMMBtus
 
Average)
 
Range
 
Average
 
Range
 
Average
 
(In millions)
 
                               
April 2006 - June 2006
                                           
Price swap contracts
   
12,830
 
 
$8.85
   
   
   
   
 
$
20
 
Collar contracts
   
7,140
   
 
 
$8.00 - $9.35
 
 
$8.55
 
 
$10.50 - $20.00
 
 
$12.60
   
10
 
Floor contracts
   
510
   
   
8.29
   
8.29
   
   
   
1
 
July 2006 - September 2006
                                           
Price swap contracts
   
12,850
   
8.96
   
   
   
   
   
15
 
Collar contracts
   
7,140
   
   
8.00 - 9.35
   
8.55
   
10.50 - 20.00
   
12.60
   
9
 
Floor contracts
   
510
   
   
8.29
   
8.29
   
   
   
1
 
October 2006 - December 2006
                                           
Price swap contracts
   
3,630
   
8.47
   
   
   
   
   
 
Collar contracts
   
11,590
   
   
9.00 - 9.40
   
9.13
   
11.00 - 15.40
   
12.28
   
3
 
January 2007 - December 2007
                                           
Collar contracts
   
17,100
   
   
9.00 - 9.40
   
9.13
   
11.00 - 15.40
   
12.28
   
(11
)
                                       
$
48
 

Oil

As of March 31, 2006, we had entered into derivative contracts that qualify as cash flow hedges with respect to our future oil production as follows:

       
NYMEX Contract Price Per Bbl
 
Estimated
 
           
Collars
 
Fair Value
 
       
Swaps
 
Floors
 
Ceilings
 
Asset
 
   
Volume in
 
(Weighted
     
Weighted
     
Weighted
 
(Liability)
 
Period and Type of Contract
 
MBbls
 
Average)
 
Range
 
Average
 
Range
 
Average
 
(In millions)
 
                               
April 2006 - June 2006
                                           
Price swap contracts
   
747
 
 
$46.77
   
   
   
   
 
$
(16
)
Collar contracts
   
151
   
 
 
$50.00 - $55.00
 
 
$52.51
 
 
$73.90 - $83.75
 
 
$78.83
   
 
July 2006 - September 2006
                                           
Price swap contracts
   
753
   
46.83
   
   
   
   
   
(17
)
Collar contracts
   
151
   
   
50.00 - 55.00
   
52.52
   
73.90 - 83.75
   
78.84
   
 
October 2006 - December 2006
                                           
Price swap contracts
   
753
   
46.83
   
   
   
   
   
(17
)
Collar contracts
   
151
   
   
50.00 - 55.00
   
52.52
   
73.90 - 83.75
   
78.84
   
 
January 2007 - December 2007
                                           
Price swap contracts
   
605
   
47.66
   
   
   
   
   
(13
)
Collar contracts
   
365
   
   
50.00 - 55.00
   
52.50
   
77.10 - 83.25
   
80.18
   
(1
)
                                       
$
(64
)

As of March 31, 2006, we also had entered into other contracts with respect to our future oil production as set forth in the table below. These contracts do not qualify for hedge accounting.

       
NYMEX Contract Price Per Bbl
 
Estimated
 
                   
Collars
 
Fair Value
 
       
Swaps
 
Additional Put
 
Floors
 
Ceilings
 
Asset
 
   
Volume in
 
(Weighted
     
Weighted
     
Weighted
     
Weighted
 
(Liability)
 
Period and Type of Contract
 
MBbls
 
Average)
 
Range
 
Average
 
Range
 
Average
 
Range
 
Average
 
(In millions)
 
                                       
April 2006 - June 2006
                                                       
3-Way collar contracts
   
417
   
 
 
$30.00 - $50.00
 
 
$38.50
 
 
$35.00 - $60.00
 
 
$45.95
 
 
$50.50 - $80.00
 
 
$63.27
 
$
(4
)
July 2006 - September 2006
                                                       
3-Way collar contracts
   
480
   
   
30.00 - 50.00
   
37.43
   
35.00 - 60.00
   
44.69
   
50.50 - 80.00
   
62.21
   
(5
)
October 2006 - December 2006
                                                       
Price swap contracts
   
30
 
 
$70.00