UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

For the transition period from       to       

 

Commission File Number 1-13515

 

FOREST OIL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

707 17th Street, Suite 3600 Denver, Colorado 80202

(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code: (303) 812-1400

 

 

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.   x Yes  o 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):

 

 

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

As of July 31, 2006 there were 62,866,871 shares of the registrant’s common stock, par value $.10 per share, outstanding.

FOREST OIL CORPORATION
INDEX TO FORM 10-Q
June 30, 2006

Part I—FINANCIAL INFORMATION
Item 1—Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005		1
Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2006 and 2005		2
Condensed Consolidated Statement of Shareholders’ Equity for the Six Months Ended June 30, 2006		3
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2006 and 2005		4
Notes to Condensed Consolidated Financial Statements		5
Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations		19
Item 3—Quantitative and Qualitative Disclosures About Market Risk		31
Item 4—Controls and Procedures		33
Part II—OTHER INFORMATION
Item 4—Submission of Matters to a Vote of Security Holders		33
Item 6—Exhibits		34
Signatures		35

 

ii

PART I—FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

FOREST OIL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In Thousands, Except Share Data)

		June 30, 2006			December 31, 2005
ASSETS
Current assets:
Cash and cash equivalents		$	5,456		7,231
Accounts receivable		139,673			178,124
Derivative instruments		10,870			941
Deferred tax assets		16,816			77,346
Other current assets		35,054			52,283
Total current assets		207,869			315,925
Property and equipment, at cost:
Oil and gas properties, full cost method of accounting:
Proved, net of accumulated depletion of $2,159,630 and $3,059,031		2,298,209			2,898,774
Unproved		264,218			275,684
Net oil and gas properties		2,562,427			3,174,458
Other property and equipment, net of accumulated depreciation and amortization of $30,152 and $32,527		28,550			25,560
Net property and equipment		2,590,977			3,200,018
Derivative instruments		3,747			—
Goodwill		87,725			87,072
Other assets		35,583			42,531
		$	2,925,901		3,645,546
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	209,266		312,076
Accrued interest		4,752			4,260
Derivative instruments		49,203			151,678
Asset retirement obligations		1,741			33,329
Other current liabilities		15,172			21,573
Total current liabilities		280,134			522,916
Long-term debt		1,086,924			884,807
Asset retirement obligations		61,023			178,225
Derivative instruments		1,197			—
Other liabilities		46,970			45,691
Deferred income taxes		152,593			329,385
Total liabilities		1,628,841			1,961,024
Shareholders’ equity:
Preferred stock, none issued		—			—
Common stock, 62,854,397 and 64,548,229 shares issued and outstanding		6,286			6,455
Capital surplus		1,179,987			1,529,102
Retained earnings		30,013			217,293
Accumulated other comprehensive income (loss)		80,774			(18,220	)
Treasury stock, at cost, 1,861,143 shares held in 2005		—			(50,108	)
Total shareholders’ equity		1,297,060			1,684,522
		$	2,925,901		3,645,546

 

See accompanying Notes to Condensed Consolidated Financial Statements.

1

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FOREST OIL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

		Three Months Ended June 30,					Six Months Ended June 30,
		2006			2005		2006		2005
		(In Thousands, Except Per Share Amounts)
Revenue:
Oil and gas sales:
Natural gas		$	94,753		160,115		221,806		314,641
Oil, condensate, and natural gas liquids		115,470			109,240		207,513		213,584
Total oil and gas sales		210,223			269,355		429,319		528,225
Marketing, processing, and other		1,630			1,700		3,980		3,121
Total revenue		211,853			271,055		433,299		531,346
Operating expenses:
Lease operating expenses		35,529			45,783		80,860		93,643
Production and property taxes		10,997			10,547		21,725		20,444
Transportation costs		5,642			4,583		10,371		9,755
General and administrative (including stock-based compensation)		11,071			11,091		28,207		21,847
Depreciation and depletion		63,253			97,249		140,921		193,525
Accretion of asset retirement obligations		1,301			4,322		4,653		8,599
Impairments		2,078			—		2,078		2,924
Spin-off and merger costs		—			—		5,416		—
Total operating expenses		129,871			173,575		294,231		350,737
Earnings from operations		81,982			97,480		139,068		180,609
Other income and expense:
Interest expense		17,340			16,061		32,491		30,560
Unrealized (gains) losses on derivative instruments, net		(14,378		)	(4,310	)	9,736		2,270
Realized losses (gains) on derivative instruments, net		13,698			(850	)	17,613		(318	)
Other (income) expense, net		(110		)	2,509		750		3,910
Total other income and expense		16,550			13,410		60,590		36,422
Earnings before income taxes and discontinued operations		65,432			84,070		78,478		144,187
Income tax expense:
Current		1,819			617		2,821		2,174
Deferred		6,565			31,252		17,360		50,941
Total income tax expense		8,384			31,869		20,181		53,115
Earnings from continuing operations		57,048			52,201		58,297		91,072
Income from discontinued operations, net of tax		—			—		2,422		—
Net earnings		$	57,048		52,201		60,719		91,072
Basic earnings per common share:
Earnings from continuing operations		$	.92		.85		.94		1.50
Income from discontinued operations, net of tax		—			—		.04		—
Net earnings per common share		$	.92		.85		.98		1.50
Diluted earnings per common share:
Earnings from continuing operations		$	.90		.83		.92		1.46
Income from discontinued operations, net of tax		—			—		.04		—
Net earnings per common share		$	.90		.83		.96		1.46

 

See accompanying Notes to Condensed Consolidated Financial Statements.

2

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FOREST OIL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(Unaudited)

		Common Stock					Capital		Retained		Accumulated Other Comprehensive		Treasury		Total Shareholders’
		Shares		Amount			Surplus		Earnings		(Loss) Income		Stock		Equity
		(In Thousands)
Balances at January 1, 2006		64,548		$	6,455		1,529,102		217,293		(18,220	)	(50,108	)	1,684,522
Exercise of stock options		152		15			3,376		(8	)	—		27		3,410
Tax benefit of stock options exercised		—		—			23		—		—		—		23
Employee stock purchase plan		13		2			364		—		—		—		366
Restricted stock issued, net of forfeitures		1		—			—		—		—		—		—
Retirement of treasury stock		(1,860	)	(186		)	(49,895	)	—		—		50,081		—
Amortization of stock-based compensation		—		—			14,684		—		—		—		14,684
Pro rata distribution of FERI common stock to shareholders (Note 2)		—		—			(317,667	)	(247,991	)	7,549		—		(558,109	)
Comprehensive earnings:
Net earnings		—		—			—		60,719		—		—		60,719
Unrealized gain on effective derivative instruments, net of tax		—		—			—		—		77,074		—		77,074
Amortization of deferred hedging loss, net of tax		—		—			—		—		1,030		—		1,030
Decrease in unfunded pension liability, net of tax		—		—			—		—		83		—		83
Foreign currency translation		—		—			—		—		13,258		—		13,258
Total comprehensive earnings															152,164
Balances at June 30, 2006		62,854		$	6,286		1,179,987		30,013		80,774		—		1,297,060

 

See accompanying Notes to Condensed Consolidated Financial Statements.

3

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FOREST OIL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 

		Six Months Ended June 30,
		2006			2005
		(In Thousands)
Operating activities:
Net earnings		$	60,719		91,072
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and depletion		140,921			193,525
Accretion of asset retirement obligations		4,653			8,599
Stock-based compensation		9,812			282
Impairments		2,078			2,924
Unrealized losses on derivative instruments, net		9,736			2,270
Amortization of deferred derivative losses		15,204			—
Deferred income tax expense		18,587			50,941
Other, net		46			(504	)
Changes in operating assets and liabilities, net of effects of acquisitions and divestitures:
Accounts receivable		(13,938		)	20,745
Other current assets		(19,197		)	1,324
Accounts payable		(19,232		)	(41,753	)
Accrued interest and other current liabilities		(12,237		)	(4,002	)
Net cash provided by operating activities		197,152			325,423
Investing activities:
Capital expenditures for property and equipment:
Exploration, development, and acquisition costs		(610,151		)	(398,208	)
Other fixed assets		(5,330		)	(4,853	)
Proceeds from sales of assets		1,355			6,437
Other, net		(35		)	(5,047	)
Net cash used by investing activities		(614,161		)	(401,671	)
Financing activities:
Proceeds from bank borrowings		1,623,943			1,157,953
Repayments of bank borrowings		(1,245,614		)	(1,126,000	)
Repayments of bank debt assumed in acquisition		—			(35,000	)
Proceeds from Spin-off (Note 2)		21,670			—
Proceeds from the exercise of options and warrants and employee stock purchases		3,775			38,453
Net increase in bank overdrafts		11,582			—
Other, net		(54		)	322
Net cash provided by financing activities		415,302			35,728
Effect of exchange rate changes on cash		(68		)	(683	)
Net decrease in cash and cash equivalents		(1,775		)	(41,203	)
Cash and cash equivalents at beginning of period		7,231			55,251
Cash and cash equivalents at end of period		$	5,456		14,048
Cash paid during the period for:
Interest		$	38,087		32,283
Income taxes		4,618			5,141

 

See accompanying Notes to Condensed Consolidated Financial Statements.

4

FOREST OIL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(1) BASIS OF PRESENTATION

The Condensed Consolidated Financial Statements included herein are unaudited and include the accounts of Forest Oil Corporation and its consolidated subsidiaries (collectively, “Forest” or the “Company”). In the opinion of management, all adjustments, consisting of normal recurring accruals, have been made which are necessary for a fair presentation of the financial position of Forest at June 30, 2006, the results of its operations for the three and six months ended June 30, 2006 and 2005, and its cash flows for the six months ended June 30, 2006 and 2005. Interim results are not necessarily indicative of expected annual results because of the impact of fluctuations in prices received for liquids (oil, condensate, and natural gas liquids) and natural gas and other factors.

In the course of preparing the Condensed Consolidated Financial Statements, management makes various assumptions, judgments, and estimates to determine the reported amount of assets, liabilities, revenue, and expenses, and in the disclosures of commitments and contingencies. Changes in these assumptions, judgments, and estimates will occur as a result of the passage of time and the occurrence of future events and, accordingly, actual results could differ from amounts initially established.

The more significant areas requiring the use of assumptions, judgments, and estimates relate to volumes of oil and gas reserves used in calculating depletion, the amount of future net revenues used in computing the ceiling test limitations, and the amount of future capital costs and abandonment obligations used in such calculations. Assumptions, judgments, and estimates are also required in determining impairments of undeveloped properties, valuing deferred tax assets, and estimating fair values of derivative instruments.

Certain amounts in the prior year financial statements have been reclassified to conform to the 2006 financial statement presentation.

For a more complete understanding of Forest’s operations, financial position, and accounting policies, reference is made to the consolidated financial statements of Forest, and related notes thereto, filed with Forest’s annual report on Form 10-K for the year ended December 31, 2005, previously filed with the Securities and Exchange Commission.

(2) ACQUISITIONS AND DIVESTITURES

Acquisitions

On March 31, 2006, Forest completed the acquisition of oil and gas properties located primarily in the Cotton Valley trend in East Texas. Forest paid approximately $255 million, as adjusted to reflect an economic effective date of February 1, 2006, for properties with an estimated 110 Bcfe of estimated proved reserves at the time the acquisition was announced in February 2006 and production that averaged 13 MMcfe per day in January 2006. Forest acquired approximately 26,000 net acres in the fields, of which approximately 14,000 net acres were undeveloped. Forest funded this acquisition utilizing its bank credit facilities.

Divestitures

Spin-off and Merger of Offshore Gulf of Mexico Operations

On March 2, 2006, Forest completed the spin-off of its offshore Gulf of Mexico operations by means of a special dividend, which consisted of a pro rata spin-off (the “Spin-off”) of all outstanding shares of Forest Energy Resources, Inc. (“FERI”), a total of 50,637,010 shares of common stock, to holders of record of Forest common stock as of the close of business on February 21, 2006. Immediately following the Spin-off, FERI was merged with a subsidiary of Mariner Energy, Inc. (“Mariner”) in a stock for stock transaction (the “Merger”). Mariner’s common stock commenced trading on the New York Stock Exchange on March 3, 2006.

5

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(2) ACQUISITIONS AND DIVESTITURES (Continued)

The Spin-off was a tax-free transaction for federal income tax purposes. Prior to the Merger, as part of the Spin-off, FERI paid Forest approximately $176.1 million. The $176.1 million was drawn on a newly created bank credit facility established by FERI immediately prior to the Spin-off. This credit facility and associated liability was included in the Spin-off. Subsequent to March 31, 2006, Forest received an additional $21.7 million from FERI for total cash proceeds of $197.8 million. The cash amount is subject to further potential adjustment to reflect an economic effective date of July 1, 2005.

The table below sets forth the effect of the Spin-off on the Company’s balance sheet at the time of the Spin-off:

		Change in Balance Sheet Accounts
		(In Thousands)
Assets (Increase/(Decrease))
Cash		$	(10	)
Accounts receivable—Due from FERI		21,525
Accounts receivable—third parties		(54,078		)
Other current assets		(44,837		)
Proved oil and gas properties, net of accumulated depletion		(1,065,992		)
Unproved oil and gas properties		(38,523		)
Other assets		(7,919		)
Liabilities and Shareholders’ Equity ((Increase)/Decrease)
Current liabilities		96,142
Derivative instruments		17,087
FERI credit facility		176,102
Asset retirement obligations		150,182
Deferred income taxes		192,212
Accumulated other comprehensive income		(7,549		)
Net decrease to capital surplus and retained earnings		$	(565,658	)

 

The following table presents the revenues and direct operating expenses of the offshore Gulf of Mexico operations reported in the Condensed Consolidated Statements of Operations. The six months ended June 30, 2006 includes only two months of the offshore Gulf of Mexico operations, through February 28, 2006, whereas the 2005 period includes all six months of activity.

		Three Months Ended June 30,					Six Months Ended June 30,
		2006			2005		2006		2005
		(In Thousands)
Oil and gas revenues		$	—		113,489		46,289		234,332
Oil and gas production expense:
Lease operating expenses		—			19,202		18,296		35,824
Transportation costs		—			1,019		344		1,861
Production and property taxes		—			690		151		1,283
Oil and gas revenues in excess of direct operating expenses		$	—		92,578		27,498		195,364

 

Sale of ProMark—Discontinued Operations

On March 1, 2004, the Company sold the assets and business operations of Producers Marketing, Ltd. (“ProMark”) to Cinergy Canada, Inc. (“Cinergy”) for $11.2 million CDN. As a result of the sale, ProMark’s results of operations were reported as discontinued operations in the historical financial statements. Under the terms of the purchase and sale agreement, Forest may receive additional contingent consideration over a period of five years through February 2009. During the six months ended June 30, 2006, Forest recognized an additional $3.6 million contingent payment ($2.4 million net of tax), which has been reflected as income from discontinued operations in the Condensed Consolidated Statements of Operations.

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(3) EARNINGS PER SHARE AND COMPREHENSIVE EARNINGS (LOSS)

Earnings per Share

Basic earnings per share is computed by dividing net earnings attributable to common stock by the weighted average number of common shares outstanding during each period, excluding treasury shares.

Diluted earnings per share is computed by adjusting the average number of common shares outstanding for the dilutive effect, if any, of stock options, unvested restricted stock grants, unvested phantom stock units, and warrants. The following sets forth the calculation of basic and diluted earnings per share:

		Three Months Ended June 30,					Six Months Ended June 30,
		2006			2005		2006		2005
		(In Thousands, Except Per Share Amounts)
Earnings from continuing operations		$	57,048		52,201		58,297		91,072
Income from discontinued operations, net of tax		—			—		2,422		—
Net earnings		$	57,048		52,201		60,719		91,072
Weighted average common shares outstanding during the period		62,195			61,419		62,155		60,817
Add dilutive effects of stock options, unvested restricted stock grants, and unvested phantom stock units		1,294			990		1,184		984
Add dilutive effects of warrants		—			318		—		632
Weighted average common shares outstanding, including the effects of dilutive securities		63,489			62,727		63,339		62,433
Basic earnings per share:
From continuing operations		$	.92		.85		.94		1.50
From discontinued operations		—			—		.04		—
Basic earnings per share		$	.92		.85		.98		1.50
Diluted earnings per share:
From continuing operations		$	.90		.83		.92		1.46
From discontinued operations		—			—		.04		—
Diluted earnings per share		$	.90		.83		.96		1.46

 

Comprehensive Earnings (Loss)

Comprehensive earnings (loss) is a term used to refer to net earnings (loss) plus other comprehensive income (loss). Other comprehensive income (loss) is comprised of revenues, expenses, gains, and losses that under generally accepted accounting principles are reported as separate components of shareholders’ equity instead of net earnings (loss). Items included in Forest’s other comprehensive income (loss) for the three and six months ended June 30, 2006 and 2005 are foreign currency gains (losses) related to the translation of the assets and liabilities of Forest’s Canadian operations, changes in the unfunded pension liability, and net hedging losses deferred in other comprehensive income.

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(3) EARNINGS PER SHARE AND COMPREHENSIVE EARNINGS (LOSS) (Continued)

The components of comprehensive earnings (loss) are as follows:

		Three Months Ended June 30,					Six Months Ended June 30,
		2006			2005		2006		2005
		(In Thousands)
Net earnings		$	57,048		52,201		60,719		91,072
Other comprehensive income (loss):
Foreign currency translation gains (losses)		15,188			(4,011	)	13,258		(6,890	)
Unfunded pension liability, net of tax		—			—		83		(149	)
Unrealized gain (loss) on derivative instruments, net of tax		1,030			27,250		78,104		(48,259	)
Total comprehensive earnings		$	73,266		75,440		152,164		35,774

 

(4) STOCK-BASED COMPENSATION

Prior to January 1, 2006, the Company accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Under APB Opinion No. 25, no compensation expense was recognized for stock options issued to employees if the grant price equaled or was above the market price on the date of the option grant. Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised), Share-Based Payment (“SFAS 123(R)”) using the modified prospective method. Under this method, compensation cost is recorded for all unvested stock options, restricted stock, and phantom stock units beginning in the period of adoption and prior period financial statements are not restated. Under the fair value recognition provisions of SFAS 123(R), stock-based compensation is measured at the grant date based on the value of the awards and the value is recognized on a straight-line basis over the requisite service period (usually the vesting period).

The table below sets forth total stock-based compensation recorded during the three and six months ended June 30, 2006 under the provisions of SFAS 123(R) and the remaining unamortized amounts as of June 30, 2006. Approximately $9.7 million of the $16.2 million of total stock-based compensation for the six months ended June 30, 2006 was attributable to a partial settlement of the Company’s restricted stock awards and phantom stock unit awards in connection with the Spin-off.

		Stock Options			Restricted Stock		Phantom Stock Units		Total (1)
		(In Thousands)
Three months ended June 30, 2006:
Total stock-based compensation costs		$	1,896		1,275		107		3,278
Less: stock-based compensation costs capitalized		(279		)	(505	)	(61	)	(845	)
Stock-based compensation costs expensed		$	1,617		770		46		2,433
Six months ended June 30, 2006:
Total stock-based compensation costs		$	3,022		11,522		1,520		16,064
Less: stock-based compensation costs capitalized		(710		)	(4,286	)	(848	)	(5,844	)
Stock-based compensation costs expensed		$	2,312		7,236		672		10,220
Unamortized stock-based compensation costs as of June 30, 2006		$	8,109		13,316		2,176	(2)	23,601
Weighted average amortization period remaining		1.5 years			2.3 years		2.5 years		2.0 years

(1)                The Company also maintains an employee stock purchase plan (which is not included in the table above) under which $.1 million of compensation cost was recognized for both the three and six months ended June 30, 2006 under the provisions of SFAS 123(R).

(2)                Based on the closing price of the Company’s common stock on June 30, 2006.

SFAS 123(R) required the Company to estimate forfeitures in calculating the cost related to stock-based compensation as opposed to recognizing forfeitures and the corresponding reduction in expense as the forfeitures occur. The cumulative adjustment recorded related to this change of approximately $.1 million was recorded as a reduction in general and administrative expense and capitalized oil and gas properties in the first quarter of 2006 and was not presented separately

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(4) STOCK-BASED COMPENSATION (Continued)

in the Condensed Consolidated Statement of Operations. The impact of adopting SFAS 123(R) as of January 1, 2006 resulted in a decrease to net income of approximately $.5 million, or $.01 per basic and diluted share.

Equity Incentive Plans

In 2001, the Company adopted the Forest Oil Corporation 2001 Stock Incentive Plan (the “2001 Plan”) under which non-qualified stock options, incentive stock options, restricted stock, phantom stock units, and other awards may be granted to employees, consultants, and non-employee directors. In 2003, the Company amended the 2001 Plan to increase the number of shares of the Company’s common stock, at par value $.10 per share (“Common Stock”), reserved for issuance. The aggregate number of shares of Common Stock that the Company may issue under the 2001 Plan may not exceed 5,012,074 shares. Options have historically been granted at an exercise price equal to the fair market value of one share of Common Stock on the date of grant. Options granted to employees under the 2001 Plan generally vest in increments of 25% on each of the first four anniversary dates of the date of grant and have a term of ten years. Options granted to non-employee directors vest immediately and have a term of ten years. In connection with the Spin-off, the shares available for grant and outstanding stock options under the 2001 Plan were adjusted to reflect the economic effect of the Spin-off by reducing the exercise price and increasing the number of underlying shares. As of June 30, 2006, the Company had 625,784 shares available for issuance under the 2001 Plan.

The Company also had a Stock Incentive Plan (the “1996 Plan”) that expired on March 5, 2002 under which non-qualified stock options and restricted stock were granted to employees and director stock awards were granted to non-employee directors. Options granted under the 1996 Plan generally vested in increments of 20% commencing on the date of grant and on each of the first four anniversaries of the date of the grant and generally had a term of ten years.

The Company has historically issued new shares of Common Stock or treasury stock to settle its equity based awards. In May 2006, Forest retired the Company’s treasury stock. As a result of the retirement, settlements on equity based awards subsequent to May 2006 will be from issuances of new shares of Common Stock.

Stock Options

The following table summarizes stock option activity in the Company’s stock-based compensation plans for the six months ended June 30, 2006. The number of shares and the exercise price of the outstanding stock options were adjusted so that the fair value of each award was the same immediately before and after the Spin-off, in accordance with the anti-dilution provisions in the 2001 Plan and 1996 Plan.

		Number of Options		Weighted Average Exercise Price Per Share			Aggregate Intrinsic Value (In Thousands)(1)			Number of Shares Exercisable
Outstanding at January 1, 2006		2,578,235		$	27.78		$	45,889		1,348,599
Granted		—		—
Exercised		(58,337	)	28.71			1,255
Cancelled		(98,587	)	30.91
Outstanding at March 2, 2006		2,421,311		27.63			55,723
Adjustment to give effect to Spin-off		1,176,804		—
Granted		50,000		36.95
Exercised		(94,516	)	18.34			1,662
Cancelled		(49,835	)	20.06
Outstanding at June 30, 2006		3,503,764		18.84			49,349			2,199,687

(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.

Stock options are granted at the fair market value of one share of Common Stock on the date of grant. Options granted to non-employee directors vest immediately and options granted to officers and other employees vest ratably over four years. All outstanding options had a term of ten years at the date of grant.

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(4) STOCK-BASED COMPENSATION (Continued)

The fair value of stock options granted in the second quarter of 2006 was estimated using the Black-Scholes option pricing model. The following weighted average assumptions were used to compute the fair market value of stock options granted in the six months ended June 30, 2006 and 2005:

		Six Months Ended June 30,
		2006		2005
Expected life of options		10 years		5 years
Risk free interest rates		5.13%		3.64% to 4.20%
Estimated volatility		45%		33% to 35%
Dividend yield		0.0%		0.0%
Weighted average fair market value of options granted during the period		$23.60		$9.17

 

The expected life of the options is based, in part, on historical exercise patterns of the holders of options with similar terms, with consideration given to how historical patterns may differ from future exercise patterns based on current or expected market conditions and employee turnover. The risk free interest rate was based on the U.S. Treasury yield curve in effect at the time of grant. The expected volatility was based on the historical volatility of the Company’s stock.

The following table summarizes information about options outstanding at June 30, 2006:

				Stock Options Outstanding										Stock Options Exercisable
Range of Exercise Prices				Number of Options		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price			Aggregate Intrinsic Value (In Thousands)			Number Exercisable		Weighted Average Exercise Price			Aggregate Intrinsic Value (In Thousands)
$ 8.41 - 16.75				727,226		6.28		$	14.93		$	13,086		519,613		$	14.79		$	9,391
16.82 - 16.85				778,726		7.05		16.84			12,524			485,641		16.84			7,784
16.88 - 20.02				761,345		4.84		18.91			10,673			716,772		18.97			9,961
20.19 - 20.47				33,436		7.88		20.30			422			11,704		20.35			146
20.60 - 36.95				1,203,031		8.22		22.41			12,644			465,957		23.44			4,392
$ 8.41 - 36.95				3,503,764		6.82		18.84			$	49,349		2,199,687		18.47			$	31,674

 

Restricted Stock and Phantom Stock Units

The following summarizes restricted stock and phantom stock unit activity during the six months ended June 30, 2006. The grant date fair value of the restricted common stock and phantom stock units was determined by reference to the average of the high and low stock price of a share of Common Stock as published by the NYSE on the date of grant.

		Restricted Stock					Phantom Stock Units
		Number of Shares		Weighted Average Grant Date Fair Value(1)			Number of Shares		Weighted Average Grant Date Fair Value(1)
Unvested at January 1, 2006		634,000		$	43.72		72,350		$	46.07
Granted		22,600		43.85			9,500		38.77
Vested		(100	)	46.07			—		—
Forfeited		(21,350	)	46.07			(6,000	)	46.07
Unvested at June 30, 2006		635,150		43.65			75,850		45.16

(1)                These per-share fair values represent the actual grant date fair value and have not been adjusted to give effect to the Spin-off. In connection with the Spin-off, holders of restricted stock awards received .8093 unrestricted shares of FERI for each share of restricted stock. Accordingly, compensation cost of approximately $8.4 million was recorded in the first quarter of 2006 as a partial settlement of the restricted stock award, or approximately $13.00 per share. In addition, cash bonuses totaling $1.2 million were paid to Canadian employees in the first quarter of 2006 who held phantom stock units on that date representing the per-share value of the FERI shares received by each holder of restricted stock.

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(4) STOCK-BASED COMPENSATION (Continued)

The restricted stock and phantom stock units generally vest on the third anniversary of the date of the award, but may vest earlier upon a qualifying disability, death, retirement, or a change in control of the Company in accordance with the term of the underlying agreement. The phantom stock units may be settled in cash, shares of Common Stock, or a combination of both, at the Company’s discretion.

Employee Stock Purchase Plan

The Company has a 1999 Employee Stock Purchase Plan (the “ESPP”), under which it is authorized to issue up to 300,000 shares of Common Stock. Employees who are regularly scheduled to work more than 20 hours per week and more than five months in any calendar year may participate in the ESPP. Under the terms of the ESPP, employees may elect each quarter to have up to 15% of their annual base earnings withheld to purchase shares of Common Stock, up to a limit of $25,000 of Common Stock per calendar year. The ESPP currently provides for four offering periods during the year which coincide with the calendar quarters. The purchase price of a share of Common Stock purchased under the ESPP is equal to 85% of the lower of the beginning-of-quarter or end-of-quarter market price. ESPP participants are restricted from selling the shares of Common Stock purchased under the ESPP for a period of six months after purchase. As of June 30, 2006, the Company had 176,056 shares available for issuance under the ESPP.

Pro Forma Effects

Had Forest recognized compensation expense for all stock-based awards based upon the estimated fair value on the grant date under the fair value methodology prescribed by SFAS 123, as amended by SFAS 148 and SFAS 123(R), its pro forma net earnings and earnings per common share for the three and six month periods ended June 30, 2005 would have been as follows:

		Three Months Ended June 30, 2005			Six Months Ended June 30, 2005
		(In Thousands)
Net earnings, as reported		$	52,201		91,072
Add: Stock-based employee compensation included in reported net income, net of tax		99			174
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax		(722		)	(1,458	)
Pro forma net earnings		$	51,578		89,788
Basic earnings per common share:
As reported		$	.85		1.50
Pro forma		$	.84		1.48
Diluted earnings per common share:
As reported		$	.83		1.46
Pro forma		$	.82		1.44

 

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(5) LONG-TERM DEBT

Components of long-term debt are as follows:

		June 30, 2006									December 31, 2005
		Principal			Unamortized Premium (Discount)		Other (1)		Total		Principal		Unamortized Premium (Discount)		Other (1)		Total
		(In Thousands)
U.S. Credit Facility		$	280,000		—		—		280,000		97,000		—		—		97,000
Canadian Credit Facility		78,839			—		—		78,839		56,806		—		—		56,806
8% Senior Notes Due 2008		265,000			(195	)	4,512		269,317		265,000		(244	)	5,652		270,408
8% Senior Notes Due 2011		285,000			7,104		4,576		296,680		285,000		7,750		4,992		297,742
73¤4% Senior Notes Due 2014		150,000			(1,870	)	13,958		162,088		150,000		(1,990	)	14,841		162,851
		$	1,058,839		5,039		23,046		1,086,924		853,806		5,516		25,485		884,807

(1)                Represents the unamortized portion of gains realized upon termination of interest rate swaps that were accounted for as fair value hedges. The gains are being amortized as a reduction of interest expense over the terms of the notes.

(6) PROPERTY AND EQUIPMENT

Forest uses the full cost method of accounting for oil and gas properties. Separate cost centers are maintained for each country in which Forest has operations. During the periods presented, Forest’s primary oil and gas operations were conducted in the United States and Canada. All costs incurred in the acquisition, exploration, and development of properties (including costs of surrendered and abandoned leaseholds, delay lease rentals, dry holes, and overhead related to exploration and development activities) and the fair value of estimated future costs of site restoration, dismantlement, and abandonment activities are capitalized.

Investments in unproved properties, including related capitalized interest costs, are not depleted pending determination of the existence of proved reserves. Unproved properties are assessed periodically to ascertain whether impairment has occurred. Unproved properties whose costs are individually significant are assessed individually by considering the primary lease terms of the properties, the holding period of the properties, and geographic and geologic data obtained relating to the properties. Where it is not practicable to assess individually the amount of impairment of properties for which costs are not individually significant, such properties are grouped for purposes of assessing impairment. The amount of impairment assessed is added to the costs to be amortized, or is reported as a period expense, as appropriate.

Pursuant to full cost accounting rules, capitalized costs less related accumulated depletion and deferred income taxes for each cost center may not exceed the sum of (1) the present value of future net revenue from estimated production of proved oil and gas reserves using current prices, including the effects of derivative instruments but excluding the future cash outflows associated with settling asset retirement obligations that have been accrued on the balance sheet, and a discount factor of 10%; plus (2) the cost of properties not being amortized, if any; plus (3) the lower of cost or estimated fair value of unproved properties included in the costs being amortized, if any; less (4) income tax effects related to differences in the book and tax basis of oil and gas properties. Gain or loss is not recognized on the sale of oil and gas properties unless the sale significantly alters the relationship between capitalized costs and estimated proved oil and gas reserves attributable to a cost center.

Depletion of proved oil and gas properties is computed on the units-of-production method, whereby capitalized costs, as adjusted for future development costs and asset retirement obligations, are amortized over the total estimated proved reserves. Furniture and fixtures, computer hardware and software, and other equipment are depreciated on the straight-line or declining balance method, based upon estimated useful lives of the assets ranging from three to 12 years.

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(7) ASSET RETIREMENT OBLIGATIONS

Forest records estimated future asset retirement obligations pursuant to the provisions of Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations (“SFAS No. 143”). SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred with a corresponding increase in the carrying amount of the related long-lived asset. Subsequent to initial measurement, the asset retirement liability is required to be accreted each period to its present value. Capitalized costs are depleted as a component of the full cost pool using the units-of-production method. Forest’s asset retirement obligations consist of costs related to the plugging of wells, the removal of facilities and equipment, and site restoration on oil and gas properties.

The following table summarizes the activity for Forest’s asset retirement obligations for the six months ended June 30, 2006 and 2005:

		Six Months Ended June 30,
		2006			2005
		(In Thousands)
Asset retirement obligations at beginning of period		$	211,554		210,176
Accretion expense		4,653			8,599
Liabilities incurred		488			3,433
Liabilities assumed		1,009			705
Liabilities included in the Spin-off		(150,182		)	—
Liabilities settled		(5,604		)	(9,266	)
Revisions of estimated liabilities		340			3,561
Impact of foreign currency exchange rate		506			(219	)
Asset retirement obligations at end of period		62,764			216,989
Less: Current asset retirement obligations		(1,741		)	(36,772	)
Long-term asset retirement obligations		$	61,023		180,217

 

(8) EMPLOYEE BENEFITS

The following table sets forth the components of the net periodic cost of Forest’s defined benefit pension plans and postretirement benefits in the United States for the three and six months ended June 30, 2006 and 2005:

		Pension Benefits					Postretirement Benefits				Pension Benefits				Postretirement Benefits
		Three Months Ended June 30,					Three Months Ended June 30,				Six Months Ended June 30,				Six Months Ended June 30,
		2006			2005		2006		2005		2006		2005		2006		2005
		(In Thousands)
Service cost		$	—		—		137		167		—		—		306		334
Interest cost		548			581		101		113		1,096		1,162		219		226
Curtailment gain (1)		—			—		—		—		—		—		(1,851	)	—
Expected return on plan assets		(607		)	(586	)	—		—		(1,215	)	(1,172	)	—		—
Recognized actuarial loss		228			188		—		—		455		376		—		—
Total net periodic expense		$	169		183		238		280		336		366		(1,326	)	560

(1)                Forest recognized a $1.9 million curtailment gain in connection with the Spin-off on March 2, 2006. This gain was recorded as a reduction in general and administrative expense for the six months ended June 30, 2006.

(9) FINANCIAL INSTRUMENTS

Forest periodically enters into derivative instruments such as swap, basis swap, and collar agreements in order to provide a measure of stability to Forest’s cash flows in an environment of volatile oil and gas prices and to manage the exposure to commodity price risk. Forest’s commodity derivative instruments generally serve as effective economic hedges of commodity price exposure; however, various circumstances can cause commodity hedges to not qualify for cash flow

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hedge accounting either at the inception of the hedge or during the term of the hedge. When the criteria for cash flow hedge accounting are not met or when cash flow hedging is not elected, realized gains and losses (i.e., cash settlements) are recorded in other income and expense in the Condensed Consolidated Statements of Operations. Similarly, changes in the fair value of the derivative instruments are recorded as unrealized gains or losses in the Condensed Consolidated Statements of Operations. In contrast, cash settlements for derivative instruments that qualify for hedge accounting are recorded as additions to or reductions of oil and gas revenues while changes in fair value of cash flow hedges are recognized, to the extent the hedge is effective, in other comprehensive income until the hedged item is recognized in earnings.

 

(9) FINANCIAL INSTRUMENTS (Continued)

Discontinuance of Hedge Accounting

As a result of production deferrals experienced in the Gulf of Mexico related to hurricanes Katrina and Rita, Forest was required to discontinue cash flow hedge accounting on some of its natural gas and oil hedges during the third and fourth quarters of 2005. Additionally, as a result of the Spin-off on March 2, 2006, additional commodity swaps and collars formerly designated as cash flow hedges of offshore Gulf of Mexico production also no longer qualified for hedge accounting.

Because a significant portion of the Company’s derivatives no longer qualified for hedge accounting and to increase clarity in its financial statements, the Company elected to discontinue hedge accounting prospectively for all of its remaining commodity derivatives beginning in March 2006. This change in reporting will have no impact on the Company’s reported cash flows, although future results of operations will be affected by mark-to-market gains and losses, which fluctuate with volatile oil and gas prices. Subsequent to March 2006, the Company has recognized all mark-to-market gains and losses in earnings, rather than deferring such amounts in accumulated other comprehensive income included in shareholders’ equity.

The net mark-to-market loss on the Company’s remaining swaps and collars that qualified for cash flow hedge accounting at the date the decision was made to discontinue hedge accounting are deferred in accumulated other comprehensive income and will be amortized into oil and gas revenues as the original forecasted hedged oil and gas production occurs in 2006. Amortization of the net deferred losses will be recorded in 2006 as follows:

		(In Thousands)
Third Quarter 2006		$	2,250
Fourth Quarter 2006		3,207
		$	5,457

 

The table below summarizes the realized and unrealized losses (gains) Forest incurred related to its derivative instruments for the periods indicated.

		Three Months Ended June 30,					Six Months Ended June 30,
		2006			2005		2006		2005
		(In Thousands)
Realized losses on derivatives designated as cash flow hedges(1)		$	1,677		33,541		38,357		54,350
Realized losses (gains) on derivatives not designated as cash flow hedges(2)		13,698			(850	)	17,613		(318	)
Ineffectiveness recognized on derivatives designated as cash flow hedges(2)		—			(2,181	)	(5,573	)	(792	)
Unrealized (gains) losses on derivatives not designated as cash flow hedges(2)		(14,378		)	(2,129	)	15,309		3,062
Total realized and unrealized losses recorded		$	997		28,381		65,706		56,302

(1)                Included in oil and gas sales in the Condensed Consolidated Statements of Operations.

(2)                Included in other income and expense in the Condensed Consolidated Statements of Operations.

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(9) FINANCIAL INSTRUMENTS (Continued)

The tables below set forth Forest’s outstanding commodity swaps and collars as of June 30, 2006:

		Swaps
		Natural Gas (NYMEX HH)					Oil (NYMEX WTI)
		Bbtu per Day		Weighted Average Hedged Price per MMBtu			Barrels per Day		Weighted Average Hedged Price per Bbl
Third Quarter 2006		10.0		$	5.51		7,500		$	51.18
Fourth Quarter 2006		10.0		5.51			7,500		51.18
Fiscal 2007		—		—			3,500		73.16
Fiscal 2008		—		—			3,000		73.02
Fiscal 2009		—		—			2,500		73.02
Fiscal 2010		—		—			2,000		73.15

 

		Costless Collars
		Natural Gas (NYMEX HH)					Oil (NYMEX WTI)
		Bbtu per Day		Weighted Average Hedged Floor and Ceiling Price per MMBtu			Barrels per Day		Weighted Average Hedged Floor and Ceiling Price per Bbl
Third Quarter 2006		50.0		$	7.43/11.88		5,500		$	46.73/65.87
Fourth Quarter 2006		50.0		7.43/11.88			5,500		46.73/65.87
Fiscal 2007		15.0		9.60/10.85			2,000		65.13/85.25

 

At June 30, 2006, the fair value of Forest’s commodity derivative contracts was a liability of $50.4 million (of which $49.2 million was classified as current) and a derivative asset of $14.6 million (of which $10.9 million was classified as current). Forest is exposed to risks associated with swap and collar agreements arising from movements in the prices of oil and natural gas and from the unlikely event of non-performance by the counterparties to the swap and collar agreements.

In July 2006, the Company entered into additional costless collar agreements. The table below sets forth the weighted average terms of these agreements.

		Costless Collars
		Natural Gas (NYMEX HH)					Oil (NYMEX WTI)
		Bbtu per Day		Weighted Average Hedged Floor and Ceiling Price per MMBtu			Barrels per Day		Weighted Average Hedged Floor and Ceiling Price per Bbl
Fiscal 2007		20.0		$	8.13/12.34		2,000		$	66.50/89.10

 

(10) BUSINESS AND GEOGRAPHICAL SEGMENTS

Segment information has been prepared in accordance with Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information. At June 30, 2006, Forest had five reportable segments consisting of oil and gas operations in five business units Southern (formerly Gulf Coast), Western, Alaska, Canada, and International. Forest’s remaining marketing and processing activities are not significant and therefore are not reported as a separate segment, but are included as a reconciling item in the information below. The segments were determined based upon the type of operations in each business unit and the geographical location of each. The segment data presented below was prepared on the same basis as the Condensed Consolidated Financial Statements. Effective in the first quarter of 2006, the Company ceased allocating general and administrative expenses to the business units to correspond with the Company’s decision to monitor and evaluate general and administrative expenses at the corporate level. Additionally, the Company modified the method utilized in allocating depletion expense between its business units effective in the first quarter of 2006 such that the depletion rate per Mcfe is consistent among those business units within the U.S. cost center. Segment information previously reported has been modified to conform with the current presentation.

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