[BARNWELL INDUSTRIES INC. LOGO]
1100 Alakea Street
Suite 2900
Honolulu, Hawaii 96813
Telephone (808) 531-8400
Fax (808) 531-7181
April 13, 2007
Mr. Karl Hiller
Branch Chief
United States Securities and Exchange Commission
Division of Corporation Finance
450 Fifth Street, N.W., Mail Stop 7010
Washington, D.C. 20549
VIA FAX TO (202) 772-9220
(Original to follow via FedEx)
RE: Barnwell Industries, Inc.
Form 10-K for the fiscal year ended September 30, 2006
File Number 1-5103
Dear Mr. Hiller,
This letter will serve as the response of Barnwell Industries,
Inc. ("Barnwell" or the "Company") to the comments received from the staff
(the "Staff") of the Securities and Exchange Commission by letter dated March
30, 2007. To assist in your review, we have included the Staff's numbered
comments and have provided our responses below each comment.
ITEM 1. BUSINESS
ESTIMATED FUTURE NET REVENUES
STAFF COMMENT:
1. We note your disclosure of the table calculating the present value of
estimated future net revenues as of September 30, 2006. Further, we
note that you have calculated net revenues using current sales prices
and costs, after deducting all royalties, operating costs, future
estimated capital expenditures, and income taxes. This measure does
not appear to differ from the standardized measure that you have
calculated and presented in accordance with SFAS 69. As such, please
revise the label to state standardized measure of estimated discounted
future net cash flows.
MANAGEMENT RESPONSE:
The Company will revise the label to state "Standardized Measure of
Estimated Discounted Future Net Cash Flows." We propose to make the
recommended change in our next Form 10-K filing.
MANAGEMENT'S DISCUSSION AND ANALYSIS AND FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
STAFF COMMENT:
2. We note that you have identified many areas of accounting that you
regard as critical, due to the significant level of judgment required
to determine various assumptions underpinning their application, and
which under different conditions, could lead to "material differences"
in your financial statements. However, the disclosures that you provide
appear to be essentially the same as the accounting policies utilized,
rather than any specific uncertainties underlying your estimates. In
other words, not all of the critical accounting policies that you
disclose appear to have critical judgment and estimation attributes,
and for those that do, the disclosures do not sufficiently address such
attributes.
Please revise your disclosures to address the material implications of
the uncertainties that are associated with the methods, assumptions
and estimates underlying your critical accounting estimates.
Specifically, you should provide the following:
(a) An analysis of the uncertainties involved in applying the
principle and the variability that is reasonably likely to
result from its application.
(b) An analysis of how you arrived at the measure and how accurate
the estimate or underlying assumptions have been in the past.
(c) An analysis of your specific sensitivity to change, based on
outcomes that are reasonably likely to occur and have a
material effect.
Please refer to FRC Section 501.14 for further guidance.
MANAGEMENT RESPONSE:
We have reanalyzed our as-filed disclosure under the guidance of FRC
Section 501.14. Based on the reanalysis, we have determined that our
as-filed disclosure would benefit from certain revisions. Accordingly,
we propose a revised disclosure which provides improved focus and clarity
of those areas meeting the requirements of FRC Section 501.14, which states
that "When preparing disclosure under the current requirements, companies
should consider whether they have made accounting estimates or assumptions
where:
- the nature of the estimates or assumptions is material due to the
levels of subjectivity and judgment necessary to account for highly
uncertain matters or the susceptibility of such matters to change;
and
- the impact of the estimates and assumptions on financial condition or
operating performance is material.
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"If so, companies should provide disclosure about those critical
accounting estimates or assumptions in their MD&A." Our proposed disclosure
is as follows:
Management believes the accounting policies that are most critical
in assisting financial statement readers in understanding and
evaluating our results due to their subjective judgments are as
follows:
- Oil and natural gas properties - full cost ceiling calculation
and depletion
Policy Description
We use the full cost method of accounting for our oil and
natural gas properties, under which we are required to conduct
quarterly calculations of a "ceiling," or limitation on the
carrying value of oil and natural gas properties. The ceiling
limitation is the sum of 1) the discounted present value (at 10%),
using prices as of the end of each reporting period on a constant
basis, of Barnwell's estimated future net cash flows from
estimated production of proved oil and natural gas reserves, less
estimated future expenditures to be incurred in developing
and producing the proved reserves but excluding future cash
outflows associated with settling asset retirement obligations
accrued on the balance sheet; plus 2) the cost of major development
projects and unproven properties not subject to depletion, if any;
plus 3) the lower of cost or estimated fair value of unproven
properties included in costs subject to depletion; less 4) related
income tax effects. If net capitalized costs exceed this limit,
the excess is expensed unless subsequent market price changes
eliminate or reduce the indicated write-down in accordance with
SEC Staff Accounting Bulletin Topic 12D.
Judgments and Assumptions
The estimate of our oil and natural gas reserves is a major
component of the ceiling calculation, and represents the component
that requires the most subjective judgments. Estimates of reserves
are forecasts based on engineering data, historical data, projected
future rates of production and the timing of future expenditures.
The process of estimating oil and natural gas reserves requires
substantial judgment, resulting in imprecise determinations,
particularly for new discoveries. Our reserve estimates are prepared
annually by independent petroleum engineers and quarterly by
internal personnel. The passage of time provides more quantitative
and qualitative information regarding estimates of reserves, and
revisions are made to prior estimates to reflect updated information.
In the past three fiscal years, annual revisions to our reserve volume
estimates have averaged 2% of the previous year's estimate. However,
there can be no assurance that more significant revisions will not be
necessary in the future. If future significant revisions are necessary
that reduce previously estimated reserve quantities, such revisions
could result in a write-down of oil and natural gas properties. If
reported reserve volumes were revised downward by 5% at the end of
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fiscal 2006, the ceiling limitation would have decreased
approximately $2,400,000.
In addition to the impact of the estimates of proved reserves
on the calculation of the ceiling, estimated proved reserves
are also a significant component of the quarterly calculation of
depletion expense. The lower the estimated reserves, the higher
the depletion rate per unit of production. Conversely, the
higher the estimated reserves, the lower the depletion rate per
unit of production. If reported reserve volumes were revised
downward by 5% as of the beginning of fiscal 2006, depletion
for fiscal 2006 would have increased by approximately $506,000.
While the quantities of proved reserves require substantial
judgment, the associated prices of oil, natural gas and natural
gas liquids ("NGL") reserves, and the applicable discount rate,
that are used to calculate the discounted present value of the
reserves do not require judgment. The ceiling calculation
dictates that a 10% discount factor be used and that prices and
costs in effect as of the last day of the period are held
constant indefinitely. Therefore, the future net revenues
associated with the estimated proved reserves are not based on
our assessment of future prices or costs. Rather, they are based
on such prices and costs in effect as of the end of each period
for which the ceiling calculation is performed.
Because the ceiling calculation dictates that prices in effect
as of the last day of the applicable quarter are held constant
indefinitely, and requires a 10% discount factor, the resulting
value is not indicative of the true fair value of the reserves.
Oil and natural gas prices have historically been volatile.
Therefore, oil and natural gas property write-downs that result
from applying the full cost ceiling limitation, and that are
caused by fluctuations in prices as opposed to reductions to the
underlying quantities of reserves, should not be viewed as absolute
indicators of a reduction of the ultimate value of the related
reserves.
- Income taxes
Policy Description
Deferred income taxes are determined using the asset and liability
method. Deferred tax assets and liabilities are recognized for the
estimated future tax impacts of differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are
measured using enacted tax rates in effect for the year in which those
temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the
enactment date. A valuation allowance is provided when it is more
likely than not that some portion or all of the deferred tax
asset will not be realized.
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Judgments and Assumptions
We make estimates and judgments in determining our income tax expense
for each reporting period. Significant changes to these estimates
could result in an increase or decrease in our tax provision in future
periods. We are also required to make judgments about the
recoverability of deferred tax assets and when it is more likely than
not that all or a portion of deferred tax assets will not be realized,
a valuation allowance is provided. Changes in the assumptions regarding
the realization of deferred tax assets could result in an increase or
decrease in our income tax provision. Furthermore, changes in our
business performance could require a valuation allowance or a reversal in
the valuation allowance in future periods. The impact of any of
these changes could be material. Historically, our current income
tax estimates have not materially differed from our income tax returns
filed with taxing authorities. However, there can be no assurance that
material differences will not occur in the future.
Barnwell has established a valuation allowance primarily for the U.S.
tax effect of deferred Canadian taxes, accrued expenses and state of
Hawaii net operating loss carryforwards which may not be realizable in
future years as there can be no assurance of any specific level of
earnings or that the timing of U.S. earnings will coincide with the
payment of Canadian taxes to enable Canadian taxes to be a fully
beneficial deduction for U.S. tax purposes.
Canadian deferred tax assets related to expenses accrued for book
purposes but not for tax purposes are estimated to be realized through
future Canadian income tax deductions against future Canadian oil and
natural gas earnings. U.S. deferred tax assets related to expenses
accrued for book purposes but not for tax purposes and the excess of
the cost basis of investment in land for tax purposes over the cost
basis of investment in land for book purposes are estimated to be
realized from deductions against future U.S. earnings from sales of
interests in leasehold land and land development rights. Foreign tax
credit carryforwards are estimated to be utilized when U.S. federal
income taxes otherwise due on Canadian source income in a given year
exceeds the foreign tax credit generated in that year. The foreign tax
credit carryforwards will expire if not utilized in fiscal years 2012
through 2013. The amount of deferred income tax assets considered
realizable may be reduced if estimates of future taxable income are
reduced.
- Asset Retirement Obligation
Policy Description
Barnwell accounts for asset retirement obligations in accordance with
SFAS No. 143, "Accounting for Asset Retirement Obligations," and FASB
Interpretation No. 47, "Accounting for Conditional Asset Retirement
Obligations - an interpretation of FASB Statement No. 143," which
requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred if a
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reasonable estimate of fair value can be made. Barnwell's estimated
site restoration and abandonment costs of its oil and natural gas
properties are capitalized as part of the carrying amount of oil
and natural gas properties and depleted over the life of the related
reserves. The liability is accreted at the end of each period through
charges to oil and natural gas operating expense. If an obligation
is settled for other than the carrying amount of the liability,
Barnwell will recognize a gain or loss on settlement.
Judgments and Assumptions
The asset retirement obligation is recorded at fair value in the
period in which it is incurred along with a corresponding increase
in the carrying amount of the related asset. Barnwell has estimated
fair value by discounting the estimated future cash outflows required
to settle abandonment and restoration liabilities. The present value
calculation includes numerous estimates, assumptions and judgments
regarding the existence of liabilities, the amount and timing of cash
outflows required to settle the liability, what constitutes adequate
restoration, inflation factors, credit adjusted discount rates, and
consideration of changes in legal, regulatory, environmental and
political environments. Abandonment and restoration cost estimates
are determined in conjunction with Barnwell's reserve engineers based
on historical information regarding costs incurred to abandon and
restore similar well sites, information regarding current market
conditions and costs, and knowledge of subject well sites and
properties. The process of estimating the asset retirement
obligation requires substantial judgment and use of estimates,
resulting in imprecise determinations. Following the implementation
of SFAS No. 143, actual asset retirement obligations through the end
of fiscal 2006 have not materially differed from our estimates.
However, because of the inherent imprecision of estimates as described
above, there can be no assurance that material differences will not
occur in the future. A 20% increase in accretion and depletion related
to the asset retirement obligation would have increased Barnwell's fiscal
2006 expenses before taxes by approximately $100,000.
We propose to make the recommended changes above in our next
Form 10-Q and Form 10-K filings.
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Please note that in the interest of providing a more concise disclosure
that focuses on material areas, concurrent with our proposal above we
also propose to delete areas that were previously disclosed in the
Critical Accounting Policies and Estimates section of our September 30,
2006 Form 10-K. This proposed change is based on the criteria of
critical estimates or assumptions as per FRC Section 501.14. A discussion
of our basis for deeming the following policies as non-critical are noted
below:
- - Contract drilling
Contract drilling revenues and costs are recognized under the percentage
of completion method. Under this method, the amount of revenue and costs
recognized is based on the percentage of labor costs that have been
incurred through the reporting period in relation to total estimated
labor costs associated with the contract. These revenues and costs are
comprised of several different jobs in varying stages of completion;
completed jobs would reflect actual performance and would no longer be
based on estimates. Jobs generally do not progress longer than a year
and therefore the duration of any use of estimates is not long-term.
Accordingly, reported contract drilling revenues and costs are not based
on a high degree of uncertainty or subjectivity. Taking these factors
into account, we do not believe the accounting for contract drilling
qualifies as a critical accounting estimate.
- - Retirement plans
The estimation of our pension and postretirement costs and liabilities,
which are calculated and evaluated by an independent actuarial
consulting firm, requires that we use estimates of the present value
of the projected future payments to all participants, taking into
consideration the likelihood of potential future events. At
September 30, 2006, we had a prepaid pension plan benefit cost of
$221,000. Our accrued supplemental employee retirement plan liability
was $568,000. Further, our pension expense was $298,000 and our
supplemental employee retirement plan expense was $105,000. Any variance
in such amounts due to changes in estimates or differences in actual
experience is not expected to be material to the financial statements.
Accordingly, we do not believe the accounting for retirement plans
qualifies as a critical accounting estimate.
- - Share-based payments
The Company determines the fair value of its stock option awards using
a closed-end option-pricing model which requires management to make
assumptions and apply judgment to determine the fair value of the awards.
The accrued stock appreciation rights liability at September 30, 2006 was
$3,326,000, and the expense related to stock appreciation rights and
qualified options was $439,000 and $144,000, respectively, for fiscal
2006. The impact of differences in assumptions and estimates on the
valuation of such options is not significant based on the number of
vested share options and the duration of the option terms. Accordingly,
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any variance in such amounts due to differences in estimates is not
expected to be material to the financial statements. With regard to
stock appreciation rights, the value of such rights is largely based
on the Company's period-end closing market price of its stock, which
is not an estimate. As such, we do not believe share-based payments
qualify as a critical accounting estimate.
- - Long-lived assets
Long-lived assets to be held and used, other than oil and natural gas
properties, are evaluated for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
fully recoverable. Estimates and assumptions are used when determining
the recoverability of long-lived assets. At September 30, 2006, the
carrying value of investment in land was $50,000 and the carrying value
of property, plant and equipment other than oil and natural gas
properties was $2,428,000. The carrying value of investment in land is
not material, and the evaluation of the physical assets that comprise
the $2,428,000 balance of property, plant and equipment, other than oil
and natural gas properties, for impairment is not subject to a high
degree of uncertainty or subjectivity. Therefore, we do not believe
the valuation of long-lived assets is deemed a critical accounting
estimate.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
STAFF COMMENT:
3. We note that you provide qualitative discussion about market risk as
it pertains to commodity price risk, interest rate risk and foreign
currency exchange risk. However, it does not appear that you have
provided the quantitative disclosures required by Item 305 of
Regulation S-K. Please expand your disclosure to provide this
information using at least one of the three acceptable disclosure
alternatives outlined in Item 305 of Regulation S-K.
MANAGEMENT RESPONSE:
Our understanding of Item 305 of Regulation S-K is that quantitative
information is required with respect to market risk sensitive instruments.
In our September 30, 2006 Form 10-K, we stated "Currently, Barnwell accepts
the volatility risk that oil and natural gas prices present as Barnwell
has not entered into transactions utilizing derivative financial
instruments or derivative commodity instruments." This statement was
reflected in the second paragraph of "Commodity Price Risk" in Item 7A.
To improve the clarity of our disclosure, we propose the following
revisions to clearly state that Barnwell does not have material
market risk:
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- - Commodity Price Market Risk
Realized pricing of our oil, natural gas and NGL production is
primarily driven by the prevailing worldwide price for crude oil
and North American spot market prices applicable to our Canadian
natural gas and NGL production. Pricing for oil, natural gas and
NGL production has historically been volatile and unpredictable,
and such volatility is expected to continue. Essentially all of
Barnwell's oil and natural gas revenue were from products sold at
spot prices. Barnwell has not entered into hedging or other
transactions utilizing derivative or other commodity instruments,
and as such Barnwell does not bear material commodity price market
risk related to such instruments.
- - Interest Rate Market Risk
Barnwell is exposed to changes in U.S. and Canadian interest rates,
primarily resulting from its borrowing activities used to fund
operations and maintain liquidity. Barnwell has a revolving credit
facility which carries a variable interest rate tied to market indices.
The credit facility is available in U.S. dollars at the London Interbank
Offer Rate ("LIBOR") plus 2%, at U.S. prime plus 1%, or in Canadian
dollars at Canadian prime plus 1%. In each of the last three fiscal
years, Barnwell has borrowed at either the one month LIBOR rate plus
2% or the floating prime rate plus 1%. Based on the amount of
outstanding debt under our credit facility on September 30, 2006,
a one percent increase in our average interest rate would result in
a decrease in our annual pre-tax net income of approximately $117,000.
As Barnwell's interest rate follows changes in market interest rates
within a period of approximately one month and as Barnwell has not
entered into hedging or other transactions utilizing derivative or
other financial instruments, Barnwell does not bear material interest
rate market risk related to such instruments.
- - Foreign Currency Exchange Market Risk
Barnwell's oil and natural gas operations are conducted in Canada.
Barnwell has not entered into hedging or other transactions utilizing
derivative or other foreign exchange instruments, and as such Barnwell
does not bear material foreign currency exchange market risk related to
such instruments.
We propose to make the recommended changes in our next Form 10-Q and
Form 10-K filings.
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FINANCIAL STATEMENTS
STATEMENTS OF CASH FLOWS
STAFF COMMENT:
4. We note that you present cash proceeds from sale of interest in
leasehold land and development rights as an investing activity on
your consolidated statements of cash flows. Since you present
the sale of interest in leasehold land and the sale of development
rights as operating revenues on your statements of operations as
well as you identify your real estate investing activities as a
reportable segment, it is unclear to us why you do not consider
these cash flows from operating activities. Please explain to us
in detail your basis for presenting these cash flows as an investing
activity.
MANAGEMENT RESPONSE:
In May of 1984, Barnwell made a $2,000,000 cash investment and
committed to drill a water well and provide pumping equipment and
other consideration to purchase a 50.1% interest in the leasehold
lands at Kaupulehu on the island of Hawaii. The Company reported the
investment in its Statement of Changes in Financial Position as a
"Purchase of investment in land" on the line under its reported additions
to property and equipment (this was prior to the issuance of SFAS 95).
This was a unique investment for Barnwell both then and now. This was the
first investment in a land position outside of land utilized in one of the
Company's businesses and up to and including fiscal 2006 its only one. The
investment was speculative in nature and the Company did not, and currently
still does not, have the resources to by itself develop the property into a
large resort/residential project, which is what the buyers of the property
have successfully done to much of the acreage to date. The land position
acquired was a significant one of approximately 11,000 acres, and over
the course of several years the Company invested substantial amounts in
legal and consulting costs to obtain zoning entitlements and development
rights with the lessor of the land. Barnwell then sold various portions
of its leasehold land interests and development rights of the original
11,000 acre position, both those for which we had obtained entitlement
rights and other portions that we had not. The outlay of the capital
funds mentioned above were reported by the Company upon the
implementation of SFAS 95 under "Cash flows from investing activities"
over a period of several years. The Company did not develop the
property and these land sales were infrequent and of a singular nature,
occurring for the first time in fiscal 1989 and then also in fiscal 1990
and 1992. Over the 23 years that the Company has been involved in this
investment the first 15 years saw only three transactions occur. After
the Four Seasons Resort opening in 1996, significant progress was made by the
developer in attracting attention to the property and they and another
developer have purchased portions of the property from Barnwell in
fiscal 2000, and 2002 thru 2006.
As discussed above, the Company's investments in leasehold land interests
and development rights are largely speculative in nature. Investing
activities are defined under SFAS 95 as "making and collecting loans
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and acquiring and disposing of debt or equity instruments and property,
plant, and equipment and other productive assets, that is, assets held for
or used in the production of goods or services by the enterprise." The
Company considers the sales of interest in leasehold land and sales of
development rights analogous to sales of debt or equity investment securities
due to the speculative nature of such investments. As such, we have presented
sales of interests in leasehold land and sales of development rights as
investing activities in the statements of cash flows in our Form 10-K and Form
10-Q filings.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
OIL AND GAS PROPERTIES
STAFF COMMENT:
5. We note that a majority of your proved reserves are gas. As such,
please disclose your method of accounting for gas imbalances and to
the extent significant, the amount of any imbalance in terms of
units and value. Refer to EITF 90-22 for further guidance.
MANAGEMENT RESPONSE:
Barnwell's sales reflect its gross working interest share.
Barnwell's production is delivered and sold at the plant gate and
Barnwell does not hold any transportation contracts with pipelines
and does not have contractual obligations related to the physical
amount of natural gas to be delivered. Barnwell does not have
natural gas imbalances related to natural gas-balancing arrangements
with its partners.
We propose to add such a statement in our oil and natural gas
properties significant accounting policy in our next Form 10-Q
and Form 10-K filings.
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INVESTMENT IN LAND AND REVENUE RECOGNITION
STAFF COMMENT:
6. We note your disclosure in which you explain that you account for
your sales of development rights under option and leasehold land
interests pursuant to the provisions of SFAS 66. This accounting
standard provides extensive guidance on how to identify criteria
to be used to determine when and how profit is recognized on
real estate sales. Due to the complexity of this guidance, please
expand your accounting policy disclosure to indicate the specific
method you use to recognize revenue including the criteria that has
been met to support your profit recognition methodology.
MANAGEMENT RESPONSE:
The Company proposes to, in our next 10-Q and 10-K filings, expand its
investment in land revenue recognition accounting policy disclosure
to reflect the following language:
Barnwell accounts for sales of development rights under option and
the Increment I and Increment II leasehold land interest sales under
the full accrual method pursuant to the provisions of SFAS No. 66,
"Accounting for Sales of Real Estate." Gains from such sales are
recognized when the buyer's investments are adequate to demonstrate
a commitment to pay for the property, risks and rewards of ownership
have been transferred to the buyer, and Barnwell does not have a
substantial continuing involvement with the property sold. The cash
proceeds received by Barnwell for the sales of development rights and
leasehold land interests were adequate to demonstrate a commitment
to pay for the property, and Barnwell conveyed the related development
rights and leasehold land interests upon consummation of the sales
with no substantial continuing involvement with the property. With
regard to the sales of Increment I and Increment II leasehold land
interests, in accordance with SFAS No. 66, the percentage of sales
payments are contingent future profits which shall be recognized
when they are realized, and all costs of the sales were recognized
at the time of sale and none were deferred to future periods when any
contingent profits will be recognized.
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In addition to providing the aforementioned responses, Barnwell
Industries, Inc. hereby acknowledges that:
- - The Company is responsible for the adequacy and accuracy of the
disclosure in the filing;
- - Staff comments or changes to disclosure in response to staff
comments do not foreclose the Commission from taking any action
with respect to the filing; and
- - The Company may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the
federal securities laws of the United States.
Please contact me if additional information or further explanations
are necessary. Although we appreciate the Staff's comments, we do
not believe that the matters raised in the letter dated March 30, 2007
are of a sufficient magnitude to warrant an amendment to the Company's
Form 10-K for the year ended September 30, 2006. However, we
propose to incorporate our responses, as appropriate and subject to
any of the Staff's suggestions or modifications, in future filings;
Barnwell's next filing will be Form 10-Q on or about May 15, 2007.
Very truly yours,
/s/ Russell M. Gifford
Russell M. Gifford
Executive Vice President,
Chief Financial Officer,
Treasurer and Secretary
cc: Nasreen Mohammed, Securities and Exchange Commission
Jenifer Gallagher, Securities and Exchange Commission
Floyd I. Wittlin, Bingham McCutchen LLP
Nancy C. Rose, KPMG LLP
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