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Clayton Williams Energy Inc. (NYSE:CWEI)

F1Q08 (Qtr End 10/28/09) Earnings Call

November 5, 2008 2:00 pm ET

Executives

Clayton W. Williams, Jr. – Chief Executive Officer

Mel G. Riggs – Chief Financial Officer

Analysts

[Neil Mark] – Zacks Investment Research

Steven Orr – Orr Investments

Bill Nasgovitz – Heartland Funds

Operator

Welcome to the Q3 2008 Clayton Williams Energy Incorporated earnings conference call. (Operator Instructions) I would now like to turn the call over to Mr. Clayton Williams, please proceed, sir.

Clayton Williams

Thank you welcome folks we’re hoping to have a nice session today, I think we have some good things to tell you. In our normal format Mel Riggs, our Chief Financial Officer, will line out our financial achievements, the different pros and cons, we will, I would ask you to ask questions of Mel during and particularly after his presentation.

After that then I will give a look back and in particular look forward on how we’re handling the current challenging situation and what our plans are to continue to grow and do well in the future. Having said, that here is Mel Riggs.

Mel Riggs

We reported net income of $94.6 million for the current quarter, that’s $7.79 per share compared to last year of income of about $1 million and $0.09 per share. Our cash flow from operations for the current quarter was $73.6 million, just a little over $6 per share compared to last year’s cash flow of $72.4 which was $6.28 per share.

Our oil and gas production on Mcfe basis averaged just over 94 million cubic feet a day, compared to 104 million a day last year for the same period. We’ll talk about what’s behind the decrease here in a moment.

Oil production rose 30% compared to last year. Gas production was down 32% compared to the third quarter 2007. When you compare the quarterly production in volumes it’s important to note that two major factors had an adverse effect on or adversely contributed in the overall drop in oil and gas production.

First of all in the 2007 quarter, in September of 2007, that quarter included production in south Louisiana , 750 barrels of oil a day and about 12 million cubic feet of gas. That production was sold in April of 2008. It came out of our, comparatively we have to sell to kind of back up and get them on an apples-to-apples basis.

Also production volumes in the third quarter this year were lower due to the curtailment of oil and gas production due to the two hurricanes. That reduced our production about 100 barrels a day and 2 million cubic feet of gas per day. So those two factors really contributed to the decline in production year-to-year.

On the price side, everyone knows all prices for third quarter were up 61%, our average wellhead prices at $116.01 gas’s prices were up 46% to $9.88 per Mcf excluding effects of hedging.

Actual settlements for the quarter on our hedges resulted in a loss of $36.8 million but offsetting that was the mark-to-market non-cash gain of $169.5 million which was a big part of why we had the $90 plus million profit.

We really reversed the situation we had at the end of June in the second quarter, when we had a loss due to the hedges. We were back in the black on the hedges and you can see the results in the third quarter.

Our operating costs increased about 21% to $2.63 per Mcfe, primarily related to selling the lower cost production in south Louisiana, so higher flow rate wells; it didn’t impact our overall operating costs company-wide.

We had an increase in DD&A and also G&A was up about 52%. The D&A increase was due mainly to the non-cash employee compensation due to our, that comes from our [inaudible] partnership. Our G&A was up $6.5 million versus the $4.3 million last year. Again that program replaces the issues of stock options and so we’re not diluting the shareholders by issuing more shares.

So you see the impact of the employee partnership plan flowing to the income statement cash. [Inaudible] breaking costs led to abandonments and impairments of $43 million for the current quarter. That’s compared to $18.8 last year. This quarter includes a pretax charge of $12.5 million of drilling costs for the abandonment of the Big Bill Simpson number one and $27.6 million of leasehold impairments in our East Texas Bossier area.

We also had a charge for impairment of costs related to the Margarita well where we really the well is producing but we wrote down the carrying costs to reflect current market value of the well. We got charged $10 million, so the total charges for the Bossier area were about $50.3 million.

Company at the end of September had about, looking at the financial conditions, the balance sheet, we had $123 million outstanding on our credit facility, the facility has bond activity of $250 million. That left us with $127 million of liquidity at that time. We also had more cash than normal on hand of about $34 million. As we all know we’ve come through a difficult credit period and Clayton will address how that affects us going forward here in a few minutes, but we feel like we’re in good shape.

I don’t know what we would call that period of time, but somebody give me a word the other day that I think I could, it was kind of like the word hippoglossus I think that’s what we went through hippoglossus that’s what we went through in the third quarter. I don’t know what that means.

Clayton Williams

In the country talk it’s a big ass wreck.

Mel Riggs

I think it has something to do with halibut in Italian but it was a very difficult period of time, and we are in the process right now of re-incoming our borrowing base with our bank group, through nine banks. We are trying to just reaffirm our existing line of credit. I think it’s going well. We’ll get that done.

In the meantime there have been trouble among the banks, I mean, all the banks have had issues and hopefully that will stabilize. We feel like we have a good group of banks and they’re working well with us. And we feel like we can live without cash flow for a while. So on the credit side we’re in good shape at this point and I think we improved our position.

Looking at our capital expenditures for the first nine months of 2008 we’ve spent $284 million. Most of that was laid to development projects. We had previously reported we were going to spend roughly $410 million in 2008. We’re going to reduce that to $348.5 million that’s a $52 million, roughly $52 million reduction reflected in the fourth quarter.

In the third quarter alone we spent $129 million and comparatively in the fourth quarter we’ll spend $64.4 million and we’ve geared back somewhat to fit our spending to make it fit within our cash flow.

And so we, as we said I think in our earnings release, we’ve not finalized plans for 2009, that’s all in process. We’re watching product prices, watching for costs to come down, trying to gauge where’s the best place to spend our money going forward.

And we would expect though probably overall to see slightly or less, or significant levels of spending versus 2008 no matter what at this point. And that’s kind of a quick overview, if you want to ask questions now of anything that I’ve said or maybe what I haven’t said, we can take those questions now and if we don’t then I’ll turn it over to Clayton.

Clayton Williams

Financial questions now I think would be productive, financial questions if you have any you can ask them later. Now would be a good time to get any detailed financial questions.

Question-and-Answer Session

Operator

(Operator Instructions) We have no questions at this time.

Clayton Williams

Very good then in summary one thing I would like to say, we’re talking about going forward, you can ask financial question and come back to us. Our company is in pretty good shape. We’re solid with the banks; the banks and the credit seem to be solid. We have accumulated some cash.

We have basically stopped our development drilling, because we’ve lost the margin. With the price coming down and the cost of drilling staying where it is, we’re going to start where we have stopped all development drilling until we regain our margin, which will come either from the price going back up, or the cost of drilling complete wells going down; more likely a combination of the two.

So we basically have no rigs drilling outside of the futuristic drilling we’re going to do, two wells in the Bossier for big potential and one in Utah which we’ll be starting pretty quick. So where are we as a company?

Okay we’re going to lay down dead because more and more liquid and see what opportunities might be involved, within a short period of time we’re going to be very, very liquid. Now the next question what about the Bossier? We have almost 300,000 acres in the Bossier. We have two wild cats drilling in the Bossier today.

That may be a new joke, why are you drilling wild cats instead of development drilling, because we have a great potential in the Bossier with our 300,000 acres. We’re drilling on two prospects deep 18,000, 20,000 feet in the Bossier. We have eight more for sure that we want to drill before we’ve evaluated this major position. Gas prices seem to be stable. We’re going forward with our exploration in the Bossier and we have provision for three more Bossier wells this year in addition to the two.

Okay Utah we have no really update. We’re drilling two seismically controlled wild cats north of the oil discovery by Occidental. We hope to start it before the end of the year, the first one, and we’ll drill the second prospect which is right on trend. We’re pretty optimistic about that.

Going forward we have a few bits and pieces like we had to deal with Brigham. They’re drilling two more wells. We’ll finish that but by in large we’re shutting down all of our drilling except that and the Bossier in Utah. That have high potential and we’re just hoofing our resource, hoofing our cash. Looking forward to where are the opportunities that may come about during this trying period of time.

I want to mention that we have three fourths of our oil and gas hedged in ’09 at like $88 of gas in 8.5. In 2010 we have three fourths hedged at $97 and 8.5 on the gas. So we have good solid production, steady production we’ll say, we’re very slow to climb and our permanent reserves and we have three fourths of our income guaranteed through the hedges.

Who do we hedge with JP Morgan is our lender bank they have a lean our production so that we don’t place margin calls which can be so destructive when you start playing the derivatives. So we’re secure with income, we’re secure with production and we just look forward to, I think, to a very interesting period of time and I believe a very opportunistic period of time for someone like us who has the income, fairly well guaranteed. We have a lot of – I want to reiterate before I leave, we have a lot of development locations, but it would be poor sense to burn up those locations unless you’re making a profit.

As we’ve done before in this company’s history and my career, put those development locations on the shelf; when you have a profit go back to drilling. With that I’ll take questions.

Question-and-Answer-Session

Operator

(Operator Instructions) Your first question comes from Sheraz Mian – Zacks Investment Research

[Neil Mark] – Zacks Investment Research

I’m actually my name is [Neil Mark] and I work with Sheraz and standing in on the call for him right now, he’s out of the office, but couple of quick questions. One in your release about for your fourth quarter CapEx spending, you said the most decreases are going to come in the Permian in north Louisiana, I’m assuming north Louisiana you’re talking about coming back from the Cotton Valley developmental drilling, is that what you’re talking about? Or are you talking about the Bossier?

Clayton Williams

That’s the Shell at Perryville drilling. At current process and current costs we’ve lost our profit margin similar to the development drilling in the Permian Basin, so we stopped and wait until we regain a margin, we do have other locations to drill but we will not drill them until and if we regain our profit margin. We think we’ve been able to preserve all the leases in that case at some point in time we may lose some leases down the line. But I do not intend to drill the locations to preserve leases if it's losing money. Did I answer the first part of the question?

[Neil Mark] – Zacks Investment Research

Yes you did, I appreciate that. I guess moving onto the Bossier in East Texas. You mentioned that people say why aren’t you, why are you wildcatting? Why aren’t you doing developmental drilling? My question is I guess along those lines, you have so much acreage, doesn’t it make sense to, because you’ guys have had not good results historically in the Bossier.

Clayton Williams

Let me argue with that we drilled in Discovery in the Bossier some six years ago, it was the Fazzino well, those three wells average about 25 BCF per wells, very profitable. If the Sunny wells we’re drilling is on trend and about 20 miles south and west of the Fazzino we have nearly all of the acreage there, we have at least, we’ve done a 3D seismic.

We have all seismic control so we’re very deliberately exploiting a resource that we have a profit, a very good profit.

Now this is a first room for big stuff and so then why would we do that, because we have the cash flow that – why would you burn up a development location if there are no profits? So we’re taking our financial energy and pushing it into the future where we’re looking at big, big reserves.

Hopefully along the line of a Fazzino field or Seville in Canada for Philips and those people, who have been very successful and we have a major position so we’re just methodically going forward.

We’ve renewed leases. We have a major lease position, so it’s now time to drill and exploit it and we look for multiple increase if it works. And we recognize like we have eight or 10 prospects left to do, I don’t know how they’re going to produce. We will have further write offs but that’s also a few of those. It doesn’t take many of those to turn out that they have total play and turn a nice profit and have a lot of gas development drilling. I think – I hope that answers your question.

[Neil Mark] – Zacks Investment Research

Just one last one if I can. Again with the Bossier did you have such a big acreage stake, have you considered any selling a portion of it just to kind of shore up the balance sheet, bring down the debt at all?

Clayton Williams

I wouldn’t say we wouldn’t consider it but today in the time of stress, the market might be very poor. We’re financially strong and we want to go ahead and evaluate it and we’ve got a major investment in these leases, in our seismic. We got two new 3D shoots coming off to help us better locate where to drill. So it’s just part of our business plan. Now but I think it is interesting that instead of drilling development location we’re wildcatting.

Why drill development wells if there’s no profit? Yes, you can say well we have completed wells but if you didn’t make a profit, so I’m pretty simplistic. If you’re not making a profit don’t drill it. But you must wildcat to have future development wells. So that’s what we're doing there.

Operator

You next question comes from Steve Orr – Orr Investments.

Steven Orr – Orr Investments

Wondering when you might gain back the loss production from, one, the hurricanes and then two, the sale of the assets back in March?

Clayton Williams

Well I think we’ve probably replaced that and I want to let Mel get into the details. This is a dynamic world in which we live in, so you sell some, we sold that to reduce our debt at the time. We will continue to do development drilling in the Permian and the Austin Chalk and the Perryville gas and so we continued to drill until lately when the price dropped, then we lost our profit so we stopped drilling. This has happened to me in my 51 years time and time again and so I’ve had a lot of practice dealing with these dips and troubles. I guess that answers it.

Mel Riggs

Yes, the production it was curtailed by the hurricanes all back on. The other thing I really failed to mention and I think it’s important is we had forecasted in, looking at our guidance and how we kind of came out in the quarter versus guidance, production was down about 8% or 9% versus guidance and in those numbers we had forecasted we would have some new wells in south Louisiana online the Brigham wells that, Brigham [inaudible] three wells, they're in the process of hooking them up.

They were delayed because the hurricane hit and shut everything down. We had two wells that we drilled, primarily oil wells, that in south Louisiana those wells were delayed, so that all contributed to missing the number so where we’re going to come out –

Clayton Williams

Those are Permian wells too.

Mel Riggs

Yes we have several Permian basin wells that are in different stages waiting on frac jobs because of the backlog of stuff that was going on at the time. So we should exit the year in really good shape.

The fourth quarter as far as our production going into ’09, you just don’t see the numbers yet. We’ll get that on, and then the other thing is on the capital spending, heading into the fourth quarter we have not just gone – we still have quite a few development wells in the fourth quarter, here we are in November. We’re getting kind of at least halfway through about.

But we in winding down we’re still drilling from the development, we’re getting we’re completing development wells, so we’re not just totally wildcatting and even if you look at the wild cats as that was all we had at this point time, it's a small capital expenditure versus what we spent all year long and versus our cash flow, so we’re not taking 100% of all of it.

Clayton Williams

Plus we get a percent of the two big wildcats compared to what we spend on development drilling. We are real comfortable with that.

Mel Riggs

Yes I think in the fourth quarter, just in the fourth quarter alone we’re still probably 60% developmental versus 40% exploratory. And then we hope to go back to drilling development wells like Clayton said but we need to get costs down and build. We’re in a different world. I mean the world changed dramatically in the last couple of months. And we’ve got to adjust our company to beat the current oil and gas price and the service companies have to adjust to that too so we can have a margin.

Clayton Williams

Let me leave you with this thought. It’s a very good question. We’re financially strong enough to continue drilling exploration wells that will hopefully bode well for our future. We’re financially strong enough to pay down some debt and build equity in our company so to speak and we’re very comfortable where we are.

One thing I forgot to mention, we’re continuing our lease exploration where we may buy further leases on other prospecting areas, because we’re financially able to do that. And we may find that there’s less competition in the leasing areas because we are doing very well.

Steven Orr – Orr Investments

Just a quick follow-up if I may. So my next question was, what contribution would the Brigham wells have and I think you answered that , there are what, three wells coming on before year-end?

Clayton Williams

I’m not – let me give you that. We completed three wells, they have, we have one dry hole a fourth, there’s two more wells to be drilled before the end of the year to complete the program. So we will have cash flow from three wells, two pretty decent, one average. Then we’ll have two more wildcats being drilled with which we paid 15% for half and then pay half of the cost after the case point in completion.

So that’s an ongoing business and I think if I leave you with anything today, we’re very comfortable with where we are. We’re comfortable, we’ve cut back, wait till we regain our margin and gain financial strength to look around for maybe opportunities down the road in a month or two or three or four.

Steven Orr – Orr Investments

And my last question for now is anything new in the Haynesville Shale or Clayton Williams Energy?

Clayton Williams

We really don’t have – we have a small position I think there may be some opportunities there but we don’t understand yet how the whole play is going to play out. So I really don’t have anything to add on that I’m sorry.

Operator

(Operator Instructions)Your next question comes from Bill Nasgovitz – Heartland Fund.

Bill Nasgovitz – Heartland Fund

End of quarter the debt went up how come?

Mel Riggs

The debt is really related to purely to capital spending. We ramped up in a major way, oil prices were climbing and gas was strong so we outspent our cash flow by about $70 million during the quarter, primarily on 80% development drilling. And then we hit the wall with the product price decline and so we’re adjusting to that.

Operator

Your next question is a follow-up question from Sheraz Mian – Zacks Investment Research.

[Neil Mark] – Zacks Investment Research

You talked about the backlog you have in the Permian, can you give a number of wells that you’ve already drilled and are waiting to complete and put on line. What that number is, I guess maybe what you plan on putting in online in Q4 and then into early ’09 just to gauge how production is going to look?

Clayton Williams

I think what you’re asking for is a complete for. We have like three in one area, two completed in another. We don’t know what they’re going to complete for, so it will be very difficult for us to predict what the cash flow would be from that. In a couple of months we’ll be able to tell you.

Mel Riggs

At least a half dozen wells but I don’t know what the production rates would be on those wells yet. We don’t know.

Clayton Williams

We couldn’t predict, we could have a guess, I think we’d rather just wait, but there is a little more coming.

Mel Riggs

We’ll be revising we’ll be updating our guidance for the fourth quarter probably in about a week and so we will put all that into account when the numbers pull together.

Operator

There are no further questions at this time.

Clayton Williams

Thank you very much, well God bless America. Let’s go forward.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect.

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Source: Clayton Williams Energy Inc. F1Q08 (Qtr End 10/28/09) Earnings Call Transcript

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