Cano Petroleum Inc. F1Q09 (Qtr End 9/30/08) Earnings Call Transcript

Nov.11.08 | About: Cano Petroleum, (CFW)

Cano Petroleum Inc. (NYSEMKT:CFW)

F1Q09 Earnings Call

November 11, 2008 11:00 am ET


Jeff Johnson – Chairman and Chief Executive Officer

Patrick M. McKinney – Senior VP of Engineering & Operations

Michael J. Ricketts – Principal Accounting Officer and VP

Benjamin Daitch – Chief Financial Officer

Philip Feiner – General Counsel


Irene Haas – Canaccord Adams

Derrick Whitfield – Canaccord Adams

Noel Parks – Ladenburg Thalmann & Co.

[Patrick Clevin] – [Pennian Capital]


Welcome to the Q1 2009 Cano Petroleum Incorporated earnings conference call. (Operator Instructions) At this time I would like to hand the presentation over to your host for today's call, Mr. Jeff Johnson Chief Executive Officer.

Jeff Johnson

I appreciate everybody joining us today for our Q1 call. Joining me in here today is Ben Daitch our CFO, Patrick McKinney our Senior VP of Engineering and Operations, Mike Ricketts our Principal Accounting Officer and Philip Feiner Cano's General Counsel.

I'll make just a couple of comments and then turn it over to Ben and Pat to give a more detailed update and then afterwards we'll open it up for any questions. One comment I would like to make is in today's market environment and the recent events surrounding it, Cano has taken active measures to preserve our shareholder value and there's a number of things that we mentioned in the press release, but primarily number one is we need to be able to go execute and continue to execute on our waterflood strategies, while number two maintaining a strong balance sheet, maintaining liquidity and at the same time trying to cut costs.

Ben and Pat will go into those a little bit here in just a few moments, but part of the events that we have taken action on to help us get to that position is we raised $54 million of equity. We also were able to sell a non-core asset within our Pantwist assets for $42.7 million gross netting out a little over $40 million.

We also were able to position ourselves for the second half of this fiscal year to be able to maintain our production rates, live within our cash flow means while at the same time have the opportunity for production growth over the next 12 to 18 months. With the results of our waterfloods from both Cato and Cockrell Ranch up in the Panhandle with capital that has already been spent over the past 12 months or so.

I will acknowledge right now that we are not happy with the current share price and you can rest assured that we working with our board are constantly looking for avenues to improve our value and Pat will talk more about that here in a few moments.

So, with that right now I'll turn it over to Ben to talk to you about the financials.

Benjamin Daitch

Regarding the first quarter earnings, net income to common was $11.8 million or $0.26 per share. This includes a $24.2 million pretax gain on derivates based upon changes in commodity prices since June 30th. Excluding this gain we would have reported a net loss of $3.6 million or $0.08 per share.

We have included a pro forma column on the income statement this quarter to show the results of the Pantwist LLC sale as if it had occurred on September 30th instead of on October 1st. The after-tax gain on the sale of $13.7 million increases pro forma earnings per share to $0.53. This gain will actually be recorded as part of our second quarter of fiscal year 2009 earnings and will be included in our bank covenant calculations.

The current quarter revenues of $10.9 million represent a 66% increase over prior year quarter revenues. Most of the rise is due to higher realized prices for oil and natural gas volume metric sales. Operating expenses increased to $15.8 million in the first quarter; of this, $3.5 million was from an impairment at Corsicana.

Due to changes in commodity markets and our revised capital budget, we could no longer place Corsicana in our five-year development plan window and thus have to reclassify its undeveloped reserves to probably from PUD at June 30th. Corsicana's PUDs represent 0.2% of both our total proven reserves and our PV10 at June 30th.

We entered the first quarter with a drilling capital budget of $97.5 million and thus undertook a rigorous work over plan to get out fields ready to be developed. The first quarter's heightened work over activity at our Panhandle and Cato fields, along with significantly increased electricity expenses, higher polling unit expenses, increase frequency of chemical treatments contributed to a per LOE increase from 25.86 to 45.93 per BOE. We have since revised the capital budget to $35.5 million and thus will slow the pace of prep work spending. Later Pat will discuss initiatives taken to reduce our LOE on a total dollar and per unit basis.

G&A expense increased by $1.2 million. This increase was driven by higher expenses associated with the wildfire litigation, labor and staffing increases, and higher stock-based compensation expense. Production and ad valorem taxes increased as a function of higher revenues and a catch-up for the first six months of calendar year 2008 as our property values were increased by various regulatory agencies.

Depletion expense increased as a function of higher rates and volumes. We had several important events that occurred in the first quarter of fiscal year 2009 and subsequently regarding our liquidity. On July 1st we completed an equity capital raise netting the company approximately $54 million. We used the proceeds to pay down first lien debt. While we have no plans to issue equity we do have $96 million of availability under our universal shelf registration.

During the first quarter we signed and subsequently closed on October 1st the sale of our non-core asset Pantwist LLC for $42.7 million. After fees and expenses we netted $42.1 million from the transaction which is recorded as $40.7 million in adjusted proceeds from the purchaser, $2 million of discontinued operating income from the assets, less $570,000 of fees and expenses.

After the sale of Pantwist our banks reaffirmed our current borrowing base of $60 million out of our $100 million senior credit facility. On September 30th we drew down on our first lien credit facility to payoff our $15 million second lien facility sometimes referred to as our subordinated loan. The proceeds from the Pantwist sale allowed us to payoff the full balance of the first lien.

During October we sold off previously purchased financial floor price contracts covering the period of July 2010 through December 2010 for $570,000. After the sale all our remaining collars and floor price contracts are with Union Bank of California, the administrative agent on our credit facilities, thus reducing our counterparty receivables exposure.

On October 29th we reduced our capital drilling budget to $35.5 million from $97.5 million as a function of turbulent capital and commodity markets. Our capital expenditures for the first quarter was $16.5 million with the majority of the remaining budget to be incurred in the second quarter.

With that I'd like to hand this over to Pat for an operations update.

Patrick McKinney

As we talked about Cano achieved its previously announced production growth target of 7 to 9% growing first quarter fiscal year 2009 production by 8.7% over fourth quarter fiscal year 2008. Pro forma for the sale of Pantwist asset production grew to 1,238 BOE per day from 1,139. The biggest production growth driver was at the Cato field where production increased 42% quarter-over-quarter.

Eight new wells were drilled in the quarter at Cato including six new producers, one injection well and one water supply well. Production gains were also noted at the Panhandle field with production increasing by 5% from the trialing quarter as we worked over an RTP at a total of 75 wells.

Production increased 14% year-on-year led by growth at the Cato field. Average production for the first quarter at Cato was approximately 300 BOE per day up almost 250 BOE per day from last year and that last year was prior to the start of our infield drilling program. Since that time, we've drilled and completed 38 waterflood development wells consisting of 33 producers, five injectors and one waterflood supply well.

The gains at Cato water partially offset by roughly 90 BOE per day of decline at the Desdemona field after we seized our development drilling at our Barnett Shale program. Waterflood production increases at the Cockrell Ranch unit offset normal field declines at our other properties.

As we mentioned in last weeks press release, our goal for the remainder of fiscal year 2009 is to maintain current first quarter production levels of approximately 1,235 BOE per day. For the remainder of the fiscal year with only maintenance CapEx spending until we see production lift coming from the prior investments made at our Panhandle and Cato waterflood projects.

I’ll give you a breakdown of the development drilling capital that was mentioned before of $34.5 million. The new full year capital allocations are as follows, $16.5 million at the Cato field, down from $40 million, $12.4 million at Panhandle down to $37, $2.2 million at Nowata down from $10, $4 million at the Desdemona properties down from $9.7, and $0.4 million at other projects down from $0.8.

Our capital development program includes the drilling of 21 new wells for the full year. This includes four ASP observation wells at Nowata, five Harvey unit development wells in the Panhandle field and 12 waterflood development wells as Cato. This is down from 86 wells that we had in original budget. As of today, we have just the five Harvey unit wells left to drill for our fiscal year.

Shifting to the individual properties at Panhandle, initial base production at the Cockrell Ranch unit waterflood has remained at approximately 80 to 100 net BOE per day between June and September. During the first quarter as a result of our previously announced surveillance program we identified and corrected injectivity issues in 16 of the 62 injection wells. This work was completed in September.

By more effectively injecting into the high remaining oil saturation intervals with a smaller amount of pour volume to flood, we anticipate that we will accelerate monthly PVI fill up from approximately 0.03 PVI per month to 0.04 PVI per month and will ultimately have a more efficient waterflood.

The current PVI for the Cockrell Ranch unit is 0.03 in total while the effective injection in the pour interval is 0.02 PVI. As a result of the injectivity corrections, we are more effectively injecting water into the higher remaining zones and as a reminder this waterflood has only been in full injection for eight months, the corrected injection for only the last 45 days.

We continue to stress that we are early in the life of this waterflood and the surveillance measures we have taken are normal. Of note, there are areas of the flood that are responding very favorably with oil cuts between 4 and 10%. We are now on track to see a more direct correlation of PVI versus oil cut in corresponding oil production.

Our original Panhandle waterflood capital development program for this year consisted of six separate mini phases on reduced well spacing to enable Cano to accelerate field development. Tighter spacing and smaller development patterns would quicken permitting and response times along a larger development footprint over greater acreage position in the field.

New capital development plan provides for the development of only one mini phase for this fiscal year. The Harvey unit had its waterflood permit application approved by the Texas Railroad Commission on October 20, 2008. The Harvey unit mini flood will consist of six injection wells 13 producing wells. Drilling is expected to commence by December 1st on the five wells required to complete this mini phase and the drilling should be completed by mid January.

We will be ready to initiate injection as soon as development work is complete. We expect to file the appropriate waterflood permits for the remaining five mini phases by the end of the calendar year. Net production at the Panhandle properties for September 2008 was approximately 610 BOE per day.

Shifting to Cato, in July we reinstated our drilling program. In the first quarter we drilled and completed six additional waterflood infield wells, one injection well and one water source well. The revised capital development plan for this fiscal year now provides for drilling in total of 12 waterflood pattern wells or four more for the balance of the fiscal year and then to initiate water injection.

We received notice on September 9, 2008 with a final approval of the waterflood application to the New Mexico Oil and Gas Conservation Commission. We currently have 10 water injection wells online and we will be positioned to initiate water injection in four additional wells by calendar yearend. In total, the initial phase of the Cato waterflood will encompass roughly 640 acres and will include 14 injection wells and 25 producing wells.

We just completed the drilling of the last of these four wells for fiscal year 2009 and this completed the initial waterflood pattern. We anticipate injection rates of approximately 7,000 barrels of water per day in the San Andres formation. Net production for September 2008 at the Cato properties was approximately 340 BOE per day.

At Desdemona, we budgeted $4 million in our fiscal year 2009 capital development to test refracting both Marble Falls and Barnett Shale zones and a number of wells, but primarily the capital is to ensure additional water supply for the Duke Sand waterflood project. While we do not expect to see meaningful response from the Duke Sand waterflood during fiscal year 2009, we feel very strongly that this is a viable project with a large probably reserve upside. Net production for September 2008 Desdemona was approximately 60 BOE per day.

At Nowata, our ASP tertiary recovery pilot project, which has been in full operation since December of 2007, has injected close to .18 PVI of ASP. We have now completed the alkaline affect in polymer stage of injection and are performing the final injection state of polymer [inaudible]. We have budgeted approximately $2 million of our fiscal year capital development budget to continue injecting polymer and to drill four ASP pilot observation wells.

We have just finished drilling these four wells and they are currently being completed. The observation wells should allow us to test flood front results in our ASP pilot. We expect to announce the results of our observation wells by calendar yearend and the water properties were producing in September approximately 220 BOE per day.

Finally, I just want to make a comment on lease operating expense. In addition to the capital reductions mentioned previously in this call, we've also taken steps to reduce our LOE. As reported earlier, first quarter fiscal year 2009 LOE was in the $45 per BOE range in our production basis. This compares to approximately $29 per BOE for full fiscal year 2008 and approximately $38 per BOE for the month of June 2008.

Part of the rise in LOE is attributed to the sale of Pantwist which was our lowest LOE per BOE property at $18 per BOE. The sale of Pantwist caused LOE to rise approximately $3.15 per BOE. This would put our June LOE on an equivalent basis of approximately $41 per BOE without Pantwist. LOE in the first quarter fiscal year 2009 was largely increased as a result of production enhancement well work including RTPs, new pumps and chemical treatments.

The work at Panhandle alone increased production by over 75 BOE per day September versus June. We've completed a number of initiatives to reduce LOE going forward. We successfully renegotiated a major pulling unit contract at the Panhandle field where the bulk of our LOE is incurred. Moreover, we will start to see the results of our recently completed work over, RTP and [inaudible] programs in the second quarter and beyond.

In summary, we estimate total company LOE will be reduced by approximately $5 per BOE in the second quarter as compared to first quarter to bring it back down to the $40 per BOE range with essentially flat production. As our costs are largely fixed, gains associated with lift from our waterflood projects in the second half of the fiscal year should allow LOE to be reduced down to the $30 per BOE range.

With that I'd like to turn the call back over to Jeff for some closing remarks.

Jeff Johnson

I guess the one thing I want to point out is although we're not happy with the share price and don't believe that the market is giving us the value that this company has, we sit here healthier today than this company has ever been. Our production is at rates that we have never seen before. We have capital that has already been invested and our two major projects, which is the Cockrell Ranch and Cato waterflood units, we are positioned so that we can see lift out of those two waterfloods second half of this fiscal year and into the second half of calendar year of next year, and at the same time although we sold off approximately 20% of our production, we have maintained our $60 million borrowing base, have a good relationship with our senior lenders and feel that we are positioned to weather the storm if you will.

We get a lot of phone calls people saying do you have survivability, will you guys be okay, and what I had asked both Ben and Pat to look at were a couple of things. Number one, go find us $3 million in cost savings and see how it would reflect upon our ability to operation They have done so and I believe that we will see these savings going forward and should not affect any of our operations as far as production goes.

The second thing that we had asked them to do is see if we can survive. If these markets stay in the current condition or possibly get worse in 2009. Do we have the ability to survive over the next 24 months just simply with the current borrowing base that we have and assuming no ability to go out and raise additional equity, and they have shown me that we can do that.

As I have mentioned earlier once we get through with the current capital here in December we should be able to have maintenance capital to maintain our production in operations within cash flow. I also think it’s important to note that through March 2011, while we do have that higher operating expenses that Pat discussed as we see lift we’re going to see that come down. So up through March 2011 when we have hedges in place with over 80% of our production with $80 to $85 floors and $7.50 to $8 dollar floors on gas and feel like that we are positioned to be able to weather the storm so to speak if the markets don’t turn around.

Now, while we are still focused on long-term value rest assured that the management team working with the board is doing everything we can and we’ll look at all options obviously to try to create value wherever it can be found.

I will now turn it over and open it up for any questions.

Question-and-Answer Session


(Operator Instructions) Our first question comes from Noel Parks – Ladenburg Thalmann.

Noel Parks – Ladenburg Thalmann & Co.

Just a housekeeping item, at the point we’re at now, sort of mid quarter, what’s the current production [inaudible] company?

Patrick McKinney

Noel we’re still in that range of first quarter production in the 1235 BOE range.

Noel Parks – Ladenburg Thalmann & Co.

You mentioned renegotiation of the pulling unit contracts and I was wondering if you could just tell me a little bit about that. Was that easy or difficult, and sort of the attitude of the suppliers and also what you think the costs trends look like for the rest of the year into maybe the first half of next calendar year?

Patrick McKinney

I think that we have a unique relationship with our pulling unit partner in the panhandle as we've had a relationship with them for quite some time and we were able to negotiate a reduction in rates and actually go through and work out a deal where we’re able to manage the workflow a little bit better. I think in general obviously what we’re seeing is rates are being stacked I think drilling costs are going to be soft for the next quarter or two at least of our type of projects with the rigs that we are looking at.

We haven’t really seen a big reduction or an indication of softening of other services but I think that electricity costs are coming down just a lot of general commodity related costs are going to come down in this quarter for us, but yes I think it’s still too early to tell exactly what the impact of the service industry is going to be.

Noel Parks – Ladenburg Thalmann & Co.

Okay and at Panhandle where you're talking about how the oil cut varies in different parts of the field at least 4% to 10% could you talk a little bit about how different areas of the field are responding and what’s the nature of the differences and maybe a sense of whether you think the field as a whole oil cuts is going increase pretty uniformly or whether it’s going to be more in certain areas of the field?

Patrick McKinney

Sure, Noel well as everyone's aware we started injection out here and it wasn’t a full field injection so certain parts of the field have received more injection than others. With the results of our surveillance work I think we’ve really, really isolated the key zones out there in the field and in some cases those are starting to respond.

Each part of the field is slightly different because its thickness is slightly different, it's [inaudible] and permeability is slightly different. So we’re seeing certain parts of the field that we’re starting to get good fill up. We’re starting to see injection well pressures increasing and continuing to increase and those are all good signs. So we’ve just got to continue to get more water in the ground. As I mentioned that effective PVI to about .2 as we said before we need to get between .25 and .4 to really see this thing kick up but based on the surveillance corrections that we’ve made we feel we’ve got this field ready to except the water in the best parts of the zone right now.

Noel Parks – Ladenburg Thalmann & Co.

And the injection volume is it 50,000 barrels a day you’re at right now?

Patrick McKinney

It’s still roughly 50,000 barrels of water per day.


Our next question comes from Irene Haas – Canaccord Adams.

Irene Haas – Canaccord Adams

You guys mentioned a little earlier at some point you’ll get to a $30 per barrel lease operating cost. How much lift would you need to bring lease operating costs down to this level alternatively, how many barrels of production would it take to hit that average?

Patrick McKinney

Well I think it’s a combination of reducing the base level of LOE costs through the initiatives that we’ve mentioned and getting some lift in the second half of the year. It doesn’t take a lot of movement on both the numerator and denominator to get that movement if we can work at it from both sides.

Irene Haas – Canaccord Adams

Can you quantify it more precisely, please?

Patrick McKinney

Well as Jeff mentioned we’re looking at roughly $3 million a year of savings and if you bid say $250, $300,000 a month on the LOE side and a little bit of lift in production you should be able to get down in that range.


Our next question comes from Derrick Whitfield – Canaccord Adams.

Derrick Whitfield – Canaccord Adams

What is the field wide oil cut today and I noticed that certain producers are really responding favorably? How much conformance directionally are seeing across the producers?

Patrick McKinney

Well as we mentioned total BOE production per day has been in this 8,200 BOE per day range. As a result of the surveillance our amount of fluid production hasn’t really increased yet until we start to see the water getting to the producers.

Derrick Whitfield – Canaccord Adams


Patrick McKinney

So the total field wide cut is still in about a 1% range but we have areas and phases of the field that are seeing much higher cuts than that and we have individual wells that are seeing the higher end cut so I still think it’s a little premature to look at the field in total right now, Derrick, but we have seen very positive response in the injection pressures where we’ve done the surveillance work in other areas of the field as we’re filling up this pour volume and each day that we inject we’re getting closer and closer to moving this water to the producing wells.

Jeff Johnson

Hey Derrick this is Jeff. The one thing that we have to keep in perspective here too is we've been at full injection now for about seven or eight months out at Cockrell Ranch and then through the maintenance of it and management of the field we actually have been at full injection in the meat of the reservoir for about three months probably, Pat, three, three and a half months, so the reservoir is filling up and we’re seeing the things that you need to see out there is I think the point that Pat's trying to make.

We have not seen anything at all to give us any pause or hesitation that we’re not going to be successful and that this thing is going to respond and respond well and it's just a matter of time. Unfortunately in this business or this part of the business it’s a capital that you spend up front and you realize the value of that capital months down the road, and if you take a look at what we’ve injected the time that we've actually been in full injection we feel we’re on path and we’ll continue to monitor and watch it.

Again, where I think we’re uniquely positioned not only with the Cockrell Ranch but also seem to be with the Cato we’re actually already got injection going up there is we’ll see lift and just to simply maintain production while we’re waiting on the investment to mature out there is a pretty unique position and we feel very confident about both of those fields and seeing a lift in production here during 2009.

Derrick Whitfield – Canaccord Adams

That’s actually a great segue into the second question which is on the Cato's field. Basically the second half of your fiscal are you going to see enough lift in the waterflood operations there to offset some of the production lost in primary?

Jeff Johnson

There's a little bit of difference between the Cato and the Cockrell and to answer your question, we believe we will see a quicker response at Cato than we did at Cockrell. For me to try to tell you when we're going to see it, I'm just not going to do that because it's just very, very hard to predict.

However, the Cockrell Ranch was drilled on 40 acre spacing, on 20, we also have 20 acre out at Cato. However, the difference is that you did have a pilot phase up here where there was already approximately five million barrels put in the ground. So we don't have as much makeup water to put in the ground and should see quicker response up there. How much quicker, I can't tell you but what we hope to see is some response out at Cato before the end of this fiscal year.


Your last question comes from [Patrick Clevin] – [Pennian Capital].

[Patrick Clevin] – [Pennian Capital]

Just some questions for you guys, more on the stock side than the actual business side, recently some of your larger shareholders have been buying stock, I've noticed that Carlson has filed a 13D and they appear to be looking to take a more of an active role. Can you just kind of discuss how you guys view having a more active shareholder base as well as what role, if any, you see either Carlson or any other shareholders play in the future of the company?

Jeff Johnson

It's interesting, the one thing that we do have we've got a large percentage base of the people who own our shares that what I would consider pretty sophisticated and smart oil and gas people. Carlson is absolutely one of those people and I invite discussion from any large shareholder that can come and bring value to the table. I've had multiple discussions with Carlson since last summer, had multiple discussions with them since they filed their initial 13D where they started becoming a substantial shareholder.

They are continuing to buy, I continue to stay involved with those guys as much as they want to be and by generally speaking, my philosophy has always been, if you've got a large shareholder and they can bring some value to the table, then you need to listen to those guys and you need to engage those guys. Not only Carlson but there's a couple of other folks that are very sophisticated that are large shareholders that we regularly visit with as well. So we think that's a positive and obviously think that having guys like that involved in our stock is good for all shareholders.

[Patrick Clevin] – [Pennian Capital]

Also, given the fact that you're saying that savvy outside investors are viewing your stock as undervalued and given the sell off we've seen in the stock over the past six months or so, does the company view buying back stock as a potential use of capital at these levels?

Jeff Johnson

We've discussed that and obviously that is something at these levels that you seriously have to look at. There are a couple of issues out there, as you know. You've got some covenants with your senior lenders as well as we have some preferred shareholders out there that we have some covenants with, but in today's market to look at the opportunity to be able to create value through some sort of share repurchase, whether it be the common or the preferred, is something that you seriously got to look at and those are things that we are currently discussing and taking a look at with our board.


There are no further questions in queue at this time.

Jeff Johnson

We appreciate everybody joining us on the quarterly call and as you all know, we're pretty accessible so if you have any other questions or need to get in touch with us, we're available. Thank you very much.

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