Pinnacle Gas Resources Inc. Q3 2008 Earnings Call Transcript

Pinnacle Gas Resources Inc. (PINN)

Q3 2008 Earnings Call

November 17, 2008 1:00 pm ET

Executives

Peter G. Schoonmaker – Chief Executive Officer, President

Ronald T. Barnes – Chief Financial Officer

William W. DeLapp Jr. – Vice President of Operations

Presentation

Operator

At this time I would like to welcome everyone to the Pinnacle Gas Resources third quarter 2008 conference call. (Operator Instructions) Mr. Schoonmaker you may begin your conference.

Peter G. Schoonmaker

Thank you for joining us for Pinnacle Gas Resources third quarter 2008 earning and operating results conference call. On the call with me today is Ron Barnes our Chief Financial Officer. We filed our 10-Q on November 14, 2008. If you would like a copy of the filing it is available on our financial report section of our website at www.pinnaclegas.com or you may call area code 307-673-9710 to request a copy by mail.

Please be advised that our remarks that follow including answers to your questions include statements that we believe to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks and uncertainties that could cause actual results to be materially different from those currently anticipated.

Those risks include among other matters that we may have described in our earnings release issued yesterday and our filings with the Securities Exchange Commission. We disclaim any obligation to update these forward-looking statements. This morning we will discuss our financial results, update you on our activities in the Powder River Basin and outline our remaining plans for 2008.

Before Ron gets into our financial results, I would like to discuss some of the highlights and challenges of the past quarter as we give an operational and development update. First we exited the third quarter producing 13.4 million cubic feet of gas per day net, up 35% from a year ago and up 8% over the second quarter exit rate.

Total net sales volume for the quarter was 1.04 billion cubic feet a 16% increase over the third quarter of 2007. The increase in sales volume was up as both our Cabin Creek project and our Deer Creek Kirby project area in Montana have increased from less than one million cubic feet per day net to our interest to around seven million cubic feet day per net as of our interest of September 30, 2008. The combined gross production from these areas is over 11 million cubic feet per day.

For the quarter we had 764 gross producing wells 433 net, with 98% operational control. Our drilling budget for 2008 is 114 gross wells which is a 31% increase over the wells we drilled in 2007. We have drilled 37 gross 26 net producing wells during the third quarter and hooked up 41 gross wells. To date for the year we have drilled 113 wells and hooked up 123 wells. We have scaled back our fourth quarter drilling plans due to the low and volatile pricing for the Rocky Mountain region.

We expect to spud our first well in the four tranche approved plan of development initiating development in a new project area in Montana. We expect to spud that well this week. This project area is immediately north of St. Mary’s Hanging Woman Basin project. St. Mary has established production from a number of coal zones less than a mile to the south of our project area.

We anticipate targeting up to eight coal seams with a total gross coal thickness of 150 foot. We will drill the four tranche on 80 acres spacing to ensure sufficient de-watering. Our Montana area which includes Deer Creek and Kirby was producing around five million gross cubic feet a day or three million net per day from 61 wells, which is up from 20 wells at yearend.

We currently have over 120 wells producing gas and/or de-watering. Over much of the last year we were limited in our well production due to the lack of water management in place. We have now substantially resolved this issue by constructing additional reservoirs utilizing temporary irrigation systems and the injection wells that we have just put into service. Increased production has been the result. We are currently producing from the Canyon, Cook, Lower Cook, Upper and Lower Wall coal formations.

As far as our financial position, we have become conservative in our 2008 drilling plan due to the gas volatility in the Rocky Mountain region along with a financial and credit crisis. For 2008 we entered the year with $8 million in cash in addition we have drawn $7.5 million on our credit facility through September 30, 2008. Based on our current market capitalization we are less than 30% leveraged as of September 30, 2008. We are currently reviewing our 2009 plan while aggressively reducing costs which will allow us to focus on our core asset areas such as Cabin Creek.

For the third quarter of 2008 we posted income of $8.9 million or $0.30 a share. Our cash flow from operations generated over $2 million for the quarter after removing non-cash items. We have 316,000 net acres under lease with over 5,000 identified drilling locations. The management team has over 20 years of experience in acquiring operating and developing oil and gas properties in the Rocky Mountain region. Our growth strategy is based on low risk development drilling in areas with multiple pay potential and compelling economics. In addition to our contiguous operating areas they provide long-term potential for reducing per unit operating costs.

And now I’d like to turn the call over to Ron Barnes, our CFO, to cover our financial performance.

Ronald T. Barnes

I will talk about our financial performance then touch on our hedges currently in place and pricing currently in the Rocky Mountain region. As far as our total revenues exclusive of hedges settled in the quarter, gas sales for the quarter ended September 30, 2008 was $5.7 million versus $2.7 million for the same quarter in 2007 or 109% increase. Our average realized price increased 80% to $5.49 versus $3.05 for the same quarter in 2007.

As far as hedges settled or realized hedge settlements, we incurred a $0.8 million gain for the third quarter 2008 versus a $1.6 million gain for the same quarter in 2007. On a unit of production basis the gain on derivatives attributed $0.70 per Mcf for the third quarter 2008 and $1.82 per Mcf for the third quarter 2007. We also marked our unrealized gains and losses to the operating statements through cash flow hedging. The unrealized gain for the third quarter of 2008 was $10 million while the unrealized loss of the same quarter in 2007 was less than $20,000.

I’ll move now to some of our expense items, production taxes for the third quarter 2008 was $0.6 million versus $0.3 million for the third quarter 2007. Production taxes are generally 11% to 13% of your revenues gross value in Wyoming and 9% to 10% of your revenues gross value in Montana. Production taxes correlate to gross revenues from gas sales. Our lease operating expenses were $1.8 million in 2008 versus $1.3 million in 2007 for the quarters ended September 30th. On a Mcf basis, that was $1.73 per Mcf for the quarter ended September 30, 2008 and $1.48 per Mcf for the quarter ended September 30, 2007.

The increase was due to higher generator rental and diesel fuel costs in the third quarter of 2008 along with water treatment costs and ongoing pump replacement costs. As we have entered new fields such as Montana's Kirby and Deer Creek and Wyoming's Cabin Creek, the permanent power or power lines built to our wells to provide power for our pumps are not yet in place. We have to utilize generators and diesel fuel. We are evaluating this situation and eliminating generators where costs are more than the revenues and/or the de-watering and we are also putting into place bi-fuel where we are utilizing gas and diesel or just gas generators alone in order to reduce costs.

As far as marketing and transportation for the quarter ended September 30, 2008, we were at $1.2 million up from $0.9 million for the same quarter in 2007. The increase was primarily related to increased sales volumes combined with a slight increase in fees through the standard escalations of fees per Mcf on a year-by-year basis. We are currently in negotiations to cut in marketing and transportation costs in a couple of our key areas due to compressor utilization being not as high as expected at this time.

Our general and administrative expenses for the three months ended September 30, 2008 was $1.3 million versus $1.5 million for the same quarter in 2007. On a Mcf basis, general and administrative costs decreased to $1.29 from $1.67 for Mcf for the same quarter in 2007. Overall, the depreciation depletion amortization accretion increased to $2.7 million for the quarter ending September 30, 2008 versus $1.7 million for the quarter ending September 30, 2007.

The increase relates to an increase in the full cost pool due to the capital expenditures in the third quarter of 2008 along with the first and second quarters of 2008, an increase in the net production for the same quarter and a lower than expected crude reserve base due to crude reserves being measured based on a September 30, 2008 Rocky Mountain index price of $3.62.

As far as impairments for the quarter ended September 30, 2008, the price used for our ceiling test was $4.95 per Mcf based on a Colorado Interstate Gas Rocky Mountain index price on November 11, 2008. This shows that we had a $2.6 million surplus based on the full cost ceiling limitation compared to capitalized properties in the full cost pool. If the impairment was measured on September 30, the price was $3.62 and the company would have taken over a $21 million write-down based on this price.

Our net income for the quarter was $8.9 million or $0.30 per share basic and $0.31 per share diluted. Absent mark-to-market gain of $10 million, the company would have incurred a loss of $1 million or $0.03 per share. Now looking at a non-GAAP measure, EBITDA earnings before interest, income tax, depreciation, amortization, and other non-cash items during the third quarter, we had EBITDA up slightly over $2 million or $0.07 per share versus $690,000 or $0.02 per share for the same quarter in 2007.

Now let's talk about hedging. We currently have hedges in place for the remainder of 2008 of seven million cubic feet per day at a floor price of $6.75 and a ceiling price of $7.48 based on the
CIG Rocky Mountain index price. For 2009, we have 4.5 million cubic feet per day of hedges in place at a floor price of $6.87 and a ceiling price of $7.31. As far as the third quarter, the CIG index prices were $8.89 for July, $7.03 for August, and $1.78 for September. This compares to the prior quarter of $7.81 for April, $8.94 for May, and $9.22 for June.

As far as looking forward for the remainder of the year and the current pricing for CIG on hedge basis as of yesterday's close, or Friday's close, we are looking at a price of $4.24 for the remainder of the year and a hedged price of $4.65 for 2009 and $5.45 for 2010. We have currently marketed our gas and submitted bids to a number of aggregators and marketers. We are receiving a Colorado Interstate Gas Rocky Mountain index price of, plus a premium of between $0.70 and $1.20 for the next year for our gas.

Now let me talk a little bit about our credit facility. Our credit facility is with the Royal Bank of Scotland and we had a re-determination, which went into effect in October. The re-determined amount was $14.5 million. The new borrowing base will be automatically reduced by $666,000 per month for the next six months at which time, or prior to this time, we should have a re-determination based on yearend reserves.

Also in the third quarter, we needed a waiver for a covenant based on the current ratio, which we were granted by RBS. The waiver, the covenant calls for a current ratio of 1:1. Our current ratio was less than 1:1 primarily based on the revenue receivables being less than anticipated due to the price dropping from over $7.00 to under $2.00 in the period of one month. We are currently cutting back on our capital spending and reducing costs to put our current ratio in line to where we will be able to get further credit extensions if needed.

I will now turn the call back to Pete for some final considerations.

Peter G. Schoonmaker

In the third quarter, our management team remained focused on the development of our assets in reducing our development costs. We believe we have the necessary expertise, manpower, and capital resources to carry out our development plan in the future. Our net crude reserves are located on only approximately 7% of our mostly contiguous acreage position in areas of known natural gas reserves, meaning that we have the room to grow as we continue our low risk development drilling program.

We have a strong leasehold position with less than 10,000 acres of the 316,000 net acres expiring in 2009. We still believe we are positioned for strong growth going forward. Again, I want to emphasize that we have had a 99% success rate in our drilling program. We have 98% operational control, we have upside from behind coal zones not currently in our crude reserves and upside in our deep rights as we own over 98% of these rights in our approximately 500,000 gross acres. We will continuously review pricing and takeaway capacity and adjust our cost structure and development plan accordingly.

Now I will turn the call over to the operator for any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) There are no questions at this time.

Peter G. Schoonmaker

I would like to thank everyone for participating in our third quarter financial update and operational review, and if anyone can think of additional questions later on, as always, feel free to call us directly. And with that, we'll conclude our call.

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