TXCO Resources, Inc. Q3 2008 (Qtr End 9/30/2008) Earnings Call Transcript

TXCO Resources, Inc. (TXCO)

Q3 2008 Earnings Call

November 5, 2008 11:00 am ET

Executives

Bob [Tomei] – Vice President, Capital Markets

James E. Sigmon – Chairman, Chief Executive Officer

Gary S. Grinsfelder – President

James J. Bookout, P.E. – Chief Operating Officer

P. Mark Stark – Chief Financial Officer

Analysts

Neal Dingmann – Dahlman Rose & Co.

Phil McPherson – Global Hunter Securities, LLC

Chris Pikul – Morgan Keegan

Presentation

Operator

Good morning. My name is [Erin] and I will be your conference call facilitator today. I would like to welcome everyone to this quarterly call of TXCO Resources to discuss the company’s third quarter and nine month 2008 earnings and to review current operations. (Operator Instructions) I would now like to turn the call over to Mr. Bob [Tomei], Vice President, Capital Markets.

Bob Tomei

Good morning everyone and welcome to TXCO’s quarterly conference call. Joining me this morning are Jim Sigmon, our Chairman and CEO; Gary Grinsfelder, our President; Jeff Bookout, our Chief Operating Officer and Mark Stark, our Chief Financial Officer. We will focus this morning on the financial results we announced yesterday morning – evening and update you on our operations. After some brief prepared remarks we’ll have time for a few questions as well.

I’d like to remind you that this conference call is being recorded and will be available for replay approximately an hour after its completion this morning. Archived conference calls, our press releases and other investor information can be found on our TXCO Resources website at www.TXCO.com for your future reference.

Now please be advised that our remarks, including answers to any questions, may include statements that we believe to be forward-looking within the meaning of the Private Securities Litigation and Reform Act. Now these forward-looking statements are subject to risks and uncertainties that could cause actual results to be materially different from those anticipated currently. Now these risks include matters we’ve described in our past filings with the Securities and Exchange Commission, including our annual report on Form 10-K for the year ended December 31, 2007 and our second quarter 2008 10-Q. We will file our third quarter 10-Q in just a few days.

We disclaim any obligation to update these forward-looking statements. During this conference call we may also make references to EBITDA, EBITDAX, or other non-generally accepted accounting principle financial measures or GAAP measures. Reconciliations of these non-GAAP measures to the applicable GAAP measures can be found within yesterday’s earnings release. With that background I’d like to turn things over to Jim Sigmon. Jim.

James E. Sigmon

Thank you Bob and good morning everyone. I’m pleased to report that TXCO had a good third quarter and nine months to date, despite the decrease in commodity prices and the tightening of the credit financial markets. We have positioned TXCO to continue developing our high impact plays in the Pearsall Shale and the Eagleford Shale. I hope everyone has had time to read the earnings release from yesterday. If not, it’s available on the News Release page of our website, txco.com.

To start off I’ll invite Mark Stark, our CFO to comment on earnings and operations from that release.

P. Mark Stark

Thanks Jim and good morning everyone. I’d like to take a few minutes to review some key metrics. I would like to first focus on the third quarter. Looking at revenues, oil and gas sales as well as total revenues grew by over 60% versus in the third quarter for 2007. Taking into account products pricing, average realized oil prices for the quarter were $103.06 per barrel including hedges, up $41.33 per barrel compared to this quarter a year ago.

Average realized natural gas prices for the quarter were $10.01 per mcf including hedges, up $3.05 compared to a year ago. You know, talking about our sales volumes for just a minute for the quarter, we had approximately 293,000 barrels of oil that we produced and sold; 705 million cubic feet of gas; on a gas equivalent basis that’s equivalent to 2.46 bcfe for the quarter. That compares to 2.38 bcfe for the third quarter of 2007 and also compares to 2.66 bcfe for the second quarter of 2008.

Going down the income statement for just a moment and looking at costs and expenses, total costs and expenses increased by 21.7% above the third quarter a year ago. This increase in total costs and expenses is consistent with current year activity levels, the commodities price environment, and the current DD&A costs. Interest expense, we incurred $2.6 million of interest expense for the quarter relating to our long term debt financing.

Dropping that down into net income at the bottom line, we had net income of approximately

$7 million and after preferred dividends we had a net income available to common stockholders of approximately $5.6 million or $0.16 per diluted share as well as $0.16 per basic share. Again that’s for the third quarter and is inside the range of earnings expectations.

I’d like to take a few moments and review our liquidity metrics. Net cash provided by operating activities was nearly $73 million for the first three quarters of 2008 compared to $32.5 million for the first three quarters of 2007. However, when you adjust for certain changes in operating assets and liability such as increases and decreases in current receivables, payables, and prepaid expenses, net cash provided by operating activities for the nine months was $63 million compared with $27.4 million for the first nine months of 2007.

Now, taking a look at EBITDA and EBITDAX for a moment, I just want to review our cash flow measures as measured by EBITDA and EBITDAX and our results were as follows. For the third quarter of 2008, we had EBITDA of $28.030 million or 67.2% of revenues. EBITDAX for the quarter was $28.3 million or roughly 67.9% of our revenues. That compares to on a year-to-date basis EBITDA of $80 million 786 which is 65.8% of our revenues and EBITDAX of $82273 which represented 67% of our total revenues.

Further, looking at EBITDA and EBITDAX on a trailing 12 month basis, this would be the trailing 12 months ended September 30, 2008, EBITDA was $100.826 million or 65.1% of revenues; EBITDAX was $102.612 million or 66.3% of total revenues.

I’d like to take a few minutes to review our balance sheet with you. At September 30 we had total assets of $467.2 million, current assets of $57.8 million, current liabilities of $77.6 million, total long term debt outstanding of $130 million, debt to asset ratio 28%, our line of credit with a balance outstanding on our revolving credit facility of $30 million with our borrowing base of

$55 million leaving $25 million available to us as we complete 2008. With those highlights I’ll turn the program back to Jim.

James E. Sigmon

Thank you Mark. You’ll be able to ask Mark some additional questions in a few minutes. I would now like to introduce Gary Grinsfelder, our President, who will point out some of our operational highlights during the quarter. Gary.

Gary S. Grinsfelder

Thanks Jim and good morning everyone. I’d like to update everyone on our operations this morning. You may want to refer to the operations press release we issued late last month which is on our website if you don’t have a copy in front of you. Now let me focus on our key plays.

As of today, we have seven rigs running. To break that down, we have three in the Glen Rose porosity plane, one drilling a Pearsall well, one a Georgetown well, one San Miguel well and the Pena Creek waterflood, and one well drilling in Fort Trinidad. To update you on our Pearsall play, on the Anadarko farm out acreage with our partner St. Mary we are flowing back gas with frac fluid in our [Jupidaro] well. This is after completing a four stage frac in a slim hole.

We continue to be delayed in fracing the San Pedro II well, also on the Anadarko acreage and due to the short supply of high [strec prop-it] necessary to properly frac the high pressure Pearsall formation. Last week we spudded our [O’Meara] well on the intent of farm out acreage. This is the first Phase II well on the EnCana farm out. With this well we intend to micro-seismic monitor the frac in this well as we did in our previously drilled well, the Myers well has averaged 1.5 million cubic feet of gas per day since it was put on production 40 days ago. And just to remind everyone, TXCO holds 341,000 net acres in the Pearsall play.

Moving to the Eagleford shale play and on the Anadarko farm out acreage, also with our partner St. Mary, we have previously drilled and fraced two wells. Those results were reported in our operations release that went out again in late October. Pending landowner approval, which is necessary due to hunting restrictions, we plan to re-enter and drill a 3,000 foot lateral in the [Katarina] west well which was drilled as a vertical well by Anadarko two years ago. This will be the first well drilled under Phase II of the Anadarko farm out agreement. We expect to spud that well within a few weeks.

TXCO holds 497,388 net acres in this growing play, most of which is located due west of the recent successful completion announced by another operator. Moving to the Glen Rose porosity, we have drilled 28 wells so far this year. Two are currently drilling and we expect to drill two more by the end of the year. As you know, our rig count drops during the fourth quarter due to the annual hunting season restrictions on our leases.

To update you on our San Miguel oil sands project, we are injecting steam in two of our three pile-ups, that being the [Sag D] in the southern part of the acreage and in the [Fas] which is located to the north. Both pilots are very early introduction in pre-heat phase and although we are producing oil, there are no meaningful results to report. We do expect to report on the Sag D by the first quarter of ’09 and on the Fas during the second quarter of ’09.

At Fort Trinidad we are drilling horizontally in one well and we are testing the vertical section in another. One well is waiting on a rig to begin its horizontal drilling effort. As you can see, we have had a busy year and we will have a record number of wells drilled by year end. With that I’ll turn things back to Jim for some final comments.

James E. Sigmon

Thank you Gary. Although we’ve seen some dramatic changes in oil and gas prices in recent weeks, it was still a good quarter. As we discussed in yesterday’s press release, we are limiting our drilling activity in the fourth quarter to what we can cover with cash flow. Even so, I want to point out again that we will still exceed our CapEx projections for 2008. Additionally, we are in the process of developing our 2009 CapEx budget and plan to drill within our cash flow in 2009.

Our focus as we prepare our 2009 CapEx budget will be to develop the Perarsall shale field, the Eagleford shale and the Glen Rose porosity zones. We believe that the shale plays has the potential to have a large impact on TXCO in the near future and the Glen Rose porosity wells give us the needed cash flow. With that, I believe we’ll have a few minutes left for questions from some of our callers.

Bob Tomei

Operator, we’re ready to take some questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Neal Dingmann – Dahlman Rose & Co.

Neal Dingmann – Dahlman Rose & Co.

Say Jim can you address a bit as far as, you know, now with your CapEx I bet sort of living within your cash flow means and that, in addition to sort of the I guess the lack of profit that Gary had mentioned, can you give me an idea, I guess, as far as how active you can get, you know, within the next quarter or two in that the Pearsall in that region? And then will that come a bit at the expense, will you slow down San Miguel or Glen Rose or not necessarily?

James E. Sigmon

I mean, we’re still developing it. But let me tell you the priorities are. It makes no sense to drill Pearsall wells if I can’t frac them. That being said, I’ve got a minimal number of Pearsall wells I have to drill under the farm out agreements by time frames. I don’t have those exact dates in front of me, but I would anticipate – I think it’s the middle of the year, June or July of next year; we have to drill by that period of time. I think we have to drill four wells under our EnCana project. We’re starting one of those now. So there’s a minimum number of wells we’re going to drill that are the Pearsall.

We – it depending on availability of profit and obviously the success of the wells, we can always adjust what we’re going to do with wells we’re going to drill next year, but we’ve got a minimum Pearsall that we’re going to get. San Miguel oil sands, we’ve got heat going in the grand on two of our [products] where we’re actually heating the wells, we’re actually getting some oil coming back. You know, a small response at the present time, starting. It makes no sense to shut down those operations and pull back that operation. I mean, San Miguel oil sands was just not doing what we want.

However, we don’t think any reason to increase our operations there and expand that activity there in the light of the financial markets, where we are today, oil prices where they are right now. So you’ll see us most likely not doing a lot of CapEx increases in the San Miguel oil sands; however, we will just maintain what we’re doing at the present time. And I don’t know if I got all your questions there –

Neal Dingmann – Dahlman Rose & Co.

You did and I guess I just want to make sure I’m clear and on what you’re still seeing at the Pearsall. I mean, there’s still nothing indicating to you that those wells are any better or any worse, I guess you’re still very encouraged about that play. Just more or less getting the needed profit to get those things fraced and, you know the stage frac that you would like.

James E. Sigmon

Yes and I might say that that last comment that you just made, Neal, about the stage fracs that we would like to do, you know, right now we’ve done a minimal number of four to five stages. We think in this environment now we’re going to have to step up and go ahead and do one that’s eight or ten stage fracs. We’re waiting on getting that volume of profit right now to be able to do that. But we think that has to be done at high rates and get the kind of – we think that will be a major impact and get a much better result from those wells than what we’ve had to date.

Operator

Your next question comes from Phil McPherson – Global Hunter Securities, LLC.

Phil McPherson – Global Hunter Securities, LLC

Hey on San Miguel, what do you think it cost you in steam a month or what kind of burn rate are we looking at as far as what you’re spending to inject right now?

Gary S. Grinsfelder

Looks like going into ’09 and through most of ’09 we’re – the operating cost to the 8H interest is about $1.2 million a month. As you recall, we’re creating steam by burning natural gas which is not the ultimate fuel type as we go forward with this. That accounts for the – probably 75% of that cost, the cost of the natural gas. And that of course is – that 8H number is split with our partner [Pearl]. And we’re taking a real hard look at that. As Jim said we are encouraged by the very early results in the [Sag D] specifically, but we’ve got to get another six to nine months production out of both these pilots behind us before we can make any decisions.

Phil McPherson – Global Hunter Securities, LLC

Gary, do you want one of the steam generators to be fired on coal or fitted to be fitted on coal?

Gary S. Grinsfelder

That’s correct. At this point we’re looking as coal being the fuel of choice going into commercialization. We still are maybe assessing that decision as we go forward, but right now that’s the way it looks.

Phil McPherson – Global Hunter Securities, LLC

Gary, can you tell me the Fort Trinidad stuff that’s going on again?

Gary S. Grinsfelder

We have one well drilling a horizontal – it’s going horizontal in the Glen Rose D, that’s our Maples well. We are testing vertically in the Four H well and we are waiting with our [Shelly II Well] to move the rig that’s drilling horizontally in the Maples over to the Shelly II.

Phil McPherson – Global Hunter Securities, LLC

And what about the previous wells? Can you give us an idea of how they’re – I know we were falling back, a lot of frac fluid at first from one and can you give us –

Gary S. Grinsfelder

Those have been relatively disappointing, Phil. We are taking a hard look at them. I think that we’re trying to understand if we need to set some up on hole packers to isolate some zones that look like they might produce – have better produce ability than some other zones. And we’re kind of in the process of working that out right now.

Operator

Your next question comes from Chris Pikul – Morgan Keegan.

Chris Pikul – Morgan Keegan

Gary, can you add any color to the Petrohawk well as it relates to the Eagleford kind of in your area? Were you able to learn anything more about what they did as to anything as far as depth – you know deposition or anything like that?

Gary S. Grinsfelder

Well, they have an Eagleford section that’s very similar to ours. It is located in a deeper – it’s deeper there. It’s about 11,000 feet. It is in front of the Edwards Reef Trend as it goes through our part of south Texas. They – I think the big difference is as we may have discussed before with some people is the type of frac they put on the zone. Our guys don’t see much change in the rock quality from where we are over to where they are, besides it being a little bit deeper.

But the significant difference that they did was they probably a little bit more than doubled the type of frac they did in their well than we’ve done in our first two wells. And as we mentioned, this Katarina west re-entry is designed to be a fracture stimulated very similar to the method that Petrohawk used, that being that we intend to drill about 3,000 feet with maybe ten stages and quite a bit more profit as Jim mentioned. That – until we are able to duplicate the frac types that are seeing the big results in the shale plays, you know, we’re very anxious to see what those results might give us.

Chris Pikul – Morgan Keegan

Jim, just as I try and think about, you know I know you guys are living within cash flow in ’09 and you know you’re in the process of formulating your budget. You know, we all want to see as much money going into the Pearsall and Eagleford as possible. When it comes down to how much money you can throw at the Glen Rose, you know, is there a way we should think about – you know I’m guessing there certainly can’t be the activity level that there was this year. And, you know, is there a minimum amount of either infrastructure – at least keeping wells that you know you’re going to have to drill, it’s going to be a certain dollar amount?

James E. Sigmon

Well, we do have a minimum lease obligation to wells we have to drill. They don’t necessarily have to be Glen Rose wells. For example, a Pearsall well or an Eagleford well on that same lease block would serve the same purposes. So we will balance between the two. What we’re looking for, as you well know would be what’s the [hour] or what’s the numbers we’re getting back with reserves we’re building would depend on which well we’re drilling. And we’ll take those kinds of things into focus as we develop in each plays.

Our focus is going to try to develop one of these plays, Pearsall and/or the Eagleford as fast as we can. And everything else will take a back seat but we will – we may have to drill – well, we will have to drill other wells to hold lease hold block because we just can’t afford to drill

$5 million or $3 million wells on every single well. We may have to drill some $1.5 million wells to hold leases, etc., like the Glen Rose well.

Chris Pikul – Morgan Keegan

I mean, I’m just ballparking, I mean we’d have to expect maybe 20 wells versus the 35 this year?

James E. Sigmon

That would probably be a good ballpark.

Chris Pikul – Morgan Keegan

And then is there any chance that we’ll see, you know, will there be any Pearsall reserves that may find their way into your reserve report? Or will that still be dependant on additional drilling?

James E. Sigmon

Well, we are obviously very hopeful that we would see some. We expect to see some but as you well know we have outside reservoir engineers audit our reserves and so we’re going to have to rely on what their judgment. We anticipate that we ought to get some Pearsall reserves and possibly some Eagleford reserves at year end.

Operator

You have a follow-up question from Phil McPherson – Global Hunter Securities, LLC.

Phil McPherson – Global Hunter Securities, LLC

On the re-entry for the Eagleford, you said you’re going to spud it in two weeks. Can you tell me how much it’s going to cost and how long it’s going to take to drill?

James J. Bookout, P.E.

We should spud that well in about two weeks. It’s just a pretty straightforward re-entry. We hope to get some five-and-a-half out of the way. We’ll be kicking out of a big hole so we’ll have a nice, large lateral in which to run four-and-a-half inch frac point equipment. We’re going to try to run ten stages and 3,000 feet of lateral like Jim was mentioning a while ago. Total cost on that thing to get re-entered and to get to the point of getting ready to frac, it’s going to be somewhere around $1.5 million. And then depending on availability and the cost of profit, you know the frac itself could run anywhere from $1.5 million to $2 million frac.

Phil McPherson – Global Hunter Securities, LLC

And you would expect it to have that completed by the end of the year?

James J. Bookout, P.E.

We would hope it would be. If we get started in a couple of weeks, the whole project should only take us about two weeks to 20 days so we should have, you know, the project completed. I’m not going to say, you know, we can get it fraced by the end of the year but we’re going to certainly try.

Phil McPherson – Global Hunter Securities, LLC

Mark, the share count went up in this quarter I assume from – with all the conversion. Can you give us - I know it’ll probably be in the Q, but a handle on how much has been converted out and where that stands at on the balance on the converts?

P. Mark Stark

Well, Phil, actually the converts took place after the end of the quarter. And as you know, about a million – as a result of the preferred that did convert, it added about a million shares to our share count.

Phil McPherson – Global Hunter Securities, LLC

It did look like in the third quarter share count went up from 35 million to 40 million. Are you now counting it into your – all the converts in your basic shares outstanding?

P. Mark Stark

On the fully diluted count, it factors all of the convert into the fully diluted share count.

Phil McPherson – Global Hunter Securities, LLC

And so that fully diluted share count, just so I had my numbers right, is it 40.2 million? I thought it was 42 –

P. Mark Stark

Yes. It is. And in fact I think there’s some slides on our website. They go into that in some detail.

Operator

Your next question comes from Chris Pikul – Morgan Keegan.

Chris Pikul – Morgan Keegan

Gary, what is the outlook for kind of getting sand as you look into your drilling program next year? What are you dependant on or what are the suppliers telling you?

Gary S. Grinsfelder

Well, I’ll throw that over to Jeff. He’s had the most recent conversations with those suppliers.

James J. Bookout, P.E.

We constantly are, you know, dealing with all the major frac companies, Schlumberger, Halliburton, Weatherford. You name it. Even some minor – some more minor players and trying to see who all is getting the division of sand. You know the good news is that we can still fairly readily get the sand we need to do the Eagleford fracs with. So you know getting an Eagleford frac done here by the end of the year is not going to be a major ordeal.

Chris, right now I couldn’t tell you – I mean, we just had conversations yesterday with Halliburton and Schlumberger and Weatherford and they can’t even tell us when they’re going to get sand. So I wish I could give you some more color on that, Chris, but today I just – I can’t even give you a flavor for what these guys are getting because they don’t even have a flavor for what they’re going to get.

Chris Pikul – Morgan Keegan

Is there supposed to be, you know, more production or mines or things coming online in ’09 or just in general?

James J. Bookout, P.E.

Well, what they’re talking about is getting a bunch of product sent in from overseas. China is starting to make a whole lot of product, especially the box-sized, so really high strength products which we actually use a lot of box-size in these Pearsall fracs because of the closure stresses that we encounter. But until we start to see some profits coming in from China and different places over the water, I don’t see any alleviation of this problem for at least another couple months.

Chris Pikul – Morgan Keegan

And you guys still treat it as a temporary – I mean, you kind of ask for sand when it’s available, you don’t enter into any sort of contracts or how does that work?

James J. Bookout, P.E.

We don’t today. We’ve actually gone in and tried to set up some different allegiances or alliances, however you might want to look at it in order to, you know, be able to better plan for ’09 on how we want to get frac sand and these guys just don’t have any idea. They can’t even make a commitment to us on that because they don’t know when they’re going to get what.

Chris Pikul – Morgan Keegan

So is it to the point where your Pearsall program - you know Jim, do you just have to drill the four? Or do you have to drill and complete the four? Or I mean, is it that bad out there that you may not be able to do those minimum wells?

James E. Sigmon

Well, we can drill the wells. You know, we may be able – if it got worse in the next six months or nine months, we couldn’t get any, you can go in and drill the wells and prepare for fracing, we’d meet our obligations, as far as having to drill the wells by that period of time.

Bob Tomei

Jim, I think that’s all the calls we have in queue. Would you like to summarize and add some closing comments?

James E. Sigmon

Well we are excited about what we’re doing with the Pearsall and the Eagleford wells. We’re – our initial result, particularly on the Eagleford are very exciting to us. The wells are holding up a little bit better than what we even anticipated. So we’re hopeful that these shoal plays will continue to develop with bigger and better frac jobs on them.

We’re disappointed about the credit financial crunch just at the same time that we’re having great opportunities before us, but we believe that this, too, will pass and we’ll be in position at the end of this tight credit crunch in order to take advantage of the assets that we have. So we just hope that everybody will look forward to what we’re doing in the future.

Bob Tomei

Operator that concludes our call but we thank all of our listeners for joining us again this morning.

Operator

This does conclude today’s conference call. You may now disconnect.

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