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Warren Resources Inc. (NASDAQ:WRES)

Q4 2008 Earnings Call

March 2, 2009 10:00 am ET

Executives

Norman F. Swanton – Chairman, President, and Chief Executive Officer

Timothy A. Larkin – Chief Financial Officer and Executive Vice President

Kenneth A. Gobble – President and Chief Operating Officer of Warren E&P

Analysts

Leo Moriani – RBC Capital Markets

Duane Grubert – CRT Capital Group

Joe Pratt – Wachovia

Irene Haas – Canaccord Adams

Derek Whitfield – Canaccord Adams

Jack Aydin – Keybanc Capital Markets

Operator

Welcome to the Warren Resources fourth quarter and full year 2008 earnings conference call. (Operator Instructions). At this time, I would now like to turn the all over to Mr. Norman Swanton, Chairman and Chief Executive Officer. Please proceed.

Norman F. Swanton

Thank you for joining us for Warren Resources fourth quarter and full year 2008 financial and operating results conference call. I’m here with Jim Larkin our Executive Vice President and CFO, Ken Gobble our COO and President of our operating subsidiary Warren E&P is also joining us from Wyoming to discuss our operating results.

Before I turn the microphone over to Tim to cover the financial results and Ken to discuss our operating results, I would like to briefly review this past year. Two thousand eight was an extremely volatile year for the oil and gas industry and Warren Resources, in particular.

We witnessed our realized oil prices rising to $135 per barrel mid-year 2008 and then dropping to under $33 a barrel by the end of the year. We experienced a worldwide financial credit crisis and saw the global impacts this had on economies and companies.

By October 2008, Warren had taken the proactive step of reducing its capital expenditures by over 80% and establishing the goal of bringing its capital expenditures into line with cash on hand, cash flow from operations and availability under our senior credit facility led by GE Capital. We believe that we have accomplished this objective for 2009 and should continue to do so until oil and gas commodity markets improve.

As you will hear in greater detail from Tim Larkin, our CFO, with 2008 revenues of over $109 million representing a 77% increase from 2007, Warren reported net income for the year of $34 million or $0.59 per diluted share before the impact of the non-cash ceiling test write-down of its oil and gas properties and a goodwill impairment totaling $275 million. The impairments stemmed from significantly lower commodity prices at year end 2008.

We exited 2008 with $29.7 million in cash on hand and over $23 million in availability under our credit facility. We are in full compliance with all terms and covenants under our credit facility and we believe we will continue to be in compliance throughout 2009.

We are also pursuing other measures to further improve our liquidity and to rectify the disconnect between the market value of the company’s oil and gas assets versus the current enterprise value of the company, including possible asset sales, joint ventures, volumetric production payments, commodity price hedging and other monetization of asset strategies. In that regard, we recently hired a large firm to help us evaluate such alternatives.

With that overview, I will turn the call over to Tim Larkin our CFO.

Timothy A. Larkin

Before I discuss the company’s fourth quarter 2008 financial results released earlier today, I would like to remind you that all statements made during our conference call that are not statements of historical fact constitute forward-looking statements and are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

Actual results could vary materially from those continued in the forward-looking statements. Factors that could cause actual results to differ materially from those in the forward-looking statements are described in our Forms 10-K and 10-Q, other periodic filings with the SEC and our press releases.

As Norm mentioned, the fourth quarter of 2008 was a challenging quarter for us. Due to a precipitous decline in oil prices, our SEC proved reserves were $194 million compared to $1 billion at the end of 2007, which represented an 81% decline.

The realized price per barrel of oil in our SEC proved reserve calculation was $32.92 per barrel at year end 2008 compared to $86.21 per barrel at 2007 year end, which represented a 62% decline. As a result, we incurred an impairment expense of $276 million during the fourth quarter.

In comparison, using a realized differential from five year forward NYMEX pricing as of February 9, 2009 would add another 16.8 million barrels of oil and $281 million of PB10 value. As a result of the decline in our SEC reserves, we incurred a $285 million net loss for the fourth quarter of 2008 compared to $4 million of net income in the same period of 2007.

Total production for the quarter was 2.5 billion cubic feet equivalent or 27 million cubic feet equivalent per day. This represented a 42% increase over 2007. Gas production from our Sun Dog and the Atlantic Rim project increased significantly and overall gas production increased 144% to 963 million cubic feet during the fourth quarter compared to 394 million cubic feet during 2007.

Additionally, production from our two oil fields in California totaled 252,000 barrels during the fourth quarter, a 12% increase over the 226,000 barrels produced during the fourth quarter of 2007. We achieved this growth primarily through the drill bit.

Average realized prices for the fourth quarter 2008 were $50 a barrel and $4.04 per Mcf compared to 2007 prices of $79 per barrel and $4.56 per Mcf. Total revenues for the fourth quarter decreased 18% to $16.5 million compared to 2007. Oil and gas revenues decreased 17% to $16.4 million compared to 2007. These decreases resulted from lower commodity prices during the quarter.

As a result of the impairment charge, total expenses increased significantly to $301 million during the fourth quarter of 2008. DD&A leased operating expense increased by 186% and 61% respectively, primarily due to increases in production and reserve write-down ramifications. Additionally, interest expense increased as we drew down additional funds from our credit facility.

For the full year of 2008, our net loss was $242 million compared to net income of $11 million during 2007. Total revenues for 2008 increased 77% to $109 million compared to the prior year. Oil and gas sales increased 82% to $108 million and production increased 45% to 9 billion cubic feet of gas equivalent or 25 million cubic feet per day.

The average realized sales prices for 2008 were $89 per barrel and $6.28 per Mcf compared to 2007 prices of $65 per barrel and $4.81 per Mcf. For 2008, net cash provided by operating activities increased 123% to $62 million compared to 2007 cash flow from operations of $28 million.

Our current borrowing base and over allotment option is at $135 million. At year end, we had $22.6 million of liquidity within our credit facility. Our borrowing base will be re-determined on April 1, 2009. Additionally, as we disclosed in our prior press release, Warren has entered into certain oil and gas price swap contracts. As a result, the company has locked in a minimum level of cash flow from operations.

Our current 2009 capital expenditure budget is $18 million. As the operator of the WTU and the NWU oil assets in California and co-joint venture of the Atlantic Rim project with Anadarko, the company has the ability to modify its capital expenditure budget accordingly. We reported fourth quarter and full year production guidance in our press release released earlier today.

Now let me turn the microphone over to Ken who will provide you with a brief operational update.

Kenneth A. Gobble

In the Wilmington Townlot Unit or WTU during the fourth quarter, we drilled one horizontal well in the tar D1-A sand and completed one other well in the tar formation that had been drilled in the third quarter. As previously announced, Warren released the drilling rig from the WTU at the end of October.

For full year of 2008, Warren drilled nine tar D1-A producers, one tar DU producer, five upper terminal producers, four upper terminal injectors for a total new well count of 19 gross wells. At this time, the company has no plans to resume drilling in the WTU until commodity prices stabilize. Lease operating expenses in the WTU, excluding taxes and well plugging activity, averaged approximately $12 per net barrel of oil produced for all of 2008.

The company plans to focus on optimization of the Upper Terminal waterflood and other related operational efficiencies in both the WTU and the North Wilmington unit in order to maximize cash flows from our production in future months.

Warren continues to make progress resolving the regulatory issues with the South Coast Air Quality Management Districts, or AQMD restrictions concerning compliance with their quality standards and permission to install the best available control technology equipment in the WTU.

The staff of the AQMD continues to fine tune the language in Warren’s environmental analysis document of Sequoia prior to posting the document for a 30-day public comment period. Once the public comment period is closed, the AQMD will answer the comments submitted by the public. Warren expects the permits will be approved after the AQMD has answered these comments.

Laboratory work for the Alkaline Surfactant Polymer Flood or ASP of the Upper Terminal oil zone in the WTU is nearing completion. Results from this work continue to provide encouraging results. The company expects the lab work to be completed in the next few weeks.

The company plans to complete additional reservoir analysis prior to implementing an ASP pilot in the WTU. At this time the ASP appears to provide attractive investment opportunity in the current oil pricing environment. As Tim mentioned, Warren continued to deliver strong growth in our gas production during the fourth quarter.

Development of our Atlantic Rim project in Wyoming was a primary driver of this growth. The company participated in drilling 76 gross producing wells in the Sun Dog unit during 2008. This brought the total number of producing wells in the unit to 116. At year end, 12 of these wells had not yet been completed. All 116 wells are expected to be producing early in 2009.

As these wells continue to dewater, Warren expects continued gas production growth from the Sun Dog unit in 2009 and beyond. Along with our partners, we are currently expanding the gas compression facilities in the unit. Three phases are planned for 2009 that will increase Sun Dog compression capacity to approximately 50 million cubic feet per day by the end of 2009.

The Doty Mountain Unit in the Atlantic Rim project also contributed to the company’s successful gas production growth in the fourth quarter. We began a fracture stimulation program at Doty Mountain late in 2008 that has provided significant production increases in several of the existing wells in the unit.

Gas production has increased from approximately 2 million cubic feet per day to approximately 5.7 million cubic feet per day, and the individual well rates, after stimulation, are comparable to those in the Sun Dog unit.

Along with our partners, Warren participated in drilling an additional 14 producing wells in Doty Mountain during 2008. The completion of these wells, as well as additional fracture stimulation work on the existing wells in the unit, has been delayed until commodity prices improve.

Warren also participated in the drilling of an additional 24 producing wells in the Catalina Unit in Atlantic Rim during 2008. One of the wells encountered a large fault and was plugged. These wells are expected to be producing gas early in 2009. Warren expects that the Catalina will also provide significant gas production growth for the company this year, even with the absence of additional development expenditures in the short-term.

Thank you, and now I’d like to turn the call back over to Norman.

Norman F. Swanton

Operator, we’ll now take any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Leo Moriani – RBC.

Leo Moriani – RBC Capital Markets

What was your debt balance at year end 2008?

Norman F. Swanton

It was $112.4 million.

Leo Moriani – RBC Capital Markets

Okay. And remind me, what’s the borrowing base on that?

Timothy A. Larkin

The borrowing base, Leo, is $120 million and the over allotment option is $15 million for a total availability of $135 million.

Leo Moriani – RBC Capital Markets

And your re-determination’s coming up on April 1 you guys said?

Timothy A. Larkin

That’s correct.

Leo Moriani – RBC Capital Markets

I imagine you’ve been in discussions with your lender at this point in time.

Timothy A. Larkin

Yes. We’ve been talking to them Leo, sure.

Leo Moriani – RBC Capital Markets

Looking at your production costs in the fourth quarter, I guess they were kind of up a fair bit from the prior quarter, just looking to get some color around that increase.

Kenneth A. Gobble

There’s quite a bit of plugging activity going on and several areas where we had some non-recurring costs. Also we had some very large tax payments from the California properties on previously determined values, Leo, at significantly higher oil prices. We would expect tax payments to decrease considerably second half of ’09.

I would like to point out just a few things there when we start talking about operating expenses. Historically, the company has had some relatively high OpEx numbers compared to our peers, and a lot of that was driven by where we’re at in the Atlantic Rim development.

Even our core areas weren’t producing gas at peak rates yet, and we were also operating several dewatering pilots there. As you saw in our press release, Leo, we trimmed that way back and we expect our ’09 OpEx numbers to come more in line with our competitors.

Leo Moriani – RBC Capital Markets

Okay. You guys talked about some non-recurring items in the fourth quarter in your op expense. Do you guys have any kind of quantification on that?

Kenneth A. Gobble

Conservatively we peeled probably close to $900,000 out of the NWU. And the WTU, we really didn’t dig into it that hard since our OpEx for the year there was only about $12 a barrel. But we’ve made some improvements out there in the way we’re operating, personnel wise and other matters where we can improve efficiencies.

I’m not certain in the long-term how much lower we can get down in the WTU, but I think in the North Wilmington Unit I’m expecting to see some significant reductions in OpEx in that unit, and also in the Atlantic Rim.

Leo Moriani – RBC Capital Markets

Okay. In terms of WTU, just trying to understand some of the timing there, you guys made some comments on the AQMD issue out there. Any sense of timing to when you guys can go ahead and start installing that gas compression equipment or gas injection equipment? Is that in the budget for 2009?

Kenneth A. Gobble

Yes. The installation of that equipment is definitely in our CapEx forecast for the year. We ran into some issues where the regulatory agencies in California were looking forward at what the greenhouse gas emission standards would look like at some point in the future.

And it took quite a while for us to agree to what kind of language needed to be in the environmental analysis document to cover the bases and make the regulatory agencies feel good with what they thought could perhaps be new regulations coming at us in a year or two.

Now we’ve worked through that greenhouse issue language question. I think the AQMD is satisfied that that’s covered. Right now we’re working on one last minor detail that includes calculations and some language adjustments on morbidity issues, and once that’s finished I believe we will get this document posted.

As far as time goes, Leo, I hate to put a timeframe on it. As you know, it’s drug on a little bit longer than we had originally anticipated, which is very common for these types of matters. But right now, with the reduction CapEx on our California properties, we really don’t see that as being a hurdle for us in the short-term. Now when we get really to go back to drilling it will be a different issue.

Norman F. Swanton

I wanted to add, Leo that as these tar wells, as the gas produced from the tar wells has declined over the last couple of quarters, it definitely has a less material impact on current production than in our prior quarters.

Leo Moriani – RBC Capital Markets

How long is it going to take you guys to install the equipment out there once you get approval?

Kenneth A. Gobble

It won’t take long. I would suspect that the new burner [inaudible] flare burner could be installed in a matter of just two or three weeks. As far as getting right to gas injection, that would probably take a little longer, but probably not more than 60 days.

Operator

Your next question comes from Duane Grubert – CRT Capital Group

Duane Grubert – CRT Capital Group

Norm, you guys have, like other California producers, had to suffer through a widening differential between California and NYMEX. Can you talk about what kind of factors in the past and what kind of factors are going forward might close that gap relatively quickly?

Norman F. Swanton

We haven’t seen the gap that much as some other California producers. Correct me if I’m wrong, Tim and Ken, but we’re still seeing about $10 to $12 a barrel differential?

Kenneth A. Gobble

That’s correct.

Norman F. Swanton

So it has not changed very much for us one way or the other, Duane.

Kenneth A. Gobble

Typically, Duane, that tends to narrow as the price comes down and I think what we’re seeing here is a little bit of lag as far as that narrowing with NYMEX coming down, but I expect that will happen.

Duane Grubert – CRT Capital Group

And then in your early comments saying that you’ve hired a large firm to look at things that would include asset sales, joint ventures and so forth, would you be willing to signal a bias on which of the business units, and I guess I’m thinking California or Wyoming, where you’d be more eager to do something like that?

Timothy A. Larkin

I don’t think we’re, I think that we’d have to analyze whatever offer came in and look at them individually. I think managements extremely excited about both assets. We would have to take that offer at the time we received it.

Norman F. Swanton

Tim, correct me if I’m wrong, Duane, I think it’s safe to say at this time we’re keeping all of our options open.

Operator

Your next question comes from Joe Pratt – Wachovia.

Joe Pratt – Wachovia

Just further to that comment. You’ve hired somebody to help you with those discussions?

Timothy A. Larkin

That’s correct.

Operator

Your next question comes from Irene Haas – Canaccord Adams

Irene Haas – Canaccord Adams

Yes. Holding up on that question of hiring a firm to look at all strategic options, I mean the way I look at your assets is that the Wilmington deal was a good project. You guys worked really long and hard to get it at where it is and similarly with the same assets in Wyoming, however, both assets might be a better fit for a larger firm that has a deeper portfolio to kind of withstand these periods of volatility. Are you guys considering selling both assets?

Norman F. Swanton

Irene, this is Norman, we are considering all alternatives. Honestly and truly. The one thing we cannot abide is what the experience has been in our stock price, I think we owe it to the shareholders, by whatever means are necessary, to improve the shareholder value for the shareholders.

Operator

Your next question comes from Derek Whitfield – Canaccord Adams

Derek Whitfield – Canaccord Adams

I’ve got a follow up question on operating expenses. You might have hit it before, but what’s the right project for the Atlantic Rim on a LOE basis?

Timothy A. Larkin

We haven’t really guided on LOEs, but Ken do you want to maybe add some more color?

Kenneth A. Gobble

Derek, closing down our pilots in the significant growth in Sun Dog and Doty, we would expect just operating this year, of course now we’re pretty well through the third quarter so we really only have three quarters of the year to realize savings of having those dewatering pilots shot in.

But with that excluded, ongoing in our core area including taxes and including compression transportation to the interstate line, I expect we’re probably going to come down in the $1.75 range. You know any swinging gas prices dramatically changes our tax structure, right?

Operator

Your next question comes from Jack Aydin – Keybanc Capital Markets

Jack Aydin – Keybanc Capital Markets

On your re-determination, which is April, what kind of [inaudible] are you hearing and what kind of pricing you think your banks will look at in re-determining your credit facility and is it at risk of being refused?

Kenneth A. Gobble

Jack, right now it looks like the banks are probably using something between the SEC and the strip price and all of the banks in our facility their price deck is somewhat different. We have ran our year end report at something that we believe is similar to the bank’s price deck, and at this time we believe the value of our collateral will suffice for our borrowing base.

Now, if we see more pressure on prices and, of course, there’s some concern on how the cash flow looks, that could change. But at this time, we believe we’re okay.

Jack Aydin – Keybanc Capital Markets

You don’t think there is a risk of reducing the credit facility at all?

Kenneth A. Gobble

I’m not going to say that, I’m not going to say that we don’t think there is a risk, but at this time we believe we’re okay.

Jack Aydin – Keybanc Capital Markets

I know you mentioned you have the cash $29 million and you have some facility and cash flow, would it be better off if you just shut in little things and just try to live within your cash flow without using your cash?

Kenneth A. Gobble

Well, as we did mention in our press release, we have a lot of flexibility, Jack, when it comes to CapEx. We’re, of course, going to monitor that very closely.

Norman F. Swanton

When we describe what our availability and cash on hand and so forth is, we just expressing what we have to work with. It doesn’t mean we’re going to go to the line in terms of these items together. It means that’s the framework. We’re seeking to maximize cash flow and minimize expenditures in this environment. So if that resulted in cash increasing as opposed to decreasing that would be highly desirable from our standpoint.

Kenneth A. Gobble

You know, Jack, I would toss one more thing out there. The properties that we’re working with that are non-operated everyone’s continuing to dial down their 2009 budget.

Operator

At this time, there are no additional questions in queue. I would now like to turn the call back over to Mr. Norman Swanton for closing remarks.

Norman F. Swanton

I would like to thank all of you for joining us today and for your interest in Warren Resources. I hope I’ve conveyed to you how committed we are to improving shareholder value by all means available to us in 2009 and beyond. Thank you and good day.

Operator

Ladies and gentlemen, this concludes the presentation. You may now disconnect. Thank you and have a good day.

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Source: Warren Resources Inc. Q4 2008 Earnings Call Transcript
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