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Carrizo Oil & Gas, Inc. (NASDAQ:CRZO)

Q4 2008 Earnings Call

March 03, 2009 11:00 AM ET

Executives

S. P. Johnson, IV - President and Chief Executive Officer

Paul F. Boling - Vice President, Chief Financial Officer, Secretary and Treasurer

J. Bradley Fisher - Vice President and Chief Operating Officer

Analysts

David Tameron - Wachovia Capital Markets

Jeffrey Hayden - Rodman & Renshaw

Ronald Mills - Johnson Rice & Company

Marshall Carver - Capital One Southcoast

Leo Mariani - RBC Capital Markets

Stephen Beck - Jefferies & Company

Raymond Deacon - Pritchard Capital

Monroe Helm - CM Energy Partners

Operator

Ladies and gentlemen, welcome to the Fourth Quarter 2008 Financial Results for Carrizo Oil & Gas, Incorporated Conference Call. During this presentation, all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded, Tuesday, March 3, 2009.

Your speakers today are Chip Johnson, President and Chief Executive Officer, and Paul Boling, Vice President and Chief Financial Officer of Carrizo Oil & Gas. Also on the call today is Richard Hunter, Vice President of Investor Relations.

This conference is now being turned over to Mr. Chip Johnson, President and Chief Executive Officer. Please go ahead sir.

S. P. Johnson, IV

Thank you, Martin. Thank you all for calling in for the fourth quarter and the year-end earnings call. As we've done in the past, Paul Boling will start out with the financials and then I'll give an operations update and then we'll open in up to questions.

So, with that Paul, do you want to get started?

Paul F. Boling

Thanks, Chip. Oil and gas revenues for the three months ended December 31, '08 were $36.2 million, compared with $40 million during the same quarter ended December 31, '07. Commodity prices including the impact of hedges decreased as natural gas prices were $6.11 per M, as compared to $6.84 per M in the fourth quarter of '07. Oil prices decreased to $76.44 per barrel, from $83.65 per barrel in the fourth quarter of '07.

Our record-breaking fourth quarter 2008 production level was 7.2 Bcfe, up 28% compared to the 5.64 Bcfe produced during the fourth quarter of '07. The increase was primarily due to the continued addition of new production from the company's Barnett Shale development. During the fourth quarter '08, EBITDA was $31.9 million, or $1.04 and $1.03 per basic and diluted share respectively, as compared to $30 million, or $1.08 and $1.05 per basic and diluted share, during fourth quarter of '07.

Oil and gas operating expenses, excluding production taxes in the fourth quarter of '08, were $9.4 million or $3.4 million higher than the fourth quarter of '07 largely due to increased production in well count in our Barnett Shale operations, and in part to the higher transaction in higher saltwater disposal with our operations in the Barnett Shale.

Our guidance for lease operating expense in the first quarter of '09 is a $1.30 to $1.35 per Mcfe. Depreciation, depletion and amortization expense was $16.4 million, or $3.5 million higher than the fourth quarter of '07, primarily due to the relative increase in production volumes. Guidance for DD&A rate in the first quarter is $2.27.

General and administrative expense increased to $4.1 million compared to $3.4 million during the same quarter of '07. The increase in G&A was primarily a result of an increase in compensation and other related... employee-related expenses, largely attributable to our increased headcount. General guidance for the G&A expense in the first quarter of '09 is about $4.1 million.

Non-cash stock option compensation expense was $1.4 million, compared to $1.9 million for the same period in 2007. The significant decline in oil and gas prices, which were based upon $4.99 per Mcf price at 12/31/08, resulted in a non-cash ceiling test write-down at the end of the fourth quarter, amounting to $138.6 million or $90.1 million after tax. The realized gain on derivatives was $9.7 million for the fourth quarter '08, due entirely to commodity derivatives, as compared to a realized gain on derivatives for the fourth quarter of '07 of 1 million.

The non-cash unrealized gain on derivatives was $28.2 million in the fourth quarter '08, comprised entirely of commodity derivatives. The non-cash unrealized loss on derivatives in the fourth quarter of '07 was $2.7 million, and comprised of $1.7 million loss on commodity derivatives and a $1 million loss on interest rates swaps.

Interest expense net of amounts capitalized was $2.4 million for the fourth quarter of '08, compared to $3.3 million for the same quarter in '07. This decrease is primarily attributable to the larger portion of interest expense that was capitalized due to the increase in our unevaluated property balance. Excluding a net $72.6 million non-cash after-tax charge comprised of a non-cash impairment of oil and gas properties of $90.1 million, a market-to-market unrealized gain of $18.4 million on oil and gas derivatives and stock compensation expense of $0.9 million, our adjusted net income for the fourth quarter of 2008 was $6.4 million or $0.21 per basic and diluted shares, as compared to $8.6 million or $0.31 and $0.30 per basic and diluted shares in '07.

Moving on to a brief review of our company's full year '08 results; financial performance for 2008 was a record setting on several fronts. Oil and gas revenues were a record $210 million, up 67% from our 2007 revenues of a $126 million. Including the impacts of hedges, commodity prices were $7.74 per M and $98.20 per barrel in the year ended 2008, compared to $6.86 per M and $69.71 per barrel for the year 2007. Our 2008 production volume was also a record 25.6 Bcfe, up 47%, higher compared to the 17.5 Bcfe produced during our 2007 year. Our EBITDA was a record $154.1 million for 2008, or $5.13 and $5.04 per basic and diluted shares respectively.

In conclusion, given the current low commodity price environment, we remain focused on preserving liquidity and funding our capital expenditure program from free cash flow. Chip?

S. P. Johnson, IV

Thanks Paul. I'll go over the operations update now. Production is currently about 92 million equivalent per day, with 74 million a day coming from the Barnett Shale and 18 million a day from the onshore Gulf Coast. We have 47 gross Barnett horizontals drilled waiting on completion. About six of those are outside operated. That should add 84 million a day net to our production when we actually began fracking all these wells. Eight of the wells were just fracked. They should come online in the next ten days and add about 14 million a day net.

We're currently operating three drilling rigs all in the core of the Barnett, all H&P Flex rigs, two in Southeast Tarrant and one in Denton County. We'll probably have no other drilling activity for next three months aside from these three rigs and one rig in the Marcellus, although there is one in-fill well in Duval County, in South Texas we might drill where we have a 25% working interest. As before we continue to add acreage in the Barnett at much lower lease cost, only along known well path with no new greenfield areas being pursued.

In the Marcellus, we have gone over 200,000 acres net to our JV with Avista Capital Partners and have wound down our leasing activity. We plan to spud the first Carrizo-operated vertical Marcellus well in the next two weeks in the Sea County area, with another well in that same area, another vertical well in April. Permitting is progressing in West Virginia and New York also. Our budget plan is to drill ten verticals and one horizontal well in 2009. Permitting will probably keep us from getting to that number, but we might get 80% of that. We plan to finish 2009 using Avista Capital funds without any Carrizo CapEx.

In the North Sea, we we're waiting on the outcome to the Oilexco bankruptcy, which could be resolved as early as April according to Oilexco people and the Morgan Stanley people that are trying to sell their assets. We're about to begin unitization meetings with BG & Hess in order to finalize the ownership interest on the Shallow Fortis (ph) reservoir. Because of these delays, first production is probably late '10 or into '11.

As commodity prices have continued falling, we've responded by reducing our budgeted CapEx. We are now planning around $105 million budget which will be detailed in the 10-K. At least $84 million will be invested in Barnett drilling which should result in about 45 gross or 30 net horizontal wells, mostly in the core area. This plan utilizes three gross drilling rigs that generate two net rigs due to partners in many of our 2009 wells. We're currently with three rigs running are drilling 2.35 net wells and because of one of the drilling pads, we're about to go to, that will drop down to probably 1.8 net wells being drilled at one time. Year-end production in the Barnett after this new program should still be around 90 million cubic feet a day depending on our frac activity in the third and fourth quarters.

Currently we're in a borrowing base redetermination which we're very bullish about based on the bank price debt we'd been given and our significant increase in PDP since last August which was last time we did this. We'd like to see the borrowing base capacity grow so that we have a stronger liquidity position not so that we can spend more CapEx in the near term. Our plan is still to live within cash flow and wait for service cost to come down and commodity prices to go up.

In regard to that, there was some macro-news yesterday that was good news. That EIA reported that U.S. gas production dropped from November to December. I mean I can't remember the last time that happened month-to-month. And the gas rig count went below a 1000. Most people thought around 1100 was the breakeven point where production would actually start dropping and is still dropping to about 50 rigs per week. We're at 2004 rig count levels now. The Barnett is down to 88 rigs from 180 four or five months ago.

And some people are shutting in production. Chesapeake announced day 250 million a day curtailment in March which has to help the supply problem and Credit Suisse analysts reported some demand increases from the ammonia fertilizer producers and from gas placing coal for power generation. Also everybody knows, we've got... we're going to have a tick up in heating three days (ph) from this big storm on East Coast.

With that, we'd like to open it up for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). And our first question comes from the line of David Tameron with Wachovia. Please proceed with your question.

David Tameron - Wachovia Capital Markets

Hi, good morning Chip.

S. P. Johnson, IV

Hey David.

David Tameron - Wachovia Capital Markets

Couple of questions, getting back to revolver. Can you give some more clarity? Reserves are 45% year-over-year, obviously that's a great number. How much they have sensed the last redetermination, the PDPs?

S. P. Johnson, IV

Andy (ph) do you have a number handy?

Unidentified Analyst

I don't Chip.

S. P. Johnson, IV

No, we didn't even have the wells on UT Arlington back in. So...

David Tameron - Wachovia Capital Markets

But maybe the let me ask where I'm going with that, I mean what's your confidence after talking with the banks that your revolver will be at least at or higher than current levels. Any indication where you expect it to come in?

S. P. Johnson, IV

I would say greater than 50%. We've run... we've looked at every price tag they can give us and it still shows a sizeable increase.

David Tameron - Wachovia Capital Markets

Okay and what's your current revolver and what you've drawn?

S. P. Johnson, IV

Currently, that will be about 175 or 179 drawn and we have a revolver of 250.

Unidentified Analyst

That's right.

David Tameron - Wachovia Capital Markets

So you saw, maybe $70 million available.

S. P. Johnson, IV

Right and we haven't really increased that amount drawn now for a month.

David Tameron - Wachovia Capital Markets

Okay so and if you have $70 million available and you are spending within cash flow in 2009, there shouldn't be any type of credit issues?

S. P. Johnson, IV

Right, there should not. But we would like to also add more banks. I think we have seven banks now. We'd kind of like to get that number up to 10 or 11 banks just to spread the risk, the bank risk.

David Tameron - Wachovia Capital Markets

Okay. Cash, let me jump to cash flow. You guys said you could spend within cash flow. What number is that and what price is that? Because if I'm right on my deck, I'm generating 120 million of cash flow. What kind of number have you drawn to the Board or what number do you guys have proposed?

S. P. Johnson, IV

The 105 we're talking about uses up the cash flow and that's... then on top of that, you've got some capitalized interest and capitalized G&A. But we... that was based on this strip last week, that's how we do it. And then we'd factor in our hedges, but still we use the strip and adjust at about every week.

David Tameron - Wachovia Capital Markets

Okay.

Paul Boling

Chip, this might be a good time to just talk about what percent of hedging we've got in place for the rest of 2009. You want me to comment on that?

S. P. Johnson, IV

Yeah.

Paul Boling

David we've got and I'll just do this by quarter. We've got 95% of our PDPs hedged in the second quarter.

David Tameron - Wachovia Capital Markets

Okay.

Paul Boling

We've got 85% hedged in the third quarter, and about 90% hedged in the fourth. The relative prices, these are the floor prices that we have locked in for those hedges and I'll give them by quarter again; approximately $6 for the second quarter, $6.10 for the third quarter and $6.40 for the fourth quarter.

David Tameron - Wachovia Capital Markets

Okay. And those...

Paul Boling

Weighing those in your strip, I think you'll kind of get the same kind of feel we have. And those are basis adjusted hedges, so --

S. P. Johnson, IV

That's right.

David Tameron - Wachovia Capital Markets

Okay. Let me ask one big picture question then I'll shut up and let people ask other questions on operations. If I... Chip if I go and talk to the average client today, you already have the Barnett spud. The play is mature. I should look at Carrizo as a valued stock not a gross stock. How would you respond to that?

S. P. Johnson, IV

I guess I would say if I was Devon, I would say the Barnett is mature. But we have 350 drill sites in Southeast Tarrant County that are going come online at 4 million a day gross and make 4 Bcf gross, and that's a 48 acre spacing and one layer of well. So, we're going to keep growing in the Barnett for years, because it's so early in our life in that play. Some of the bigger companies have already drilled up most of the good acreage, and will probably level out or will start declining in the next two or three years, but we have a long way to go.

David Tameron - Wachovia Capital Markets

Alright. Good. Thanks.

Operator

And our next question comes from the line of Jeff Hayden with Rodman & Renshaw. Please go ahead with your question.

Jeffrey Hayden - Rodman & Renshaw

Good morning guys.

S. P. Johnson, IV

Hi Jeff.

Jeffrey Hayden - Rodman & Renshaw

I guess, start just kind of one follow-on on the hedging, you mentioned the percentage PDP hedge, could you actually give us the volumes that you attribute to those hedges?

S. P. Johnson, IV

Yes, we're looking at 85 million a day, in the second quarter. And for the third and fourth quarter, 68 million a day.

Jeffrey Hayden - Rodman & Renshaw

Alright. I appreciate it. And then you talked about what's the new program, the three rigs running kind of ending the year at that 90 million a day exit rate or the kind of 90 million a day in the Barnett. Based on what you're thinking right now as far as kind of coke-up timing et cetera, when we do expect to sort of reach that plateau?

S. P. Johnson, IV

I think our current plan is not to do that until probably the beginning of the fourth quarter and we're just trying to time that based on where we think service costs will go and commodity prices will go. We're basically now holding back on fracking in a lot of places, just waiting. So I don't think we'll pay at that rate or hit that rate early, but we'll have the potential to do that fairly quickly towards the end of the year when we decide we want to.

And in line with that, I think it sounds like we are going here as modeling the year. We would probably say for the company our first quarter is going to be between about 90 and 94 million equivalent per day. If we can end the year around 90 million a day in the Barnett, we could end the year at for the customers close to 100, which is about a 40% increase over '08. I don't think many companies can say that.

Jeffrey Hayden - Rodman & Renshaw

Okay. And then one last one; you drew out what you have drawn on the revolver. What's the current cash balance?

Paul Boling

We've got about $5 million in the banks.

Jeffrey Hayden - Rodman & Renshaw

Okay. I appreciate it guys. I'll let somebody else hop on.

S. P. Johnson, IV

You bet.

Operator

And our next question comes from the line of Ron Mills with Johnson Rice. Please proceed with your question.

Ronald Mills - Johnson Rice & Company

Good morning. Chip just and maybe for Andy (ph), just a question on and I think you had spoken in the recent past about moving away from multi-well pads and just drilling a well, coking that one up helped kind of smooth production a little bit. Is the plan just to be able to drill wells and complete wells in order just to hold acreage, particularly in your Southeast Tarrant areas. Is that the focus of your itinerary program in that area?

S. P. Johnson, IV

Yes, that we will be trying to spread our rigs around to hold acreage and basically just frack enough to make enough EBITDA to pass all of our debt covenants and have slight production growth.

Ronald Mills - Johnson Rice & Company

Okay and where... how I don't know what the company has mentioned at least in terms of comfort level with staying within your covenants based on your $105 million budget have in the growth profile you just laid out to David and Jeff. Does that keep you all in the comfort zone from covenant standpoint?

S. P. Johnson, IV

Yeah that's a part of that how we came up with that number was that satisfies all of those conditions and so we're able to grow, stay within cash flow and also meet all the covenants. And the whole time, we'll be sitting there with an inventory of wells we could frack if prices started up or we have some availability in our borrowing base after we're comfortable with those prices.

Ronald Mills - Johnson Rice & Company

And can you talk about the deferral of fracking a little bit? I think you'd had service agreements where you negotiated year-to-year. How does that the deferral of frack jobs impact your completion and other services agreements and when is that contract up for renewal?

S. P. Johnson, IV

Brad, do you want to talk about that?

J. Bradley Fisher

Yeah, as far as the service agreements go, there is no minimum work commitment under those. It's strictly a discount agreement and commitment to frack reserve wells on first come first serve basis, so there is no commitment there. And then as far as, that impacting our program, it will have no impact on it really.

Ronald Mills - Johnson Rice & Company

Okay. And then one last question and may be Paul or to Chip, just financial ones Paul. When does the cost guidance that you provided in the beginning comments; are those at levels where you would expect from a unit cost standpoint LOE and DD&A, and G&A to remain for the course of the year? And secondly, what caused the increase in borrowings in your revolver from the December redetermination announcement to today? Was it just the funding of leases and stuff from the latter part of last year?

Paul Boling

Yeah, the latter question first, yeah it's just the timing of how we took care of some of the leasing activity that we had in place and funding some of our invoices. So that's all timing. But, as you can see, I think, we think that the outstanding draw on that borrowing base, based on this $105 million program we have laid out and based on the current strip with all the hedges we have in place, we think we'll be able to accept the year with roughly that same amount of draw on the outstanding borrowing base.

Ronald Mills - Johnson Rice & Company

Okay. And....

Paul Boling

As far as the other unit costs, I think those are within the ballpark for the rest of the year.

Ronald Mills - Johnson Rice & Company

Okay. Great. Let me let someone else chip on. Thanks.

Operator

And our next question comes from the line of James Horn with Newdata Robert Securities (ph). Please proceed with your question.

Unidentified Analyst

Hi, good morning. Can you tell me, did you buyback any of your converts in the fourth quarter and possibly talk about what your thinking is in terms of future buybacks. The bonds look... has a nice attractive 22% yield to the preferred date in 2013? Thanks.

S. P. Johnson, IV

We have not bought any of those back. We have also not bought any of our equity back. We've been approached by every investment banker in town about different ways to buy that convert back. It's kind of appealing but it also uses up a lot of capital or forces you to trade debt for debt. And right now it's Form 3a it's coupon money with the nearest maturity being in 2013. So we're just not in a hurry to change that out. Plus it has almost no covenants of change of control.

Unidentified Analyst

Okay. great. Thank you very much.

Operator

And our next question comes from Marshall Carver with Capital One. Please go ahead with your question.

Marshall Carver - Capital One Southcoast

Yes, in terms of wells where you are going from your completion right now, you have 47 drill waiting on completion and you're drilling 45 gross wells this year. How do see that count of wells waiting on completion moving through the year. Will you be... will that be growing in the first couple of quarters or where would that be and then how do you see that working off towards the year end?

S. P. Johnson, IV

Paul do you want talk about that, what's your views in that model.

Paul Boling

Yeah, in the model we're assuming a number of fracs that we've completed in the first quarter already which I'll let Brad comment on and then we've got budgeted for the remainder of the year approximately 15 to 16 additional fracs scheduled out throughout the year at various times.

J. Bradley Fisher

And that number is actually that of 47 that Chip quoted as 6 non-operated wells which we have small interest in.

Marshall Carver - Capital One Southcoast

Okay.

J. Bradley Fisher

Basically the way we worked through that numbers, we have done some fracking in January and February. We expect, based on the 16 fracs that we've scheduled in that we can do out of our existing cash flow that we will end up the year with 58 wells, waiting to be fracked.

Marshall Carver - Capital One Southcoast

That's including the 6 non-operated.

J. Bradley Fisher

No, that does not include this. That's just strictly operated. Non-operated wells we typically have 2 and 3 and 4% interest in.

Marshall Carver - Capital One Southcoast

Okay, and that I think I missed the G&A guidance for the first quarter, what was your guidance there?

Paul Boling

About 4.1.

Marshall Carver - Capital One Southcoast

Okay, thank you.

Operator

And our next question comes from Leo Mariani with RBC. Please proceed with your question.

Leo Mariani - RBC Capital Markets

Yeah, good morning here guys. Question on the Marcellus. It sounds like you guys are hoping to get off in around 11 well total could be a little lower based on your comments Chip. Are you maybe able to tying those wells into production in the course of 2009 and is your plan just to go out in kind of test acreage and see if it works?

S. P. Johnson, IV

Well, mostly we're just trying to get data on geology and frac technique and frac results. But in most cases, I'd say half the cases we're drilling fairly close to some shallower well that has some gas infrastructure. So, we think we would be able to get those wells on line. We'd probably be going into a low pressure system that might be full of leaks almost like Parker County was back in the Barnett. But, at least it would give us a way to get some longer-term flow test data. So, that would me my guess. About half of them will be some sort of infrastructure.

Leo Mariani - RBC Capital Markets

Okay. Jumping over to Barnett, could you talk about the some of your lease terms and drilling commitments on your core acreage out there for next couple of years?

S. P. Johnson, IV

Well, we've got a plan that takes care of all that. We go through all of our leases and all of our units and determine when we have to drill or start dropping or renewing. So, we have thousands of leases now that are pulled up into dozens of units and so we're... that's something we work on all the time. And we don't think we're going to lose any of them in the key areas.

J. Bradley Fisher

Yeah Chip, to add to that, with our three rig program, we had originally scheduled to come in most of these pads drill four to six wells, and with the three-rig program we've pared that down to two or three per pad which will allow us to meet all our obligation deadlines.

Leo Mariani - RBC Capital Markets

Okay. And is there a plan to seeing a ramp up in rig activity in 2010 and beyond?

S. P. Johnson, IV

No.

Leo Mariani - RBC Capital Markets

Okay. Jumping over to the North Sea, obviously you guys are kind of waiting to see what happens with Oilexco. Given kind of mark conditions right now and sort of current liquidity, I think you will be leaning more towards the potential sale of interest over there?

S. P. Johnson, IV

Well, I think we've always said we'd sell it at the right price and there was a flurry of activity related to sale back in... right at the end of '08, because one of our partners Nareco (ph) put their interest up for sale and now Morgan Stanley is trying to sell Oilexco's piece. But some of the people that are involved in that bidding process drew to bankruptcy and there is really nothing going on. I think all the people that had approached us have backed up waiting to see what's going to happen in the bankruptcy and who is going to end up with that 40% piece of Huntington because I can change whether they want to be unit don't want to be in it. So everybody's just waiting.

Leo Mariani - RBC Capital Markets

Okay. Thanks a lot guys.

Operator

And our next question comes from a line of Stephen Beck with Jefferies & Company. Please proceed with your question.

Stephen Beck - Jefferies & Company

Hey good morning. Most of my questions have been answered. But, I was just wondering in the Barnett, given the changes to three rig program and they are drilling up to three rig wells per pad. What does that do with respect to your spud-to-spud days?

S. P. Johnson, IV

Well if we are moving from pad-to-pad it's obviously going to link them at average to spud-to-spud where we're drilling with the Flex rigs and drill more than one well on a pad, we're still down to the benefits of the Flex rig which we've been able to spud well, in less than a day after you finish with the pervious one. So it's all linked in that. Overall our cost to prepare locations will go up as a percentage of the wells we drill. But we've gone through the map on that and it still makes more sense to do that, to hold leases than it does to drill six well pads.

Stephen Beck - Jefferies & Company

And do you have any... can you give us a sense of how much the increase will be in terms of the average overall, the days?

S. P. Johnson, IV

Brad you want make a stab at that.

J. Bradley Fisher

I'm not sure I followed the question, to answer that.

Stephen Beck - Jefferies & Company

I was just thinking, in the past we could we were looking at a one well per rig, per month on average and just thinking about, as you're moving rigs around more often, does that materially change?

J. Bradley Fisher

I don't think that's going to materially change anything. Those flex four rigs move in four days. And I don't think it's going to be material.

Stephen Beck - Jefferies & Company

Alright, cool. Thanks.

Operator

(Operator Instructions). Our next question is a follow-up question from the line of Ron Mills. Please proceed with your question.

Ronald Mills - Johnson Rice & Company

Just a little clarification for Paul on the hedging position. Do you not have anything hedging in the first quarter?

Paul Boling

Yes, we do. We've got roughly about $40 million a day hedged in the first quarter of 2010. I'msorry, of '09? Of '09, yes we were about 60% hedged in the first quarter, which averages out about 75 million a day.

Ronald Mills - Johnson Rice & Company

And where is that priced?

Paul Boling

That's pricing in it about 670.

Ronald Mills - Johnson Rice & Company

Okay. So, just to recap, you have 75 million a day at $6.70. You have 85 million a day in the same quarter at $6. And then you have 68 million a day in the second half for the year at $6.10 and $6.40 for the third and fourth quarter is that?

Paul Boling

That's correct.

Ronald Mills - Johnson Rice & Company

Correct?

Paul Boling

That is correct.

Ronald Mills - Johnson Rice & Company

And then lastly, just the plans in the Marcellus; are you... Chip, I think you mentioned the Sea County, is that where you're going to focus most of your activities this year or will you start moving up into some of Northeast Pennsylvania acreage?

S. P. Johnson, IV

I think, we'll probably end up about a third, a third, a third. A third at the North end crossing over in the New York State to bring get those permits and a third in the Sea Counties and then a third in Northern West Virginia.

Ronald Mills - Johnson Rice & Company

Okay. And then what's in the Barnett? What's the plan on using the stagger-stacked method as you go through this year's drilling program? Are you still monitoring how the first one continues to perform?

S. P. Johnson, IV

We're still watching the first one, it looks like it was very profitable. We don't know the... we don't have an update yet to say if this is good as a typical core well or we're getting something like an enhanced Tire 1 well above a core well. And really it doesn't make much sense to start working on that right now, while we're in a program where we are basically just drilling a couple of wells per pad anyway to hold the acreage.

Ronald Mills - Johnson Rice & Company

Okay. Alright guys. Thank you very much.

Operator

And our next question is a follow-up question from the line of David Tameron from Wachovia. Please proceed with your questions.

David Tameron - Wachovia Capital Markets

Hi, a couple of questions. Paul what's your absolute debt level at year end or debt to cap; however, you want to give it to me?

Paul Boling

Let's see ...

David Tameron - Wachovia Capital Markets

Maybe while you're taking that up Chip, can you talk about your expectations for kind of pricing over the six months. What you see markets et cetera, as far as regionally obviously?

S. P. Johnson, IV

Well, we're just assuming that, the strip is going to be the answer for the next six months. So there is not enough change in supply to make a difference and that demand is going to just stay where it is and not start up. There has been weakness in the Rockies and there has been weakness in Waha party caused by weather and hopefully that will go way. The Future's market shows that the Waha prices comeback to normal in the summer. But we were beaten up pretty bad in the last two or three months. So overall, I hope it gets better, but it's... there is no way we would bet on it and start spending money until we see the gas supply come down.

David Tameron - Wachovia Capital Markets

Okay and what's your percentage... where do you sell your gas into?

S. P. Johnson, IV

Right now we're probably 60 or 70% Waha, I'd say 10% Henry Hub and the rest ship channel. We have entered into some deals to move more gas to Houston Ship Channel and later in the year to Carthage.

David Tameron - Wachovia Capital Markets

Alright.

Paul Boling

Your question David about debt. Net debts to total capitalization is about 51% at the end of the year. Total debt outstanding is 159 on the revolver and course of 374 on the convertible. To clarify one question, Ron Mills had on the hedging in the first quarter, I should have said as to 60 million a day average for the first quarter and about 64% hedged.

David Tameron - Wachovia Capital Markets

Alright, thanks.

Operator

And our next question comes form the line of Ray Deacon, with Pritchard Capital. Please proceed with your question.

Raymond Deacon - Pritchard Capital

Hey, I was wondering with the marketing on the gas side and realized prices is I guess the reason you think that it improves over the summers, is it the fair fill express going in, so differential sort of kind of easy little bit in kind of a general areas. Is that what's happening?

S. P. Johnson, IV

I don't know. We have marketers the work for us that are trying to figure that out and we have some hedging specialists that work for us that can't figure that out, but are trying to figure it out.

Raymond Deacon - Pritchard Capital

Right. Got it

S. P. Johnson, IV

I think the big answer was Waha hurt by Rex dumping gas into the Permian system at the North end which backed up all the way to Waha and then you had totally mild weather in California and Las Vegas this winter and if you look at the storage number for the rest, just nothing was drawing down. So it just backed up.

Raymond Deacon - Pritchard Capital

Got you. And I guess just one question I feel like lot of people are asking. With cutbacks in capital in '09 where will you... what all sort of the outlook you'd say year from now, given that you spend $105 million. You've got 47 wells to hook-up now. I guess, where do you think that inventory will be a year from now and how... if gas recovers to 6 to $7; how much capital do you see yourself committing in 2010? Have you thought that far, I guess?

S. P. Johnson, IV

Well, like Brad said, we'll have a bigger inventory at the end of this year, than we started the year with as far as unfracked well that's in our current plan. So, that will give us kind of a rapid response answer if gas prices startup. And if they startup enough that we can just lock them in with hedges, then we will start fracking. And we could add a lot of gas fairly quickly by doing that, and for us it's a lot of gas. I'm not sure for some of these bigger companies that are also holding back inventory, and I don't think it's 80 or to a 100% of their existing production that they're holding back. But, we'll able to do that and we wouldn't have to add a lot of drilling rigs, but we could just start fracking and add a bunch of production if we see the prices start backup.

Raymond Deacon - Pritchard Capital

Right got it. And thanks. And I guess just one quick question for Paul; Paul I was wondering are there any covenants at all attached to that the convert? It didn't seem like there are any restrictive covenants on that?

Paul Boling

No, there are no covenants attached to it.

Raymond Deacon - Pritchard Capital

Okay. Alright. Thanks.

Operator

And our next question comes from the line of Monroe Helm with CM Energy Partners. Please proceed with your question.

Monroe Helm - CM Energy Partners

Sure, just to clarify a few things you touched on; you said that your production capacity of about 90 million at the end of this year, but what these additional wells that haven't been fracked at the end of the year, that you just plan that you can double your production if you'd add 58 of those wells up?

Paul Boling

I did.

Monroe Helm - CM Energy Partners

Okay.

Paul Boling

That's essentially what happens. We start declining pretty quickly from that point but if you could bring all those wells on in the same month, you could double production.

Monroe Helm - CM Energy Partners

Okay. I guess its too early to give us any production guidance for 2010 then where all the gas prices can be, safe assumption?

Paul Boling

That's right.

Monroe Helm - CM Energy Partners

Could you talk about, I'll be a little bit more specific; you started to talk about your hedge position for 2010. Do you have... can you talk about I think you mentioned you'd 40 million a day in the first quarter. You didn't say what price do you have hedges on for the second, third and fourth quarters of '10? Can you kind of color that pressure in for us?

Paul Boling

Yeah, we can give you a little color on that. We've got the first quarter is at $6.70 that's a 30 million a day and for the rest of 2010, we've got 22 million a day employees at a price of $5.75.

Monroe Helm - CM Energy Partners

Okay. What price would you be willing to lock in additional hedges given your funding cost?

Paul Boling

Chip?

S. P. Johnson, IV

Those are realized floor prices.

Monroe Helm - CM Energy Partners

Okay.

S. P. Johnson, IV

Yeah, in '10, we've been concerned about the first half of the year but we're not too concerned about the second half of the year. If we can keep locking in Waha ship channel in part to around $5.50 to $6.50, we'd be comfortable doing that because we can still make quite a bit of money at drilling F&D cost is under $2.

Monroe Helm - CM Energy Partners

Okay. Can you talk a little bit about where do you expect frac prices to be. I mean how much your fracking cost down now and where do you think that might be coming at the fourth quarter this year versus the fourth quarter of '08?

S. P. Johnson, IV

Brad, have you got a handle on that.

J. Bradley Fisher

Chip let me take that. Yeah, we've seen fracking cost come down just this year about 30% already.

Monroe Helm - CM Energy Partners

Me too.

J. Bradley Fisher

As far as forecasting that through the end of the year, I mean I expect cost to continue to come down, what exact percentage can be a little tough to give you. I mean the market is very soft. There's lot of companies doing but we are postponing the frac works of the frac companies are pretty hunger right now. So I do expect the cost continue to comedown but they have come down significantly already.

Monroe Helm - CM Energy Partners

Okay. On the three rigs, three Flex rigs you still are drilling in the Barnett, how long are your commitments on those rigs, still to run and what rates for these rigs are?

J. Bradley Fisher

Chip, let me take that as well.

S. P. Johnson, IV

Yeah.

J. Bradley Fisher

Most of those rigs are contracted through March to June of 2011 and it rates 23,300 a day right now.

Monroe Helm - CM Energy Partners

2300. Some it's been terminated... early terminating their contracts with Helmerich & Payne. How would you do the same thing, then just go to try to pick up some other rigs?

S. P. Johnson, IV

Well, we did that with another H&P rig we had that had an easier contract. But these were rigs that they essentially built for us and so they had pretty unemployed contracts.

Monroe Helm - CM Energy Partners

Okay. I appreciate your answers.

Operator

And we have a follow up question from the line of Marshall Carver with Capital One. Please proceed with your question.

Marshall Carver - Capital One Southcoast

Yes, on the 45 gross wells and 30 net wells for the joint plan for this year, that's all just operated the wells, correct? Just making sure if my number is wrong.

S. P. Johnson, IV

That's right.

Marshall Carver - Capital One Southcoast

Okay. And then could you give us a breakdown on average Barnett well, what the drilling cost would be and what the completion cost would be, or your forecast for this year?

S. P. Johnson, IV

Well, what we've used in the forecast was around 3 million. But that includes some wells that are being fracked. Now our current cost or some averaging probably 3.3 million to drilling frac and some of the ones and that more complicated urban settings or more, some of the ones that are more suburban or on exiting pads or less, but we use 3 million per net well because that accounts for some reductions in cost and also some wells not being fracked.

Marshall Carver - Capital One Southcoast

Okay. And the breakdown between drill costs and frac costs of that 3.3?

S. P. Johnson, IV

It's about I see...it's about 45% completion, 55% drilling.

Marshall Carver - Capital One Southcoast

Okay. Thank you. That's all for me.

S. P. Johnson, IV

Thanks Marshal.

Operator

And our next question comes from the line of Jeff Hayden with Rodman & Renshaw. Please go ahead with your question.

Jeffrey Hayden - Rodman & Renshaw

Hey, guys. Just kind a cross checking numbers here. Q4 production just out of the Barnett, was that about 60 million a day?

Paul Boling

That would be about right. It's about 78 million a day.

Jeffrey Hayden - Rodman & Renshaw

Okay. I appreciate it guys. Thanks a lot.

Operator

And we have the following-up question from the line of Ron Mills with Johnson Rice. Please proceed with your question.

Ronald Mills - Johnson Rice & Company

Paul, did you say those hedge prices you gave us were realized prices, so that takes into account on the basis differentials?

Paul Boling

That's correct.

Ronald Mills - Johnson Rice & Company

Was there any transportation or anything off of that the prices you gave us?

Paul Boling

No, those are basically a lot basis slots.

Ronald Mills - Johnson Rice & Company

Okay. And then, what's your expectation on cap interest for 2009? It should be at a similar kind of 15 million levels we had in '08 or what do you expect form that standpoint?

Paul Boling

Yeah, I would just say take our current effective rate, which we're using about 8%, and take a look when we file the 10-K, you can take a look at the existing unproved balance and just assume roughly that balance going throughout the year for capitalizing interest.

Ronald Mills - Johnson Rice & Company

Okay. Thanks guys.

Paul Boling

And speaking of that, we are going to be filing a notice today indicating we plan on filling our 10-K in about a week. So, I want to get that out to everybody.

Ronald Mills - Johnson Rice & Company

Okay. Thank you.

Operator

And we have a question from the line of Ray Deacon with Pritchard Capital. Please proceed with your questions.

Raymond Deacon - Pritchard Capital

Hey Paul, I had a question about the interest rate expense on the convert. I was assuming that was going to show up in December and the June quarters. I guess how will you expense that?

Paul Boling

We were accruing it on a monthly basis. The actual payments are occurring twice a year. There is a December first payment and then we pay... then we have a June first payment.

Raymond Deacon - Pritchard Capital

Okay, got it. So it just shows up in your interest expense over twelve months?

Paul Boling

That's right.

Raymond Deacon - Pritchard Capital

Got it. Thanks.

Operator

And there are no further questions at this time. I'll now turn the call back to you. Please continue with your presentation or closing remarks.

S. P. Johnson, IV

Thank you, Martin. I guess in general, we're very disappointed on our stock price after going over half a Tcf in reserves and replacing 700% of our production at excellent F&D costs and congratulations to our staff and management who accomplished everything they were supposed to do last year. Debt is our biggest weakness, but I think we're addressing that with hedging and reduced CapEx and it's also important to remember that our debt is very cheap with an average interest rate below 5%.

The other thing to remember is that we use that debt to buy acreage in the core of the Barnett and in the Marcellus. We didn't spend that money drilling a much of dry holes or wasting in an overpriced acquisitions. So we still have a huge growth story somewhere out there when supply and demand get back in sync and I think it was David Tameron who pointed out that so many investors now are concerned that, they're looking at us as a value play instead of a growth story, and that's true. That's what everybody does when prices pullback this far.

We've been through this before in other cycles. But we are growth story and we have to maintain our assets so that when these supply and demand imbalances strike out again, we'll be credited with being a growth story which huge upsides. Until then, we'll just have to live with an cash flow, drilling about half of what we expected to drill six months ago, but still potentially growing our production 40% from '08 to '09 in preserving our assets.

So with that, I'd thank you all for calling in and for your support and we'll talk to you again in another three months.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for you participation and ask that you please disconnect your lines.

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