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Clayton Williams Energy, Inc. (NYSE:CWEI)

Year End and F4Q08 Earnings Call

March 10, 2009 11:00 am ET

Executives

Clayton W. Williams Jr. - Chairman of the Board, President, Chief Executive Officer

Mel G. Riggs - Chief Financial Officer, Senior Vice President, Director

Analysts

Neil Malkin - Zacks Investment Research

Douglas Thompson - Thompson Investors

Gregg Brody - J.P. Morgan

Dan Rice- BlackRock

Ryan Zorn - Sarasin

Katherine Cymbalski] - Jefferies & Co

Steve Orr - Orr Investments

Operator

Good morning ladies and gentlemen and welcome to the Clayton Williams Energy, Incorporated Year End and Fourth Quarter 2008 Conference Call. My name is Antoine and I will be your operator for today. (Operator Instructions) I would now like to turn the presentation over to Mr. Clayton Williams, President, and Chief Executive Officer. Please proceed Mr. Williams.

Clayton Williams

Thank you and good morning. We are going to start with our normal procedure, our annual report, but first Bill has one condition to read and then he will give the financials, as is normal, and then after the financials we will take questions on financials. When that draws to a close then I will give an overview of where we’ve been and where we’re going and I will tell about the future that we have. We’ve got some nice things to tell you about in spite of the worldwide troubles. Mel, I will now turn it over to you.

Mel Riggs

Thanks, Clayton. Before I take a shot at our fourth quarter 2008 results I will need to provide a caution about forward-looking statements that we might make.

All statements that relate to future results are forward-looking statements that are based on current expectations. Actual results may differ materially from those expressed or implied by these forward-looking statements because of a number of risks and uncertainties affecting our business. Boy that’s an understatement! Including those discussed in our quarterly and annual SEC filings and in the cautionary statement contained in our press release and on our website.

Looking back at 2008 it was an amazing period of time. It is really amazing when you see what happened during that period. We were on a roller coaster for the first nine months. We had the thrill of escalating oil and gas prices eking out kind of late summer and at the same time we were sort of chilled by the fact that our drilling placing costs were also escalating at an almost record pace and it reduced our costs more dramatically and that really started impacting some fourth quarter.

In the fourth quarter this roller coaster ride came to a pretty abrupt halt as we really hit a brick wall and plug prices collapsed along with the global economy. So what we were left with at that point was really trying to determine what makes sense to drill. What do we have that makes sense to drill in this current environment and that is factory and commodity prices and the prevailing cost structure. Clay will get into a lot more detail on that in a minute. But overall, for the quarter we reported net income of about $59.9 million, nearly $60 million, $4.93 per share compared to net income the previous quarter 2007 of $8.5 million or $0.74 a share.

Cash flow from operations in the fourth quarter of ’08 was $158.9 million, $13.08 per share compared to $6.30 per share for the same period in ’07. One thing to keep in mind here, a really important point, is both earnings and cash flow were heavily influenced by our decision to take the profit out of our commodity hedge position, our future position, in December of ’08. An example of this is the lifting of that hedge for those hedge positions added over $99 million of cash proceed into the quarter, so it has a major impact.

Oil and gas production for the fourth quarter actually increased over ’07 by about 6% and we exceeded our previously announced fourth quarter guidance by 8%. Despite that, oil and gas sales decreased compared to last year. We had $96.3 million in the fourth quarter of ’07 in oil and gas sales and our sales were $82.4 million in the same quarter of ‘08. The reason is that in spite of the production increase our realized oil prices decreased to $59.63 per barrel for the fourth quarter compared to $89.55 in the prior year. Gas was also down. So, we went from a period of for nine months we averaged over $100.00 a barrel on oil and over $9.00 in Mcf on gas to less than $60.00 for the fourth quarter. Things have gotten worse since then as we all know.

The fourth quarter was also, as I mentioned, positively affected by hedging gains, the derivative gains. We had $136.7 million net gain on our derivatives in the quarter on the income statement. That was compared to a loss the previous year.

The settlements, actually during the quarter we settled, we actually had a settlement of $111 million in hedging gains. That includes the lifting in December of the big hedge and then we had another $25.8 million mark-to-market on some of the remaining hedges that we eventually lifted.

We may have been premature on lifting the hedge. Time will tell, but since then we have gone in and reinstated additional oil hedges. We’ve hedged 1 ½ million barrels for 2009 at prices ranging from roughly about $45.00 to $53.00 a barrel through out the year. On the gas side we have hedged, we’ve even been a little bit more bearish, we have gone out longer. We have hedged over $20 million MMBtus’ for the periods of 2009 through 2011 at prices ranging this year from the mid $5.00 range all the way up to the low $7.00s in 2011. So, we have added price protection. We think it’s critical in this environment to ensure risk management, as nobody really knows where this is headed, but we are protected, at least on the major part of our production at this point.

Looking at operating costs for the quarter, operating costs were up a little bit, 16%, $236 per Mcfe of production. Mainly that is because we’ve been drilling a lot in oil prone regions out in the Permian Basin where you’ve got higher lifting costs and also that is impacted by the sale of some South Louisiana wells earlier in the year. We sold some pretty high flow rate wells.

DD&A for Mcfe increased 33% to $357, a little bit higher finding prospect, and the inputs of a lot of leases that we’ve added to our lease base.

G&A was up overall, but if you strip out the non-cash employee compensation which comes from our back end partnerships, actually our G&A per Mcfe decreased 6%. So we have managed our overhead pretty well if you look back over the past year and that will be a continuing focus for the company.

We did record in the quarter substantial abandonment and impairment costs of roughly $35 million compared to about $15 million last year. We had a significant charge-off on a go to well in North Louisiana, the Claudia Education Trust well. The total write-off of that well plus the leases that were impaired was about $25 million and then we have recently written off a well in the over thrust area of Utah: including the leases that is a $6.4 million write-off, so those two items pretty much covered most of that number.

As 2008 ended and the financial crisis continued to deepen we have really turned our focus to liquidity. I think Clayton told me this morning he used to run the company, but now he is letting me run the company, because we’re focused on liquidity. I know that’s going to last about 30 minutes, but right now we are focused on liquidity. We don’t know how long this economic downturn is going to last: we don’t know how deep it’s going to go and we have to stay liquid. That’s going to be the key to come out of this. If we do we’ll come out of this in fine shape. There is going to be a lot of opportunities and Clayton will show you that we’ve got a heck of a lot to do around here when things recover.

During 2008 we were able to reduce our long-term debt from $430 million to $347, about an $83 million reduction. That’s in spite of pretty much a record year on capital expenditures. We had a lot of cash flow. We did pay down debt. At the end of ’08 we had $94 million outstanding on our bank credit facility.

We have a boring base of $250 million so we had roughly $156 million of liquidity available; we still fit in that position today. We are in good shape. Our boring base is scheduled to be re-determined in the later part of May. We don’t expect a significant reduction to our boring base, but in the meantime we have reduced our CapEx where we are spending somewhat below our cash flow and we’ll monitor that as we go. But, we feel pretty strong about our relationship with our banks at this point and we think we’ll be fine when we re-determine.

The CapEx for last year, we spend, I think it was a record number for our company, $373 million on exploration and development: $314 million of that loans for drilling and 70% of that total expenditure was for developmental drilling prospects.

In response to the current commodity price environment and the current cost environment, because costs are coming down, but they’re not down to where we are really comfortable to drill in a big way right now. We have reduced our capital spending to $56 million at this point and that is being evaluated pretty much every day as we watch what is going on in our industry. At this point in time, we plan to defer most of our development drilling in the Permian, the Chalk, and North Louisiana, but that all depends a lot on what happens with product prices and with the cost of drilling and completing wells.

Looking at the Company’s reserves, we did replace 97% of our production for the year. We got hit hard, somewhat, by product prices at the end of the year. We probably lost some due to economic fall out a lot of the reserves we would have booked. Primarily we’re drilling a lot out here in the Permian Basin and again, 75% of our drilling was for development drilling. So, we had less allocated to drilling exploratory wells at new reserves.

Our reserves at the end of the year were impacted dramatically by product prices. We lost 57 Bcfe due to product prices at the end of the year. We had some upper provisions in the Permian and also Chalk, primarily where we added about 7.4 Bcfe on wells that have just outperformed over times, so netted down to about 50 Bcfe overall revisions. Also, during the year we sold 11 Bcf back in April and that came out of the reserves.

Our year-end reserves were about 60% concentrated in the Permian Basin and we are a little more oilier, we’re about 55% oil. I think both of these percentages would have been somewhat higher if not for the low oil prices at the end of the year, because that knocked a lot of reserves out due to economic life here in the Permian, where you’ve got higher operating costs and then the impact of the low oil price.

That pretty much summarizes the fourth quarter and kind of some of the look at the end of the year stuff. With that I will let Clayton take the call.

Clayton Williams

Thank you, Mel. This is a good time to reflect and say we’ve mentioned some dry holes and write offs particularly in rank [wildcast]. On the flip side of that, we have added substantially to our inventory of proven locations. For example we have 142 booked buds; future oils to drill that are absolutely proven. We have 600 that are in the realm of probable to possible and several hundred more out in the future outside of that. The flip side is we have a tremendous drilling and I might run those down just a little bit.

In West Texas we have 107 booked buds, 14 in the Chalk, 20 in Loco Hills, one Romere Pass and then the probable and possible we have 600; those are in West Texas, we have about 90 in the Chalk, probably 26 gas in North Louisiana and we mentioned in the last release that we had a discovery with Swift in the water. That is on a three-way closure covering 3,000 acres and we’re pretty optimistic that we’ll have other step outs that we’ll probably have a good chance to drill in deeper. So, we think that’s a good solid upside as well as some proven locations to drill in Louisiana.

Our Chalk has always been our most profitable, because you have a pretty quick pay out. We’re very optimistic about what we have there. Moving to West Texas we have several areas that we have stepped out and done exploration drilling and found reserves. So, we have a great deal of work in front of us.

What is our problem? Our problem is that we have lost our profit margin due to the drop in oil price and increased the drilling and completion process. Now, we believe that our focus then is to manage our drilling and completion costs for the future. There are several ways to do that, but long-term contracts may be one. Ownership of some of the vendor services, if you can buy them at a big discount, but we realize that one of the major problems in our business has been that when the price goes up and the cost of drilling goes up and you lose your profit margin. It is still about profit margin and so we’re very interested in trying to make that into a long-term ability to drill and complete over the longer term so that when the prices start up we’re able to maintain lower prices. We don’t have that all figured out yet, but it is high second in liquidity, it’s a high priority.

We say to you shareholders that we’re, number one, we are very focused on liquidity. Number two, we have a lot of good place to drill into the future. We’ve got a lot of reason to be optimistic once we can regain a profit margin for our drilling. We have a lot places to drill that are low risk. We have a good experienced team. We feel good about a lot of things.

With that said, I will take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Sheraz Mian with Zacks Investment Research.

Neil Malkin - Zacks Investment Research

This is actually Neil Malkin filling in for Sheraz. Mel you are saying liquidity is going to be the main focus in ’09 and based off of your preliminary CapEx guidance figures it looks like you’re going to have a fair amount of cash flow. Is it fair to assume that paying down the vast majority of that credit facility is what’s going to happen during the year?

Mel Riggs

Yes. We are in the process right now of paying off for wells, paying bills on wells that were drilled in the past. Trying to get everything in order there, keep our payables current. Then cash flow will first of all go in the line, but we’ll be monitoring that. If things turn around, get a little higher oil price, costs are down, you can see our CapEx budget increase some.

Obviously, our plan is to keep the company down the middle of the fairway here during this year. This is a critical year. I mean this economy thing, everybody is kind of in the same predicament right now, I think, and we’ve got to be very cautious.

Clayton Williams

I would add to that that it’s really important to us to meet all of our past commitments. So, we had some commitments made in 2008 and so we’re finishing winding those up, ending them. While liquidity is first, also we are maintaining your commitments and fulfilling your commitment, these things are important to us.

Operator

Your next question comes from Douglas Thompson with Thompson Investors.

Douglas Thompson - Thompson Investors

I have two questions. The first one is on the Sun unit, #1; you mentioned there is a completion in the middle bossier sands. Does that mean that you missed the primary target?

Clayton Williams

No, there is upper, middle, and lower Bossier and the deep Bossier, the middle Bossier is generally been the most productive in this well field and cannas completion and [arpazino] was in the lower Bossier. There have not yet been commercial completions in the upper Bossier, but I don’t rule that out. In this case we have some sands developed in the middle Bossier, which moves prospective. We’ll just have to wait and see. It’s difficult until you flow the well.

We would have liked to have had more sand, but we had enough sand to run pipe. We had good gas shows. Beyond that we can’t estimate what we’re going to have there. We can’t estimate how far out the sands extend, how far the permeability extends. We’ll be testing it pretty quick and we’ll have some idea. We can’t predict what we have at this point. We cannot tell you that’s a commercial well.

Douglas Thompson - Thompson Investors

Thank you. The second question I have is in regards to the Lariat joint venture. Can you give me a brief update on that and where the statuses of idle rig fees are and if your cash flow will be enough to carry those idle rig fees as well as your capital program.

Mel Riggs

The answer is yes. We’re continuing to make the idle rig payments. The rigs are, for the most part, not active right now. Like the other rigs I hear, they are all lying down. Which we think also will get costs down, but we’re budgeted to continue to make the idle rig payments and the debt payments.

Douglas Thompson - Thompson Investors

What is the viability for that for 2009?

Mel Riggs

For the idle rig payments and the debt and everything combined we have about $26 million for this year.

Operator

Your next question comes from Gregg Brody with J.P. Morgan.

Gregg Brody - J.P. Morgan

What have you been seeing on the cost improvement side for services thus far?

Clayton Williams

Costs are dropping. In some cases the frat costs have dropped substantially, but they’ve [audio gap] dropped enough, for example pipe is still pretty high to where we could go back to drilling. So, our basic belief is that the oil price should be at least $60. But, we continue to see prices go down and so we have a slot for our drilling rigs when the prices go back up. We may enter some other services to be able to have a long-term, more or less, stable price and that may be part of the equation in your drilling holes. I hope I answered your question.

Gregg Brody - J.P. Morgan

You are breaking up on me there a little bit, but I think I heard you say you are looking for a $60.00 oil to get more comfortable with the accelerating drilling?

Clayton Williams

At least $60.00 and a continued drop in overages, it’s about a profit margin. I can tell you today we do not have a profit margin and there is no point in starting to burn up [inaudible] drilling them when you’re not making money. So, I think that I wouldn’t expect us to do substantial drilling [inaudible] absolute costs within reason and a higher margin and then one that we can kind of lock in as this thing is very unknown in our thoughts.

Gregg Brody - J.P. Morgan

You mentioned locking in on the cost side. Would you use hedging to help lock that in as well?

Clayton Williams

We’ve done a great deal of hedging and when prices were always going up we lost some money, but when they started going down, we’ve been helped a lot. Mel mentioned $120 million or so. Recently we’ve re-hedged all of our oil for this year, about $47 or $48. We’ve hedged gas for three years, $50 this year, $680 next year, $711 in 2010. So we’re always very conscious of locking in some good price that guarantees our business plan. We have done that with great consistency for a long time.

Gregg Brody - J.P. Morgan

That’s helpful. I have two more questions. What was the percentage per developed of your preserve numbers?

Mel Riggs

Our rig develop component is about 705.

Gregg Brody - J.P. Morgan

And then how much of your pre-tax CB10 that you disclosed, could you break that out between for developed as well as PUDs?

Mel Riggs

The PDP makes up about actually almost 80% of our CB10 value.

Gregg Brody - J.P. Morgan

Okay. Do you further break down PDP and between for about [interposing]?

Mel Riggs

I think the total was reserves were roughly $511. The crude is $511 million. It would have been, you base it on the new SEC regulations to modernize the reserve reporting. If we use those kinds of numbers we would have been close to where we were last year, around $1.3 billion. That is the impact you see, it is dramatic, but roughly about $400 million of PDP, about $65 million of behind pipe, and the rest were PUDs.

Gregg Brody - J.P. Morgan

And you had mentioned your bar determination, you had expected it to be pre-determined much lower than the current level. You said there was a May re-determination, have you been running the most recent decks of $4.00 cash from $40.00 oil?

Mel Riggs

Yes, we’ve looked at some. We’ve run some hypothetical cases based on what we think bank decks are. We don’t know what they will be exactly in May. One thing that helps us is we did have a pretty strong push for drilling in the fourth quarter. We’re going to have a lot of new wells that we’ll put on into the reserve port, the banks really haven’t seen. There are a couple of fairly material wells that we drilled. So, I think all in all we may be impacted a little bit, but I don’t think it’s going to be real material. We are prepared. That is how we’re paying back our

CapEx. We’ve got to get past that point and understand exactly where we are and that will be pretty quick.

Operator

Your next question comes from Dan Rice with BlackRock.

Dan Rice- BlackRock

I remember you tried to complete a deep Bossier well in Texas; I think it was last year, maybe the year before, where you were looking for 15% porosity in these deep. At the time I think you had 10% porosity. You weren’t sure if it was going to be productive; it turned out to not be productive. I think that from the fact that you said casing here that the porosity that you saw was over 10 but it’s still not at the 15 that gives you a real good feel that you’re going to have a commercial well.

Clayton Williams

You know we drilled the big bill and then we had a lot of sand, not enough frost. We got a marguerite and it had slack porosity, both made non-commercial wells. I can tell you that the porosity was better in this well, but we didn’t have a lot of it and so how far do these sands go? If we drain 600 or 800 acres it would be a commercial well. If we drain 100 acres it is probably not commercial. Now we know we’re on a freeway: a seismic 3D three-way closure, but if we had had 100 feet of good sand we would have said boy it looks good. This is in the twilight zone and we just don’t know.

Dan Rice- BlackRock

Okay and you had some acreage in the Haynesville, but you’ve been kind of reluctant to talk much about it, because it is a little bit out of what is considered the core area. With the drilling that’s been done over the last six months do you have any better feel for what your acreage looks like?

Clayton Williams

It’s not good. I think ours is on the deep end of it and it’s going to be marginally commercial and at 3 ½ gas I think it probably will not be commercial. It is deeper and more expensive to drill from this. So, part of it we’ve got some term we’ll be able to launch, but we’re saying we don’t feel very prospective about that at this time.

Operator

Your next question comes from Ryan Zorn with Sarasin.

Ryan Zorn - Sarasin

Can you refresh my memory on the big bill? Did you get down to the deep Bossier? Was that the middle Bossier that you were speaking of?

Clayton Williams

We did. We got down to where we had salt. We had substantial amounts that were in the hole and we had substantial amounts of sand. We have 3D’d the area since then; we are hopeful. We are still trying to look at the new reprocessing and we feel hopeful, but we can’t tell you that, that we have any prospects or not. We’re in the middle of it.

Ryan Zorn - Sarasin

Okay, but on the latest test in Boylston County, mechanically were you able to get down to the deep bossier or just to the middle?

Clayton Williams

We drilled all the way to salt. We had a very large amount of cotton valley sand and then we had got all the way to salt and we didn’t have much bossier. This is memory, I’m not positive, but about 180 feet of bossier and that’s all the bossier we had. We didn’t have the development of frost and we had very low permeability; so it turned a lot of sand, encouraged us to shoot the 3D, but it was a purely non-commercial well and that was in a hole.

Ryan Zorn - Sarasin

Okay. Of the 142 pods that you’ve got booked, how may get drilled this year?

Clayton Williams

None will get drilled probably. We are not going to drill until we have a profit margin, which means that oil has to be at least 60 and we need to continue to get costs lower by we’ll buy some pipe at a discount, tracks coming down. We have our own drilling rigs, of course. We don’t need a profit margin; we just need to get them going. But, we do not see a profit margin and we do not plan to drill this year, so we’ll take all of our cash flow and nearly all of our cash flow down the past commitments; pay down like we have the one well we’re drilling with BP and by and large we’re going to stand still until we see the air clear.

Ryan Zorn - Sarasin

Okay. On the stand by rates, for the Larclay, mechanically where does that get handled? Is that part of the $56 million in CapEx?

Mel Riggs

No, that’s out side. That $26 million is sort of outside the CapEx. That’s our full what we expect to spend on the lower Larclay joint venture this year. Mainly paying down debt; it’s mainly the debt amortization, but there is some addition in there.

Ryan Zorn - Sarasin

Okay, so can you give me a regional break out of the $56 million you’re going to spend this year?

Mel Riggs

Yes. We will spend in South Louisiana $17.7 million, $14.6 in the Permian Basin. Keep in mind a lot of this has been going pretty heavy in the first quarter. East Texas bossier $11.8, that would cover the primarily the Sunny well and some 3Ds; Utah $7.4 million, which is done at this point. Austin Chalk $2.1, that was completing finishing up some wells there that are currently not active. In North Louisiana, $1 million 9 and again the same thing, we’re finishing up wells that are done and then other $0.5 million. So, a good part of our CapEx is already done, will be done by the next month or two and then we look forward. We look at the environment. We look at private process costs; where we are with the banks, the whole thing, and then decide what to do.

Ryan Zorn - Sarasin

Did you say you are going to drill any more deep bossier exploration this year?

Clayton Williams

Not this year.

Ryan Zorn - Sarasin

Okay. Do you have a PDP decline rate from your reserve report for this year?

Mel Riggs

I do not have that. If I gave you a number I would probably be giving you a bad number. I can say this, our guidance we put out for 2009, put back in a couple of months ago, we expected at that time to have, with our limited drilling that we were going to do, production was going to be about 10% down compared to what our production in 2009 was overall. We’re adding some wells this year in South Louisiana: a couple of them I think are already on and then we’ve got a pretty material well we hope to add in the summer, so it all kind of balances out.

That is the one thing we have, is our production cash flow should be fairly flat. We have the efforts from drilling last year and we’re just now getting some oil slicks done.

Operator

Your next question comes from Katherine Cymbalski from Jefferies & Co.

Katherine Cymbalski - Jefferies & Co

Are there any financial covenants associated with the Lariat revolver? If so do you think you could trigger any of them this year given the reduced cash flow from the JV?

Mel Riggs

No.

Katherine Cymbalski - Jefferies & Co

Okay and how much do you expect to amortize of that revolver this year?

Mel Riggs

I think we’re going to be down to about, we’ll have probably two years left?

Clayton Williams

$26 million in December of outstanding.

Mel Riggs

We’ll be down to $26 million at the end of the year.

Katherine Cymbalski - Jefferies & Co

Okay and at year-end that stood at around $47 million, is that correct?

Mel Riggs

It was about; I think it was around $47 million at the end of the year.

Clayton Williams

It is about $1.5 million of principle a month.

Katherine Cymbalski - Jefferies & Co

Okay, great. Thank you very much.

Operator

Your next question comes from Steve Orr with Orr Investments.

Steve Orr - Orr Investments

Did you all say what you’re going to be doing in terms of paying down debt this year?

Mel Riggs

Well we don’t know exactly. I think that is why we’ve been beating around the bush a little bit. We probably will pay down some debt. We’re sure not looking to add any debt. It just really depends on what happens with product prices and the cost structure out here. But right now, we would say we have cash flow in excess of our capital expenditures and we would pay down debt. We can’t really guarantee that though, because we are going to be opportunistic and take advantage of the opportunity to drill if it comes along.

Steve Orr - Orr Investments

That is very good, thank you.

Operator

There are no further questions at this time, so I would like to turn the call back over to Mr. Clayton Williams.

Clayton Williams

Thank you for tuning in. I think we would like to leave you with that we are very positive. We are financially in reasonably solid shape. Our liquidity is good. We’ve got a lot of drilling to do in the future and our job is to make sure that there is a future. We’ve got a lot of things to do out there.

One of the things that I failed to mention is we’ve got two new 3D shoots that we have paid for, that we have not had a chance to work super prospects out. So, we see a lot of good things for us to do in the future. We remember there is no saying there is no long run unless there is a short run. So, we’re making sure there is a short run.

As I said, Riggs is running the company now from a financial standpoint and we’ll do explorations again some later year.

Thanks for tuning in. We appreciate your time.

Operator

Thank you for your participation in today’s conference call. This concludes the presentation. Have a good day.

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