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Clayton Williams Energy, Inc. (NYSE:CWEI)

Q3 2007 Earnings Call

November 07, 2007 1:00 pm ET

Executives

Clayton Williams - Chairman, President and Chief Executive Officer

Mel Riggs - Senior Vice President of Finance, Secretary, Treasurer and Chief Financial Officer

Analysts

Dan Rice - BlackRock, Inc.

Brad Evans - Heartland Advisors

Eric Calamaris - Wachovia Securities

Operator

Good day, ladies and gentlemen. Thank you very much for your patience and welcome to the third quarter 2007 Clayton Williams Energy Incorporated earnings conference call. My name is Bill, and I'll be your conference coordinator for today. At this time, all participants are in a listen-only mode. We will be conducting a question-and-answer session towards the end of today's conference. (Operator Instructions) As a reminder, today's conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today's presentation, Mr. Clayton Williams. Please proceed, sir.

Clayton Williams

Thank you very much. Welcome. As our normal procedure, Mel Riggs will present the financial overview. After that, I will give a general overview, more or less coming from the west side of our operations to the east side. And we look forward then, as always, to answering your questions, we'll do the best we can, and thanks for tuning in.

Here's Mel.

Mel Riggs

Thank you, Clayton. We have reported the highest revenues in a quarter in the Company's history, $101.8 million. We reported, also along those lines, $1 million of net income for the quarter, $0.09 per share, compared to a net income last year of $0.48. For the nine-month period, we reported a loss of $2.5 million. That's $0.22 a share compared to net income of $2.38 per share last year.

And although our net income was adversely affected by abandonment and impairment costs during the quarter, we are very pleased with our overall performance. Most of all, we are pleased that the third quarter marks, actually, the fourth consecutive quarter in which our production, both oil and gas, have increased. On an Mcfe basis, production was up 33% over last year's same period.

We're also up 7% in the third quarter over the second quarter of this year. Most of this increase has come from really gas production that's associated with new wells in both South and North Louisiana. Our production was also about 2% over the midpoint of our previous guidance. And so we're pleased that we were able to beat our guidance for the third quarter.

Cash flow from operations increased. Again, this was a record cash flow for a quarter for the Company. It increased to $72.4 million. That's $6.28 per share compared to $3.52 per share last year. And production increases were probably the most significant factor in this increase.

We had some modest increases in product prices. This big run up in oil prices really happened after the end of the quarter. Our average oil price was up 7% to $72.10 per barrel. Gas was up for the quarter about 8%. We realized $6.77 per Mcf.

As has been the case for the last quarter, our metrics for operating cost, DD&A and G&A per Mcfe all declined. That's due primarily to the increases in production. We have exploration costs related to abandonments and impairments, which I mentioned earlier. They were $18.8 million for the quarter as compared to $19.7 million last year.

Most of the current quarter abandonment costs came from an unsuccessful non-operated exploratory well in South Louisiana and from the partial abandonment down in the lower portion of the hole at the Margarita No. 1. That's one of the Bossier tests in Robertson County, which Clayton will be talking about here in a moment.

In addition, we recorded an $11 million impairment from the (inaudible) acreage primarily in North and South Louisiana. We also recorded an impairment of crude properties of $8 million during the quarter to adjust the carrying value of certain long-life assets to their estimated fair value.

Part of this $8 million was $5.1 million related to new but unassembled drilling rigs, 2,000 horsepower rigs. We've written down the value of those. And also, we have $2.9 million write-down due to one West Texas producing property.

The Company's financial condition still remains strong. At the end of the quarter, we had $188 million of debt outstanding against our $275 million credit facility, which gives us at that point about $86 million of liquidity.

Subsequent to the quarter, in November, on November 1, we sold a property in Pecos County for $21 million. That will create a $13 million gain in the fourth quarter of this year.

And then the sale of some producing properties, actually some non-operated producing properties and some leases and, again, the southern region of the Permian Basin, which had very little impact on our production or cash flows, these are some gas properties. So we have made a sale where we feel we've gotten some good value. We will pay down the debt now.

And we are still working on and we still have an ongoing sort of negotiations or efforts to sell our South Louisiana production and also try to market some of the big 2000 horsepower rigs.

In the past several years, for capital expenditures, if you look at our efforts over the last couple of years, our drilling efforts have been really directed toward our natural gas reserves.

Our acquisitions that we've done were prediction properties were really for oil properties. And there really hasn't been any plan to prefer one product over the other. But the effort in the acquisitions really was to try to find long-life properties to help offset the short-life nature of the Company's Gulf Coast properties.

And so really the end result -- not that we really planned it this way, it's just the way it worked out -- is that we're very well capitalized now or very well positioned to capitalize on this high oil price environment that we're experiencing.

So having said all that, the company has spent through the third quarter $184.3 million. We're projecting to spend for the year $251 million in the drilling and leasing, and that's an increase of $16 million over where we were, I guess, in the second quarter. So we're kind of bucking that up.

But this increase is mainly going to be related to the developmental drilling in oil prone regions, which are two areas that we have that are primarily oil prone, the Austin Chalk, we call it the Trend, and then the Permian Basin. And so in the fourth quarter, we will spend roughly $67 million. Of that $67 million, two-thirds of that expenditure will be developmental drilling.

Part of the cost for the quarter are carryovers from the East Texas Bossier wells. That's a big part of that. It's about $13 million. And in the Permian and the Chalk, we'll spend $13 million in Permian and about $15 million in the Chalk. And those are primarily for oil. And I think Clayton will talk about that here in just a moment.

So with that, I think, we're really pleased with the quarter. Financially, the numbers are good. And we've got a lot of work to do, but we feel like we're well positioned. Clayton?

Clayton Williams

Good. Save your questions for Mel. I'll give an overview. We have recently, naturally, directed more of our efforts towards oil. Particularly, with the acquisition of Southwest Royalties, we have a number of opportunities there that we're looking forward. We're adding some people and beefing up. We'll probably add some more overhead in West Texas based on the oil-oriented program.

We're shifting away, basically, from gas to oil. We have two rigs drilling at this point for oil in West Texas. That probably may increase to three, maybe four, depends on success. We're very positive towards our Permian Basin, which is actually our home.

As we move along east, we have two rigs drilling in the Austin Chalk. Nice payout, a little less than a year of payout. We've also accelerated water fracs, which have a nice payout. And we're involved in the second water frac. So we're probably most of the wells we have in the Austin Chalk, all oil related, all good, solid payouts.

As we move then further east, to Central Louisiana, we are still drilling a successful Hosten Cotton Valley program. But now, we've added occasional Gray Sands to that. We have one well that we just did low, not completed yet, on the east side of the Terryville play, in the Rusten (ph) area.

We've encountered some sands, we believe, are commercially productive, but we have not perforated yet. So we think we've probably got 6 to 12, 15 more wells to drill there, but depending on the outcome of this last well we've drilled in the Rusten area.

Now, I want to talk about the Bossier, and I'll come back from west to east. Our Margarita well, we released, was a disappointment. That's south of our existing deep Fazzino production that we drilled some six, seven years ago. We did not have the middle Bossier or lower Bossier sands. They were present up-dip in our Fazzino production.

It was a disappointment, but we did encounter some upper Bossier sands that had some shales did have pressure. And while we are not optimistic, we are going to test it, and maybe we'll get a pleasant surprise. But disappointing not to have the sands in the middle and the lower Bossier, the lower produced in the Fazzino up-dip, the middle produced from the production on East (inaudible) where you read about a big sale.

We hope to complete that. We're waiting on some part manufacturer to make it work, because we did not expect to have upper Bossier we would complete in. Disappointment that we might have enough production to pay out the well is questionable.

Moving on to the Big Bill. We did have encouraging gas shales. We did run pipe. Unfortunately, in the attempt to completion, we lost a fishing tool. We've been fishing for a month. We're hopeful we will have that out in a week or 10 days. We think we will. If we do not, we will have to sidetrack.

But we wish we could tell you more about the Big Bill. We had encouraging shows, encouraging log shows. But until we test and actually until we frac it, we can't say whether it's commercial or not. We're hopeful.

Moving on east then into the deep Louisiana Bossier, where we have 175,000 acres. We did have a disappointment, but we think we still have a good chance because the well did not reach target. Therefore, we had the middle Bossier and the lower Bossier sands. We're in the process of evaluating where to go from there. It's very prospective. We're very hopeful. A lot of work could be done.

South Louisiana, then, we still have a number of prospects. The cost of drilling and completing wells is not quite prohibitive. But at this point, our production is for sale. We've not had an adequate offer. If we don't receive a very good offer, we will produce it out. The cash flow from that is excellent.

In the meantime, we have prospects. We continue to prospect. Our plan is to look for a partner on the South Louisiana, mostly gas prospects, as we shift our emphasis to oil drilling in the Chalk and in West Texas.

So we've had an interesting period. We've had disappointments, particularly in the Floyd. We've had opportunities develop in West Texas that we're very hopeful about. So it's a little bit of a mix.

Mel says we've had good performance. Things are going well. The cost of drilling in South Louisiana is more than double what it was when we started. So that's had an influence on our plans though. At some point, we have position, we have prospect in South Louisiana. Hopefully, we may get the drilling cost down to some point where we can go back to work there.

With that, we'll take questions, and we look forward to handling them the best we can.

Question-and-Answer Session

Operator

Thank you very much. (Operator Instructions) And we will hold one moment to compile our list of prospective questions.

And we'll take our first question from the line of Dan Rice with BlackRock. Please proceed.

Clayton Williams

Hey, Dan.

Dan Rice - BlackRock, Inc.

Hello, Mel and Clayton. On the economics of the Austin Chalk refracs, can you give us a feel for what you're seeing? How much they cost? I know you've got a lot of wells back in the early '80s that are sitting there. How many opportunities do you think you have, etcetera?

Clayton Williams

As we go forward, we expect that we maybe have about 100 wells. We don't expect all of them to be prospective. We think many are. As we go forward, we'll learn more. This is our second water frac. We've gotten the cost down through competition from $300,000 a water frac to $250,000. The payout is about two and a half months.

We're not able yet to tell what reserves it would add. But in many cases, it's increased the production in multiples 5 to 10 times. Very economic. And hopefully, if it works perfect, as it never does, we might have all 100 wells. Most likely, it will somewhere in between, but we are proceeding to frac those. They will probably be over a year and a half to two years, before we've completed the water fracs. We're very happy with it.

Dan Rice - BlackRock, Inc.

And what sort of production increase are you seeing so far on a per well basis?

Clayton Williams

Well, they are variable, but maybe from 10 barrels to 100 barrels.

Mel Riggs

Yeah. One thing I'd point out, Dan, is they perform. The decline curve is very similar to the natural decline curve of the well. You can recover probably, what, half the reserves.

Clayton Williams

Maybe even faster.

Mel Riggs

Maybe faster. So you're going to recover most of the reserves or the two-thirds of the reserves probably in the first year or so. So it's a quick cash flow impact. And at these product prices, obviously, that's a great opportunity.

Clayton Williams

Mel, I would add too that we have two rigs doing infield drilling. We are now drilling on what would be an equivalent of 40 acres, 160 acres going four or five times that. These wells so far appear successful. They are probably a little less than a one-year payout.

Reserves, of course, wouldn't be near as good as the first wells but I think economic. And so as we go forward, we may have 10 to 20 wells to drill. And we will learn that as we move forward as well. At this point, we are happy with both the water frac and the infield drilling.

Dan Rice - BlackRock, Inc.

Thanks, guys.

Mel Riggs

Thank you.

Clayton Williams

Yes, sir.

Operator

Thank you very much. Ladies and gentlemen, your next question comes from the line of Brad Evans of Heartland. Please proceed.

Brad Evans - Heartland Advisors

Yes. Good afternoon.

Clayton Williams

Yes, sir?

Mel Riggs16

Hi, Brad.

Brad Evans - Heartland Advisors

Could you just give us a sense as to the reserves that were associated with the asset package that was sold in Pecos County?

Mel Riggs

Yeah. It's probably the reserves, really immaterial, most of it we didn't really even have booked in our reserves. Our production from that area was probably less than 1 million a day, 1 million cubic feet a day, and we didn't have much booked there, Brad. And there were a lot of leases that we sold also. We sold out of that particular area. So it has very little impact on reserves or cash flow.

Brad Evans - Heartland Advisors

Okay. That's helpful. Could you just give us an update in terms of the cap structure, the amount of revolver debt, and what the balances on the non-recourse rig debt?

Mel Riggs

Yeah. At the end of the third quarter, we have $225 million of senior notes. We had $188 million outstanding on the revolver at that point. Now, we have received the $21 million. We've paid that down. And that's where we are today based on other working capital needs and stuff. So we paid that down somewhat. And we started with $75 million of rig debt and we are amortizing that debt right now. We started amortizing on July 1 of this year, and we will pay 35% of that debt off within a 12-month period. So in the third quarter, we paid a little over $6 million and gets down to about $68 million or $69 million on the rig debt.

Brad Evans - Heartland Advisors

Okay.

Mel Riggs

And that's everything.

Brad Evans - Heartland Advisors

Thanks for that. Can you just give us a little bit of additional detail on the impairment charges in North and South Louisiana on the acreage. You mentioned the acreage impairment in those areas.

Mel Riggs

Yeah. We had…

Brad Evans - Heartland Advisors

Can you give us a sense as to what happened there?

Mel Riggs

It's just every quarter we evaluate and our people involved in these areas help us determine what the real market value of the acreage is, and based on what's being paid per acre, plus based on activity that might condemn acreage. So we had a $4 million attributable to South Louisiana and $5.4 million in North Louisiana related to Bossier acreage.

And it can be impacted by what acreage is going to expire, the time length on that. Then we had about $1 million in impairments in North Louisiana. But I don't think it's anything that acreage is anything in the areas that we're really active in right now.

Brad Evans - Heartland Advisors

Okay. Can you give us your sense as to -- maybe this is a question for Clay in terms of just the Bossier activity going forward. It's my understanding you haven't drilled any the Bossier wells with 3D. Is that correct?

Clayton Williams

No. That's not correct. Margarita was 3D.

Brad Evans - Heartland Advisors

It was 3D. Okay.

Clayton Williams

It was 3D. We had our (inaudible) trap, and it was down-dip from our Fazzino production, where we had lower Bossier sands. And the disappointment was that those sands did not continue down-dip. And so we had not our main sand, we thought was a lower Bossier, but we had no middle Bossier. It was a very sand poor environment.

And so that does impair a substantial amount of acreage in that immediate area and that's just the way it is. We might have commercial production from the upper Bossier. We were skeptical about it. We will be surprised if it were good, but there's enough to attempt completion.

Brad Evans - Heartland Advisors

So what do you think you will I mean, it's early days as we think about '08 at this point, but what do you think about your Bossier program as you look out over the next 12 months? What's the…

Clayton Williams

Well, this immediate area, we were very disappointed. And that's very negative. It's gone (ph) nearly a dry hole. But Big Bill, we had substantial amounts of sand. We ran pipe. We hope if we had sands with 15% ferocity, at pressures, we said we would have a commercial well.

If we had had 6%, we said we'd have a dry hole. But we have 10%, which is somewhere in between. We are encouraged. We believe, we will make gas. The other problem, we'll face in the Big Bill area that we don't know the extent of each sand, how far it will drain.

Will it drain 200 acres or 100 or 40 or more? And each well probably will be a little different. And sands will come and go. But the optimistic thing is we think we will drill future wells cheaper outside of this fishing job, which was involved in completion. We drilled the well very well and we think we might drill these wells cheaper. So the jury is out.

Brad Evans - Heartland Advisors

I mean, so how much of your capital budget do you think you will spend next year on the Bossier?

Clayton Williams

I just can't tell you because I don't know.

Mel Riggs

We really can't say until we complete these wells and see what we got. And that will determine it.

Clayton Williams

The thing on the east Louisiana Bossier, where we have major acreage, we've got some more seismic to do. We have two big prospects that have not been evaluated. We don't know what to do with this well that we had Bossier gas up the hole and pressure until we got into the water, which confused us.

And so that's under evaluation, but it's not condemned. We're still prospecting. Where do we go from here? We are studying and we will make decisions, which will be probably financial decisions as well.

Brad Evans - Heartland Advisors

May I ask you…

Clayton Williams

I'll try, I couldn't give you a better answer, but that's truly where we are. We are in limbo (ph). Now, remember that Big Bill, we have almost 25,000 acres there. If it's good, we have a lot of work to do. If it's bad, we have lost a lot of money.

Brad Evans - Heartland Advisors

Just shifting gears for a second, on the divestiture of the South Louisiana assets, I mean this is a pretty robust environment for M&A activity and I'm curious as to why you think you haven't been able to solicit interest in the property that are acceptable to you.

Clayton Williams

I'm not sure I could tell you that. The problem that we face in drilling is that the cost of drilling and completing wells has increased substantially. These Louisiana wells have a very high cash flow, and a relatively short reserve life. Maybe that's it.

So, in case, we don't get a solid buyer, we will produce out the well and we'll receive substantial amounts of the cash available in the next two and a half years.

Brad Evans - Heartland Advisors

My last question and I will get back into queue and I'll see before, with respect to some of the Southwest royalty assets, have you explored whether they would be appropriate assets for an MLP structure?

Clayton Williams

We have, but we think we have a lot of work to do. We are hiring some people there. We have things that didn't look attractive at $50 oil. At $80 but commercial. So, we are in the prospect of mining all the potential we have in that and we're adding some people. And we're positive about that. As in all of the business, it ain't over. We are hopeful.

Mel Riggs

Yes. Brad, we evaluated that pretty hard and at the end of the day, we realized it made us focus a lot on the Permian assets and they are pretty immature. There's a lot of opportunity to think we're better. We can really get more value by putting drilling dollars into these properties and then we'll evaluate those options down the road.

Brad Evans - Heartland Advisors

Okay. Thank you.

Mel Riggs

Thank you.

Operator

Your next question comes from the line of Eric Calamaris of Wachovia Capital Markets.

Please proceed.

Eric Calamaris - Wachovia Securities

Good afternoon, guys. If you can't find an appropriate bid on the assets and package in Louisiana, what is the capital portion that you would expect to spend on those, if they were to be retained?

Clayton Williams

Well, they are mature properties.

Mel Riggs

These are producing properties.

Clayton Williams

These are producing properties. Now in combination with them, we have an ongoing drilling program that we made a decision shifting into oil and our assets in the Chalk in West Texas, which have pretty good economics, as you heard.

So we're saying we have the ongoing drilling program. We have leases. We have a track record, but we are considering making a deal on that, which we might consider a deal with the production or a deal separate, and we have some flexibility.

But I think, you would expect the shareholder to be sure and put the money where we believe has the best upside potential. So we have to put South Louisiana on a platter, while we move to the Chalk drilling, which is less than a year payouts. The water fracs are two and a half months. That's where our money should go, obviously.

Eric Calamaris - Wachovia Securities

Without the, I guess, if you end up keeping the properties and without any significant developments step out …?

Clayton Williams

Well, we have monetized those properties.

Eric Calamaris - Wachovia Securities

I'm sorry, say again.

Clayton Williams

The properties that are for sale are all producing properties. There are some production behind pipe, an offset or two, but basically they are mature properties and we put them on the market to help us accelerate some of our West Texas drilling for oil, where we see more opportunities.

Eric Calamaris - Wachovia Securities

What is the production of the assets?

Mel Riggs

About 1,000 barrels a day and roughly 25 million to 30 million cubic feet of gas.

B>Eric Calamaris - Wachovia Securities

And the total 2P portion that's up for sale? What does that look like?

Mel Riggs

The reserves?

Eric Calamaris - Wachovia Securities

Yes.

Clayton Williams

That's in the eye of the beholder, I think.

Mel Riggs

Yes, I really don't.

Eric Calamaris - Wachovia Securities

Well, I mean. Okay.

Mel Riggs

Cash flow probably net of operating cost next year, somewhere around $60 million to $70 million of those assets.

Eric Calamaris - Wachovia Securities

Okay.

Mel Riggs

Part of the problem is I think, it is a producing property divestiture and it is little bit in a short life. So it's tougher deal.

Eric Calamaris - Wachovia Securities

Sure.

Mel Riggs

We do have a lot of prospects as Clayton said, that we will probably come back to later and he may do a deal where he offers up those prospects for some kind of deal. That might do it.

We are comfortable just to own those assets and to produce them. We are getting the benefit of higher product prices now that's helping fund the Permian Basin drilling. So the urgency to do that is not as strong.

Eric Calamaris - Wachovia Securities

Okay. That's helpful. And I guess, turning to the balance sheet, is there a strong desire to clean down the revolver at this point?

Mel Riggs

We think we can work down. We think we can have a pretty strong drilling expansion program. And we can work the debt down and make sure that's one of our plans.

Eric Calamaris - Wachovia Securities

Do you have any …?

Mel Riggs

We are not under pressure to pay it off in any major way. We can deal with it.

Clayton Williams

It's somewhat of a balance between opportunities on the one side, which are now much better at $90 oil, and paying down on the other banks. We've been with them a long time. There's no pressure from the banks.

So we think, we will just deal with it as it moves along. I think we answered your question. I'm not sure.

Eric Calamaris - Wachovia Securities

No, I think you did as well. Thank you.

Mel Riggs

Thank you.

Operator

Thank you very much. Sir. I would like to turn the call back over to Clayton for any closing remarks you may have.

Clayton Williams

Well, we feel pretty good. Of course, $90 oil, you would feel good. We have disappointments in the Bossier. We have hope and we have confusion over in Louisiana. We have new opportunities, we think, because of the oil price in West Texas and the Chalk.

We have some more drilling to do in central Louisiana and intermediate depth at Cotton Valley. So I think we are on solid ground. We wish we owed less money but when you start wishing, you can't wish the debt away. We are not uncomfortable with it. I know some people have been.

So we feel like it's probably we are going to continue to drill rather than worry about debt first, because we're seeing some very good economic opportunities. But we will react to that debt. It's an asset as long as you control it and it's a mean enemy if you lose control. We thank you for tuning in. We are always glad to talk to you.

Operator

Thank you very much, sir. Thank you, ladies and gentlemen, for your participation in today's conference call. This concludes your presentation for today. And you may now disconnect.

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