Rosetta Resources Q3 2007 Earnings Call Transcript

Nov.13.07 | About: Rosetta Resources (ROSE)

Rosetta Resources, Inc. (NASDAQ:ROSE)

Q3 2007 Earnings Call

November 13, 2007 11:00 am ET

Executives

Charles Chambers - Executive Vice President, CorporateDevelopment

Mike Rosinski - Chief Financial Officer and Executive VicePresident

Randy Limbacher - President and Chief Executive Officer

Analysts

Robert Rodriguez - First Pacific Advisors

John Gerdes - SunTrust Gerdes Group

Rehan Rashid - Friedman, Billings, Ramsey

Mark Lear - Sidoti & Company

Neal Dingmann - Dahlman Rose

Stuart Kovensky - Onex Credit Partners

Chris Chaice - Southpaw Asset Management

Operator

Good morning everyone, and welcome to the Rosetta ResourcesThird Quarter 2007 Conference Call. Today's conference is being recorded, andall lines have been placed on mute to prevent any background noise.

If you're not able to participate in the conference call, anaudio replay will be available from 1 pm Central on November 13, 2007 through12 am on November 20, 2007 by dialing 888-203-1112, or for international,719-457-0820 and entering the conference code of 3746730.

A replay of the call will remain online atwww.rosettaresources.com for 60 days after the initial call. To access thereplay, click on the Investor Relations section of our website and select Presentationsand Events.

Our speakers are Charles Chambers, Rosetta's Executive VicePresident, Corporate Development; and Mike Rosinski, Chief Financial Officerand Executive Vice President. Also on the call today is Randy Limbacher,Rosetta's new President and Chief Executive Officer.

At this time, I would like to turn the call over to yourhost, Mr. Michael Rosinski. Please go ahead.

Mike Rosinski

Thank you very much. To begin the conference, as is ourcustom, we will make a note regarding forward-looking statements. Allstatements other than statements of historical fact included in thispresentation are forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995.

These statements are based on current expectations and aresubject to a number of risks, uncertainties and assumptions, which are morefully described in Rosetta Resources' annual report on Form 10-K and quarterlyreports on Form 10-Q filed with the Securities and Exchange Commission.

These risks, uncertainties and assumptions could causeactual results to differ materially from those described in the forward-lookingstatements. Rosetta Resources assumes no obligation and expressly disclaims anyduty to update the information contained herein, except as required by law.

Now, with that done, I'll comment briefly on today's agenda.First, we'll begin with an operations update from Charlie Chambers, and I willfollow with the financial review for the company's third quarter activity.

We'll talk briefly about our hedge program and also commenton the Calpine transition. After that update, Randy Limbacher will make a fewintroductory comments, and then we will go to the Q&A session.

At this time, I will now turn the call over to Charlie forthe operations update.

Charles Chambers

Thanks, Mike. Again, welcome to our ‘07 third quarteroperations update. As you are going to hear, we have had a solid third quarteroperationally, and at this midpoint in the fourth quarter have established significantmomentum, which should provide us a strong finish for the year.

Specifically, in the Sacramento Basin of California, we havedrilled 19 wells in the first three quarters of ‘07. 15 of these wells havebeen successful, and one has been cased, awaiting further evaluation. 12 of the15 successful wells are currently on production, two are awaiting completionand one is waiting on a pipeline connection.

Since the end of the third quarter, we have drilled twoadditional wells successfully, with the expectation of drilling eight morewells in the fourth quarter. As you will recall, in 2006, we acquired a 3-Dsurvey over our Bradford Island area in the south part of the Rio Vista Field,which covers approximately 7,000 acres.

Seven wells have been drilled based on the survey this year,bringing the total number of producing wells drilled in this area to eight,with one currently waiting on pipeline connection. I might add that thisresults in 100% success based on this new 3-D, which we are very excited about.

To support this activity, we installed additional pipelineinfrastructure to gather the increased gas production. And this south enddrilling, coupled with pipeline improvements, added approximately 10 millioncubic feet a day in September. You may also recall our acquisition of theCalifornia properties of OPEX at the beginning of this year.

Since closing this transaction, we drilled two successfulwells in the third quarter. The two wells have a combined net production of$3.1 million to Rosetta, and this additional rate almost doubles our productionassociated with these properties since the acquisitions. We plan three moreadditional wells associated with these properties before the end of the year.

In the DJ Basin of Colorado, the company drilled 54 wells inthe first nine months of the year. 43 were successful, and we expect to drillanother 15 wells before year-end. Current net production from the area isapproximately 8 million cubic feet a day, today.

You may recall we recently curtailed 2 million to 3 millioncubic feet due to operational constraints on the Cheyenne Plains transmissionline, which is presently corrected. And we have since added delivery pointsinto Southern Star and Kinder Morgan pipelines, which is intended to reduce exposureto future curtailments in the area.

Now moving to South Texas, where we have drilled 35 wells inour Lobo play through the end of October, and will have drilled 43 wells inthis area by year-end. We completed 28 of the 35 wells drilled, with net productionfrom these wells of approximately 24 million cubic feet a day.

We’ve also added approximately 10,000 acres and acquiredover 80 square miles of additional 3D seismic coverage. We plan to shoot anadditional 100 plus square miles of 3D seismic over our leasehold in 2008. Thisnew 3D coverage, along with our leasing activity, is expected to addsignificantly to our drilling inventory in our Lobo play.

In our South Texas Perdido play, where we participate 50/50with EOG, we have drilled and completed nine wells, with one additional wellcurrently being drilled. The nine completed wells are producing today at acombined net rate of approximately 8 million cubic feet.

In the Gulf of Mexico, Rosetta's Main Pass 118 and 29platforms continue to produce at net rates of 8 million cubic feet a day, whilethe East Cameron 88-89 platform is producing 7 million cubic feet a day netafter a recent successful workover.

Production in our Sabine Lake project began at the beginningof this month, and the construction of production facilities is nearcompletion, with a net production rate to Rosetta expected to reach 7 millioncubic feet by the end of November.

We have designed facilities to support additional drillingin this area, which will take place in 2008. As you may know, we own 50%interest in 6,800 acres, supported by 70 square miles of 3D seismic. Rosettaparticipated in several other successful wells, including the deepening of twowells in Kleberg County and the drilling of a successful Wilcox test in DuvalCounty.

The net production from two of these wells is approximately3 million cubic feet a day, with one well yet to be completed. We plan threeoffset wells in Duval County, based on this discovery, which will occur, wepresume, in 2008. In closing, operationally we’ve had a good third quarter,which represents record production and revenues.

However, we were disappointed that we did not meet ouroriginal guidance for the quarter. As I’ve discussed earlier, the productionshortfall was attributable in large part to factors outside of our control,including downstream third-party pipeline problems and weak prices in theRockies.

We do expect to continue to face these same challenges inthe fourth quarter, and achieving our total year guidance of 120 million cubicfeet a day average is dependent on our ability to manage the issues in the DJBasin and to bring Sabine Lake production up on a timely basis.

That concludes my operational comments, and now I will turnthe call back over to Mike Rosinski for his financial update.

Mike Rosinski

Before I get into my comments, I just want to make one quickpoint. I thought, I heard Charlie say 120 million a day, which would be viewedas news. We are still looking at and are unchanged with our guidance at 125million a day for the year.

This is the guidance that we've had in place all along.Again, as Charlie says, we are working Sabine Lake, we are working thesecurtailment issues in the Rocky Mountains. But again, we are still at $125million a day for the year. So with that, then, let's go in and talk a bitabout third quarter results.

Production and revenues for the third quarter were $126million a day and $89.7 million, respectively. In the third quarter, productionand revenues were at their highest levels since Rosetta has been an independentcompany, and we have now had seven consecutive quarters of productionincreases.

And in fact, the $126 million a day we had in the thirdquarter is up from the $120 million a day we recorded in the second quarter ofthe year. So, again, reinforcing the idea of consecutive production increases.And in fact, the 126 a day we had in the third quarter is up from the 120 a daywe recorded in the second quarter of the year, so, again, reinforcing the ideaof consecutive production increases on a quarterly basis.

Average realized prices for the quarter were $7.39 per Mcf,and that includes a $10.3 million benefit from the Company's hedging program.

As we go through the presentation this morning, you're goingto see that is a larger number on a September year-to-date basis and evenlarger number since inception of Rosetta for the performance of the hedgeprogram overall. The revenues for the quarter of $89.7 million are up 26%versus $71 million in the third quarter of 2006.

Total lease operating expenses, which includes LOE, workoverand ad valorem taxes and insurance, was $11.9 million or $1.03 per Mcfe. Andyou will recall, from previous calls and conversations we've had on anindividual basis, we believe on an overall basis that we are going to be in therange of $1 per Mcfe for total lease operating expenses as I've defined ithere.

Direct LOE for the quarter, $8.4 million or $0.72 per Mcfe.Workover costs, $0.3 million or $0.03 per Mcfe. As you saw in the release, wenoted that we had an insurance recovery of $2.4 million associated withHurricane Rita.

This $2.4 million is in addition to $1 million we haverecovered in previous periods. So the total damages we had due to that event ofabout $3.6 million, we now have recovered $3.4 million of the $3.6 millionthrough our insurance program.

Ad valorem tax was $2.6 million for the period, whichequates to a cost of $0.22 per Mcfe, again in line with the guidance we'vegiven for this particular cost factor in previous quarters.

Production taxes, $1.2 million or $0.11 per Mcfe andtreating, transportation and marketing charges were $1.9 million or $0.16 perMcfe. Our all-in depreciation, depletion and amortization expense for thequarter was $38.2 million, which represents a DD&A rate of $3.29 per Mcfe.

General and administrative costs were $12 million for thequarter, including $900,000 for non-cash charges for option expense. During theperiod, we had a $3 million settlement expense associated with our former ChiefExecutive Officer.

Again, if we adjust for our CEO transition costs , we'vetalked in the past about Calpine and SOX. We start to get them to the $0.50 perMcfe rate that we have talked about in previous calls, which is, in effect, ourtarget for G&A per Mcfe, excluding these extraordinary items that we dealwith from time to time.

Net income for the period, $12.7 million or $0.25 perdiluted share, up 4% compared to the $0.24 we had in the third quarter of 2006.

Turning to September year-to-date, the first nine months ofthe year, production averaged 118 million cubic feet equivalent per day.Average realized prices, $7.60 per Mcfe, and on a year-to-date basis, our hedgebenefit is a shade under $18 million.

Realized oil prices, $65 per barrel. Revenues for theperiod, $252 million, that's for the first nine months, which is a 27% increaseversus $199 million for the first nine months of 2006.

Total LOE for the period, again, $1.03 per Mcfe, as it wasin the third quarter. Direct LOE, $0.65 per Mcfe. On a year-to-date basis,workover costs net were $3.0 million or $0.09 per Mcfe for the period.

Ad valorem tax year to date, $7.7 million or $0.24 per Mcfe,with production taxes $3.4 million or $0.11 per Mcfe. DD&A on ayear-to-date basis, in line with the third quarter at $105.1 million, with anall-in DD&A rate of $3.26 per Mcfe.

Year-to-date general and administrative costs, $30 million,including $4 million for option expense, again the $3 million for the severancecosts associated with a former CEO.

And Calpine, this is a question we get quite often. Calpinecosts year to date, $2.1 million. Net income for the period rounds to $40million, $39.8 million or $0.79 per diluted share, again up nicely versus thefirst nine months of 2006, up 27% versus the $0.62 that we had for the firstnine months of 2006.

So, there you have a financial update for the quarter forthe first nine months. Let's speak briefly about our hedging program. For 2007,we have been talking in terms of $65 million a day hedged. And since we beganour program, this is from inception we have had a $31 million benefit from ourhedging activities.

We have recently added hedges for 2008 and 2009. You mayrecall in our conversations in the past, we have said we like gas prices above$8. For 2008, we have entered into an additional $10 million a day per MMBtu ofhedges, at an average price of $8.29 per Mcfe. We have also entered into anadditional $11 million a day for 2009 at $8.40 per Mcfe.

With the addition of these hedges as we go into 2008, we'renow just under $65 million a day of hedges in place. These are all fixed-priceswaps. We will continue to look at the market. To the extent that we seeopportunities to add hedges, again above $8, I believe you will see us doingthat. Again, our average price right now for 2008 on our hedges is $7.74.

As I said, we added additional hedges for 2009. We have $42million a day hedged for 2009 with an average price of $7.49 per MMBtu.

Finally, we will talk briefly about where we stand with theCalpine transaction and transition. We have had some measure of success, as youare aware. The court approved our partial settlement, and we have now finalizedour California state audit. With that finalized, I can say that there will be,as a result of that, no cost, no dollars going out the door for Rosettaassociated with that audit.

I also know that you all are interested in the next stepswith respect to the Calpine proceedings. As we've stated on numerous occasions,we continue to plan to defend our position.

We are watching the proceedings with the following dates inmind. November 20th, Miller Buckfire, consultant to Calpine, discloses itsrevised evaluation. That's important because it adds another data point, if youwill, in the determination of whether or not we have a full payout plan.

And I'm sure you all recall that we filed a motion todismiss on the basis that we expect this to be a full payout plan, that motionhaving been denied because it is not yet determined for sure whether or not wehave a full payout plan.

Again, this Miller Buckfire date is important, because itadds a very significant data point in that process of determining whether ornot we have a full payout plan.

November 30th is the deadline for voting on the plan, andit's also the deadline for objecting to the plan. We expect that will be a veryinteresting time. We do plan on submitting objections, and again, we'll becarefully monitoring the proceedings with respect to the plan.

And then finally, throughout the second half of December,there will be confirmation hearings, which presumably will be designed toachieve finalization of Calpine's plan of reorganization.

Finally, I would say that the discovery process is underway.We are heavily involved in it. As a result of new data and information we haveseen, there has been nothing to change our views that this Calpine suit istotally baseless, and our view with respect to defending our position in thislawsuit are unchanged.

So, that concludes my comments, and I think what we will donow is to turn the call over to Randy Limbacher, our new President and CEO, forhis comments. Randy?

Randy Limbacher

Thanks, Mike and good to everyone. Let me just say firstit's a pleasure to be on the call today. I'm very pleased and excited to assumethe President and CEO role here at Rosetta. Let me start, though, byacknowledging Charlie, Mike and the entire management team for just theoutstanding leadership that they have provided at Rosetta during thistransition period.

Now, as to my comments today, I'd like to point out thatit's very early in my tenure. So I'm going to limit my remarks to just a coupleof topics or, if I could, couch it in terms of maybe what is a frequently askedquestion of me right now.

One, I want to talk a little bit about why I came toRosetta, maybe give you some of my early impressions of the company; and, two,talk a little bit about where I plan to focus my time and efforts during thenext couple of months.

So first questions first. Why did I come to Rosetta? Afterbeing approached by the Board, let me just say I went through a very carefuldue diligence process. Really, I focused the thoughts around that on fiveitems.

I took a hard look at the people with the company, numbertwo, the company's financial position, number three, thought a lot about theasset base, thought a lot and did a lot of due diligence around the Calpinelawsuit, of course, and finally, gave a lot of thought to the potential forincreasing the shareholder value of the company.

And based on that initial work, I reached the conclusion theRosetta was a company that had significant upside potential. To support thoseconclusions, I'd make the following observations. First, I think we have aquality team of people in place at Rosetta.

The people here, they have been responsible for assembling avery nice set of assets with a couple of key core areas. I think we'vedemonstrated the ability to increase the assets' value, based on our trackrecord of increasing production and reserves over the last couple of years.

I think, when you look at the company financially, our coststructure is very competitive with our peers, and there's room on the balancesheet, certainly, to fund some future growth. I think, if you look at theexisting assets, we do have a very strong set of existing assets. There's anice inventory at the drill bit in our two core areas in South Texas and RioVista.

So there seems to be a lot of running room left with thecompany. We've got some nice, new, evolving areas that show promise at SabineLake and into Niobrara play as well. And I've also spent a lot of timeevaluating the Calpine lawsuit. Now, I think our recent release and thecomments that have been made this morning do a nice job summarizing thecompany's position.

But I think that they also echo some of the conclusions thatI reached prior to coming to the company and having the opportunity to be privyto the data that I've now seen. But just from an outsider looking in, myinitial thoughts were that, hey, you had Calpine's experienced Board. Theyundertook the sale in a transparent, very appropriate, arms-length process withthe benefit of the expert internal and external advice and opinions that wereavailable.

It seemed to me these were assets that they obviously knewvery well. Then, from an outsider's point of view, it looks to me that thevalue paid for the assets was certainly within, if not the high end of therange that assets traded for during that period of time.

But let me emphasize, I don't take this issue lightly atall. But my assessment coming in was that, while this is a distraction to thecompany and one, which will continue to vigorously defend our position, it'scertainly difficult for me to see any merit coming in to Calpine's claim. Ihaven't seen anything since coming on Board to change that view.

Then finally, I would say as far as my up-front observationsabout the company, there have been some distractions associated with the CEOsearch, and the Calpine issue has certainly impacted the stock.

But I think putting these issues behind us over time willallow us to focus fully on exploiting our assets, adding some new opportunitiesto grow shareholder value in the future. So in short, I think the company hasthe right ingredients to continue to build a successful enterprise for thefuture.

So now, if I move to the question on where am I going tofocus my time over the next several months, I would say you're probably notreally going to hear any surprises in this. But there's a couple of areas thatI'm going to be keenly focused on.

One is obviously I want to get around and meet all of ouremployees. Especially in today's world, you look at this group of people,that's any company's most valuable assets, ours included. I want to reassureour employees that their management team is fully committed and fully engagedto making sure that we have a successful future for our company.

I think the next thing is as part of that, I want to assessthe organization's capabilities, what skill sets do we have and what are thosethat we need to develop to ensure and build on our success. Third, I want toget an even better understanding of our existing core areas in a lot moredetail, put a lot of attention around cost structure as well as getting a littlebetter handle on what our drill bit inventory is.

I'd like to spend some time evaluating our efforts andopportunities to find new core areas and adding new assets, whether that'sorganically or through acquisition. I'd like to, of course, get around and meetas many of our investors as I possibly can in the next couple of months.

And then, based on the assessment of those data points, sitdown with our team, and we want to put together a kind of a going-forward planand strategy to grow the company and improve our shareholder value. Obviously,at the appropriate time, we will begin to share that plan with you.

Finally, again, I'll reassure you that we're going tocontinue to aggressively defend the Calpine issue. I'll be heavily involved andengaged in that over the next several months as well. So I would just concludemy remarks by again reiterating that I think this is a company with a verybright future. I look forward to being a part of the team at Rosetta.

At this time, I'm going to turn the call back to themoderator to take your questions. The way we're going to work this today isthat, obviously, because I'm very new at the company, questions pertaining tothe operating results, the financial results, our history, litigation details.

I'm going to defer to Mike and Charlie. But I would beinterested in any comments and questions that you have outside of those areasfor myself as well. So again, that concludes my comments, and I'll turn it backto the moderator. Lisa.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes fromRobert Rodriguez with First Pacific Advisors.

Robert Rodriguez - First Pacific Advisors

Well. Good morning I didn’t expect that. But I just reallywanted to wish you welcome, Randy, and best of success in joining theorganization and going forward. But I was curious if you could cover two areasfor me.

One would be your consideration for acquisitions orexpenditures or leverage that you might have in your mind; and secondly, if youcould detail a little bit about your management package that brought you toRosetta?

Randy Limbacher

Okay. Rob, yeah. Thanks for the well wishes. Again, I amlooking forward to it. Your first question was as to what consideration wewould have for acquisitions. Is that…

Robert Rodriguez - First Pacific Advisors

That's correct.

Randy Limbacher

I would say just a couple of comments. Again, it's veryearly days. But when I think about the acquisitions, it's all aboutsustainability for the company. And, so what part of the assessment will begoing in is getting a real good handle on what's our, let me back up a bit. Imean there's a couple components to building a sustainable company.

Number one is the base assets, and I feel pretty good aboutthem. I want to learn a little bit more about the drill bit inventory, but itlooks to me like with we've got good running room there. And then the otherareas that you have available to you are organic opportunities.

We've got a couple of nice plays that are in the Niobraraand Sabine Lake that are starting to hold a lot of promise. And then, when youget beyond that, when I look to sustainability, it's all about what can we dowithin our skill set as far as finding new resource plays to get intoorganically and building around that or going to the M&A market, as yousuggest.

Right now, I would say that, again, it's all aboutsustainability. The world has certainly come to fully respect the acquisitionof these resources, and of course the U.S. market seems to be a little bitconcerned about the impact that the MLPs are going to have on that.

But I think they're probably chasing a different set of orshould be chasing a different set of assets than what we would potentially belooking for. But again, I would tend to think about what are things thatcomplement, upfront, our core areas and our core skill sets?

What are things that would have significant running room forthe future to build for a sustainable company? Of course, I always look at thevalue proposition on that. It's hard to go into a whole lot more detail untilI've had a chance to more fully evaluate that full package.

Robert Rodriguez - First Pacific Advisors

May I just ask this follow-up question on that, before we goto the other…

Randy Limbacher

Sure.

Robert Rodriguez - First Pacific Advisors

That would be, in your mind, after having evaluated theassets, etcetera, is there a geographic region that you would be thinking aboutthat would be contiguous additions in a particular area or would you be lookingat or thinking about incrementally new areas?

Randy Limbacher

Well, it's probably too soon in the process to include orexclude anything from it, I mean there is a couple of things that occur to me.One is that we're a U.S. based and focused company, that's where our skillsetsand opportunities are. When you look at the size of the Company’s and you lookat the opportunities around North America, there are certain things that we'regoing to be a player in and certain things that we are not likely to be aplayer in, just because of the size and capabilities of the organization.

But we have good skillsets in the area of North Americanresource plays. We understand them. We understand what makes this type of playswork and how to be successful in building sustainable programs; that's acore-set, skillset that we have.

But I think you always, so you start with these resourceplays, but you always have to look around your core and existing areas and Ithink it's a part of any business plan, is how you maintain and build aroundthose existing areas and then, when you get beyond that, you have to just thinkabout how does that fit with our existing skillset.

So, again, I would tend to think that you can think throughthose things by the areas we're already in, the resource type plays that we'vebecome good at playing, but again, I'd start with South Texas and theSacramento Basin and those are certainly areas that we would went to continueto build on.

But again, very early days and I don't want to foretellsomething yet that I haven't had a chance to work appropriately. So we areanxious to dive in the middle of that.

Robert Rodriguez - First Pacific Advisors

Okay.

Randy Limbacher

Your second question Rob, it was…

Robert Rodriguez - First Pacific Advisors

On your compensation package in terms of options, stock,etcetera, since I've not seen anything along those lines.

Randy Limbacher

Yes, I think actually there ought to be some data out therethat has been filed on that line, but what I…

Mike Rosinski

Randy, If I may, we have done an 8-K that included, I think,a summary of your agreement and I believe your agreement is also filed as anattachment to that 8-K. So that's accessible to be in the website.

Robert Rodriguez - First Pacific Advisors

Okay, I had not seen it, Mike. So anyway…

Randy Limbacher

Yes, so I would refer you to that, but I would just say,from my standpoint going in, and looking at the assessment of the Company, oneof the things that I wanted to have was significant exposure to the Company'sequity and when I looked at the Company going forward and the opportunity andwhat I was interested in, in coming onboard, was obviously we had acompensation package that's competitive with our peers.

So, I think it's a market-based package, but I would say itwas heavily weighted toward the equity side of the component as opposed to thecash side.

Robert Rodriguez - First Pacific Advisors

Okay. Thank you very much.

Randy Limbacher

Thank you.

Operator

And our next question comes from John Gerdes with SunTrustGerdes Group.

John Gerdes - SunTrust Gerdes Group

Thank you ma’am. Randy, congratulations on your role.

Randy Limbacher

Thank you, John.

John Gerdes - SunTrust Gerdes Group

You mentioned sustainability on a couple of occasions. Oneof the concerns that I think the market has had regarding Rosetta is thesustainability of the growth profile of the firm, the depth of the drillinginventory. Maybe a few comments and potentially for Charlie a couple specificson saving some of those concerns.

Charles Chambers

I'll go ahead and start, John. A good example, I mightsuggest, is if you look at one of our primary core areas, South Texas, in lieuof buying, producing properties down there, we have expanded our leaseholdposition and to support that, we’ve acquired some very critical 3-D data andhave some plan to shoot in 2008.

Randy alluded to it; this market has been very difficultfrom an acquirer's standpoint. In lieu of that, we have focused our core areasand have found ways to build inventory by drilling leasehold that we'vepurchased and have had success doing that.

Another area is the D-J Basin. We hold 80,000 acres in D-Jnow. We've got some significant inventory still to drill. It's low-risk typeopportunity, so that helps and then in California, our second core area, wehave purchased the OPEX acquisition at the first of the year and if you willrecall, with that we acquired a significant amount of drilling inventory,exploratory as well as development drilling and initial results have been 100%successful.

So, we've got a good balance sheet. We want to be in theacquisition market. We're continuing to look at opportunities that areavailable, but we've got to pick our time to do it. I think it's critical thatRandy gets familiar with what we're doing, that we get his stamp on the programgoing forward with support from the Board. But Mike has kept a clean balancesheet for us. We've got the wherewithal to do some pretty sizable things goinginto 2008.

Mike Rosinski

If I may add just one other point you may be familiar with.When we were doing our Lobo inventory at the beginning of the year, I think ournumber was 90. We're talking about drilling a 30-well program for 2007; we had90 locations. During the course of the year, and in fact at mid-year, weupdated that location inventory to 120 and as you know, we brought the programup to 43 wells for this year.

So we have already seen a growth in our backlog, our organicbacklog in the Lobo, with evidence of our ability to generate sustainability,and now we're talking about 43 wells, 120 locations. That doesn't include someof these recent acquisitions of both seismic data and acreage that werementioned in this most recent release.

So, I would point to Lobo in particular as an area where wehave demonstrated an ability to build and give some assurances, at least inthat area, with respect to sustainability.

John Gerdes - SunTrust Gerdes Group

That's helpful. That 10,000 acres you mentioned in yourpress flow, is that fairly contiguous to the acreage that you have beencurrently working?

Charles Chambers

Correct. It's offset to us to the west and to the North andactually, we've got a pretty active leasing program going on now, so we expectto add to that inventory.

John Gerdes - SunTrust Gerdes Group

One last question regarding inventory. Mike, you have raisedit here a bit. Is there a sense of a goal where organizationally, maybe Randyinto this as well, where you would like to go in terms of the presentation tothe market in terms of the depth of inventory?

I'm thinking about this in the context of years, three plus,five plus. Naturally, a number of these resource plays probably one of thereasons for the market attraction in terms of the expensiveness they arewilling to pay for the enterprise is the depth or the perceived depth of theinventory. Is there a goal, per se, in mind organizationally on depth ofdrilling inventory in units of years?

Charles Chambers

Let's go back to the beginning. When we first came out, wetalked about having in excess of 500 locations. I believe that in '06 wedrilled 142 wells, which would have been well over three years of inventory. Ithink that that's probably one area where we've suffered a little bit in thetransition. We continue to main our location inventory above 500, where we aretoday.

It's clear to me and I think it's clear to everybody elsethat we want to build that beyond where we are. Now, if we are at 200 wellsthis year, just under 200 wells, we're talking about a two and a half yearinventory, which I think the market would look for something stronger andlonger than that.

In my mind, the transition to Randy, to the new CEO, is anopportunity for us to build. We've, quite frankly, had to be in a maintenancemode here during the transition period and I just say I believe that's going tobe part of the plan going forward, is to strengthen that backlog.

Randy Limbacher

I would just Randy, I would just add a couple of comments.One is that again, when I think about sustainability, you've got to wrap it ina package of two or three different things. One is the base assets and sothat's a key and that’s what’s the inventory on those base assets?

And then, even more important than knowing that exact numbertoday, what is the quality of it, and my assessment is that we've beensuccessful in generating new inventory by working those assets. We've alsoadded on new acreage in some key areas.

And so, I would caution you against taking a two orthree-year inventory at this period of time and saying, that's all we have onthe base assets. In fact, what you'll find is by owning quality and owning inthe right areas, you tend to come up with new ideas as you move these thingsforward. So, I think that's one key component.

I think the second key component is building within theorganization the ability to go out and tackle new resource plays or newexploration and I think with a couple of things that you've seen brought intothe inventory again, Niobrara play and Sabine, some of those areas there is ademonstrated ability.

We want to continue to assess that and look for newopportunities there. And then also, at the appropriate times, you want to beable to look at the M&A market. So I think it's a combination of thosethings that are important to generate long-term sustainability.

But in coming that the Company, one of the things that Iwanted to look, take a hard look at was how much running room do we haveupfront? So how fast do we have to tackle this problem? What I would say is Ifeel pretty good about it coming in, that I would say we have a healthy levelof inventory and the kind of assets that are going to allow us to regeneratethat going forward.

John Gerdes - SunTrust Gerdes Group

Thanks for the response guys.

Randy Limbacher

Thank you.

Operator

And our next question comes from Rehan Rashid with Friedman,Billings, Ramsey.

Rehan Rashid - Friedman, Billings, Ramsey

Good morning, Randy.

Randy Limbacher

Good morning.

Rehan Rashid - Friedman, Billings, Ramsey

Congratulations on joining Rosetta. I'm looking forward toyour leadership. A couple of quick thoughts here. On the front of a little bitmore concrete strategic kind of plan for Rosetta, is there any timeline thatyou have in mind?

Sometime early next year, middle of next year?

Randy Limbacher

Well, I'm actually coming at a pretty good time, in thatthis is the time of year when we put together budgets and long-range plans. SoI don't want to tie myself to a specific time period now. But it makes senseover the next three months or so that I get a chance to know the organization,know the assets, work with our Board and our management team to decide where wewant to specifically take it.

So that's one of the key issues that I am really going to befocused on over the next three or four months. So we are not going to let thegrass grow very much by doing that. That's one key area. So hopefully, veryquickly thereafter, we would be able to start sharing some of that.

Rehan Rashid - Friedman, Billings, Ramsey

Okay. Second question, and then another and one more forCharlie. For you, Randy that your recent experiences have been with much largerenterprises, Burlington and Conoco and coming down to Rosetta. Any kind ofparticular challenges that working with a smaller enterprise than what you havebeen used to in the near past, recent past?

Randy Limbacher

I'd just observed a couple things. I think you make a goodpoint. This is a different type of challenge than what I would have had inleaving at the end at Burlington or at ConocoPhillips.

But I think, what I would observe, though, is that I waswith a large independent for 22 years. It didn't start out, necessarily, as alarge one. So I had the opportunity to watch a company can grow through a lotof different business cycles, both good and bad, over a 22-year period of time.

So I think the particular challenge is more around, morefocused on growth, more focused on building the Company and the organizationfor the long term versus with a larger organization, it's more about justsustaining every day. You're starting with a much larger base that you have tobuild from.

So you can think about those things in a little differentterms. But I would say that over 22 years at Burlington, I had the chance towatch that grow from a pretty small company and through a lot of thosedifferent business opportunities and I, in a lot of ways, liken this to thatchallenge of many years ago when I started out there.

Rehan Rashid - Friedman, Billings, Ramsey

But do you feel that call it the rules of engagement havechanged for the better or the worse over the last 20 years that will affectyour strategic plan?

Randy Limbacher

Well, I think that the issues have certainly changed over 20years. I think the things that impact industry today, such as the cost ofservices, the availability, access to new resources and opportunities, what arestate and federal governments going to do around regulatory and policy issuesthat certainly has evolved and changed a lot over 20 some years.

Those are probably the things that we've watched. But again,I think our company is uniquely positioned to tackle those.

Rehan Rashid - Friedman, Billings, Ramsey

Okay Thank you. Charlie, real quick, or maybe Mike, what wasthe exit rate for production for the third quarter? Maybe what else could comeonline during the quarter that would help me get a feel for where we are headedfor on fourth quarter production?

Mike Rosinski

First, let's talk about exit rate. We were above the 126number maybe you think 130 issues where we came out of the quarter, the thirdquarter. As far as where the upside is, in spite of these issues that we aredealing with in the D-J Basin, we have got a couple million a day we get intocall it the winter season you get a hard pull. We got a couple million a day Ithink we can pick up in the D-J Basin.

Charles Chambers

That's right.

Mike Rosinski

Secondly, Sabine Lake, our technical people say, well, weknow what we have. But as far as what we can do day in and day out, we arebringing that up on a gradual process, and there might be a little bit morethere, than we see at a first glance that's a source of potential pickup.

We've had some recent success in Lobo. We've got a couple ofnice wells coming on there, Charlie.

Charles Chambers

Right.

Mike Rosinski

That are also a source of a little bit of a pop, if youwill.

Charles Chambers

Perdido as well.

Mike Rosinski

Yes, okay, for a strong fourth quarter. So I think we havesome good things going on, on a couple of fronts. Is there anything to add inCalifornia?

Charles Chambers

Yes, we have got more production. You recall this south endof Rio Vista Field. We're completing one well there, and we have two rigsrunning in the Sacramento Basin. Our success rate there has been above what ournormal average is, so greater than 85%.

The important thing is we've installed pipelineinfrastructure to put these new wells to sales quickly, so we think we'll havesome quick input there.

Mike Rosinski

So Rehan that's a long answer. The short answer is we've gotsome good things happening in just about every area here in the fourth quarter.

Rehan Rashid - Friedman, Billings, Ramsey

Okay. Sacramento Basin deep, any thoughts on when do we goback and attempt one?

Charles Chambers

I'm sorry, we Sacramento Basin deep. Oh, the deep? Well, wecurrently have a Winters well drilling. That's our deepest interval out therethat we explore for. We've had some success in the Winters before.

We're looking at that objective throughout the field.Another point is we have reprocessed our dataset that covers our field and theperimeters of the field, and we're incorporating the data we acquired on theOPEX transaction with that data as well.

So that's an area that Randy mentioned is regeneratingopportunities. With all the intervals that we produce from in Sacramento Basin,16 in total, each well adds new data, new seismic, particularly outside the fieldarea gives us opportunities. So we think that's an area we can add in inventoryas well.

Rehan Rashid - Friedman, Billings, Ramsey

Okay. Thank you.

Operator

And our next question comes from Mark Lear with Sidoti &Company.

Mark Lear - Sidoti & Company

Good morning guys.

Randy Limbacher

Good morning Mark.

Mike Rosinski

Good morning Mark.

Mark Lear - Sidoti & Company

Welcome, Randy. That was some good insight into your thoughtprocess and deciding to come on and take the job. I just had a few operationaltype questions, I guess. With the Sabine Lake coming on, I guess that would getyou a little bit more oily on the production side?

Charles Chambers

Well, correct. Two of our wells out there produce asignificant amount of well, one produces a significant amount of condensate,and one has tested a fairly high rate of oil. So we installed facilities totake care of that production and expect that to be a significant part of thatproduction.

Mark Lear - Sidoti & Company

I guess you guys just sell off a little bit in your oilproduction sequentially. I was just curious what to reason for that was.

Charles Chambers

I'm not sure …

Mark Lear - Sidoti & Company

Mark, I don't …

Charles Chambers

The main part area that we produce oil is in the Gulf ofMexico, in our property out there. So we had some down hole problems with oneinterval on one of our platforms. We've got our rework scheduled for thatplatform, that particular well bore.

But again, that same platform is today producing over $7million a day net to the Company. I think that's primarily the falloff in theoil production.

Mark Lear - Sidoti & Company

It wasn't anything significant; I was just not too much of aconcern. In terms of 2008, do you guys have any idea yet in terms of what theCapEx budget is going to look like?

Mike Rosinski

The answer is, kind of echoing Randy's comments, we arebeginning the budget process, right now. We've got our first round of meetings,scheduled early next week. We'll be presenting to the Board in December.

Our preference is to stay away from that and not givepreliminary numbers but rather, once we have gone through that full processwith the Board and got approval on their part, then we will come out with afull package on where we think will be, both on production and on capital.

Mark Lear - Sidoti & Company

All right. Thanks a lot.

Mike Rosinski

Thanks Mark.

Operator

Our next question comes from Neal Dingmann, with DahlmanRose.

Neal Dingmann - Dahlman Rose

Hi, good morning guys.

Charles Chambers

Good morning Neal.

Neal Dingmann - Dahlman Rose

To say in that Lobo area, Charlie, where you talked aboutshooting the seismic and maybe you already touched this; I dropped off for asecond, how quick do you see or perceive yourself doing some activity afterevaluating that seismic, I guess, is what I'm asking?

Charles Chambers

The data that we have already acquired, 80 square miles ofdata, has already proved beneficial. We've drilled several wells that areimaged by that data. The additional 100 square miles we're going to shoot afterthe first of the year will cover some of this new leasehold to the west andnorth. So, we're already seeing benefits from the first package that weacquired. In fact, we have added significant amount of locations to ourdrilling inventory.

If you'll recall, there was a point where we weren't doingso well in Lobo, and that was based on drilling the perimeter of our leaseholdand our seismic coverage. This new data gives us more coverage in that area,and our success has already generated the success has already been better thanthe first part of the program, so we expect that to continue to generatequality inventory.

Neal Dingmann - Dahlman Rose

Okay. And then did I hear you right on an earlier answer asfar as talking about the deep prospects in Sacramento? What are the deepprospects as far as you get to that southern end of the Rio Vista? I waswondering how that field looked.

Charles Chambers

Well, the southern end is this new survey we shot; it'sabout 7,000 acres that it covers. We've just drilled our eighth well, whichit's all imaged by the seismic in the contributions from that particular areahave been significant; it's the Martinez interval. It's kind of a stand-aloneplay down there, although we produce Martinez wells in other parts of thefield.

This is sort of an area that's unique that we had noproduction in, in late ‘06. So we think it's got more running room and moredrilling to do. We've got the infrastructure down there, pipeline andgathering-wise. So I think this will continue to be a significant add to ouroverall Sacramento Basin production that we see.

Neal Dingmann - Dahlman Rose

Okay. And then lastly, Mike, you've mentioned a lot of thekey dates for the Calpine. Where do we stand on the non-consent properties? Iassume you're continuing to run that. But do you count that in any of yourresults yet, or do you is there any key dates for that?

Mike Rosinski

No, we do not count any of the production revenues orreserves for the non-consent properties in our income statement or reserve basefor the year. They're completely excluded from our reported results in thatrespect.

Almost from the beginning, Calpine has taken the positionthat they wanted to roll the non-consent property question into the overallsettlement with respect to this lawsuit. We have no alternative but to workwith them on those terms. So we continue as we try to work the lawsuit issue,we continue to keep that in mind, that we expect to get the non-consentproperties addressed when the overall lawsuit is resolved.

Neal Dingmann - Dahlman Rose

Okay, okay. Thanks guys for all activity.

Charles Chambers

Thanks.

Operator

(Operator Instructions) And our next question comes fromMike Gelblat, with Onex Credit Partners.

Stuart Kovensky - Onex Credit Partners

Hi, it's actually Stuart Kovensky calling from Onex. I waswondering if you could maybe break down the issues that impacted yourproduction in the third quarter, how much of each of those in what percentageof each of those issues really contributed to the shortfall and then which oneof those, which of those are resolved now and not really impacting productionin the fourth quarter?

Charles Chambers

Well, let me, I don't know that we can break it down bypercentage. But just let me go through the issues that impacted thatproduction.

Stuart Kovensky - Onex Credit Partners

Okay.

Charles Chambers

One, as we talked about, we've had some curtailment in theD-J Basin. We've had some price issues where we shut in some gas just becauseof price constraints out there. We have added a hedge in ‘08 to correct thatprice issue, in part.

We're going into ‘08 with $2 million of hedges and $3million of firm transport, both of which are greater than $6 per thousand. Sowhat we are doing at D-J is we are watching this price correctly. It's a veryvolatile part of the country, and anything that gives us an average below $4we're going to look at seriously.

We've added two more take points in there, so we feel thecurtailment because of Cheyenne Plains is fixed. So we've got some backupthere. We've had a little bit of shut-in production offshore for operationalreasons and a pipeline constraint there; that has been rectified.

Stuart Kovensky - Onex Credit Partners

Okay. That has been rectified.

Charles Chambers

Correct. So, for the most part, everything has been takingcare of.

Mike Rosinski

The only thing I would add to what Charlie said is you'reasking on a percentage basis, and remember, our original guidance for thequarter was $130 million a day. We came in at $126 million. And these items,whether it's the D-J or the downstream problems in offshore, each of thosecosts us, nicked us, let's say, for $1 million a day or so. So it was spreadevenly over a couple of areas where we had issues. It was not a problem uniqueto one specific area.

Then finally, again, I would echo Charlie's point. We'reworking our way through these issues in D-J, which is really the only majoroutstanding, if you will, roadblock we have as far as moving productionforward.

Stuart Kovensky - Onex Credit Partners

So the issues that were in the South Twitchell bypasspipeline and the Rio Vista Field those have been resolved?

Charles Chambers

Those have been resolved.

Stuart Kovensky - Onex Credit Partners

Okay. All right. Thanks a lot.

Charles Chambers

Good.

Operator

(Operator Instructions) And our next question comes fromChris Chaice, with Southpaw Asset Management.

Chris Chaice - Southpaw Asset Management

Hi, thanks for taking my call. I have a clarificationquestion, related to the non-consent properties you referred to.

Charles Chambers

All right.

Chris Chaice - Southpaw Asset Management

You mentioned that those, in settlement talks, have beenpreferred by Calpine to tie it into larger settlement discussions. Is that anindication of ongoing talks, or is that with respect to?

Mike Rosinski

You either I misspoke or you misinterpreted. We have neverindicated there's been anything in the way of settlement talks going on. Mypoint is that in, let's call it, the public communications and dialogue thattakes place and I think there has been correspondence filed with the court andso forth.

But in effect, the above board and known communications thathas been Calpine's position from the very beginning, that the non-consentproperties are entwined with the settlement of the fraudulent conveyancequestion.

Chris Chaice - Southpaw Asset Management

Got it. Thank you.

Mike Rosinski

Okay.

Operator

And there are no further questions at this time. I wouldlike to turn the conference back over to Mr. Randy Limbacher for closingremarks.

Randy Limbacher

Thank you. That does conclude our call today. I thank youfor your interest in our company, and I look forward to working and meetingwith you in the future. So have a good day. Thanks.

Operator

And that concludes today's teleconference. Thank you foryour participation. You may now disconnect.

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