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Rosetta Resources, Inc. (NASDAQ:ROSE)

Q3 2007 Earnings Call

November 13, 2007 11:00 am ET

Executives

Charles Chambers - Executive Vice President, Corporate Development

Mike Rosinski - Chief Financial Officer and Executive Vice President

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 Resources Third Quarter 2007 Conference Call. Today's conference is being recorded, and all lines have been placed on mute to prevent any background noise.

If you're not able to participate in the conference call, an audio replay will be available from 1 pm Central on November 13, 2007 through 12 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 at www.rosettaresources.com for 60 days after the initial call. To access the replay, click on the Investor Relations section of our website and select Presentations and Events.

Our speakers are Charles Chambers, Rosetta's Executive Vice President, Corporate Development; and Mike Rosinski, Chief Financial Officer and 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 your host, Mr. Michael Rosinski. Please go ahead.

Mike Rosinski

Thank you very much. To begin the conference, as is our custom, we will make a note regarding forward-looking statements. All statements other than statements of historical fact included in this presentation are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

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

These risks, uncertainties and assumptions could cause actual results to differ materially from those described in the forward-looking statements. Rosetta Resources assumes no obligation and expressly disclaims any duty 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 will follow with the financial review for the company's third quarter activity.

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

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

Charles Chambers

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

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

Since the end of the third quarter, we have drilled two additional wells successfully, with the expectation of drilling eight more wells in the fourth quarter. As you will recall, in 2006, we acquired a 3-D survey 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 this results in 100% success based on this new 3-D, which we are very excited about.

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

Since closing this transaction, we drilled two successful wells 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 production associated with these properties since the acquisitions. We plan three more additional wells associated with these properties before the end of the year.

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

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

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

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

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

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

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

We have designed facilities to support additional drilling in 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. Rosetta participated in several other successful wells, including the deepening of two wells in Kleberg County and the drilling of a successful Wilcox test in Duval County.

The net production from two of these wells is approximately 3 million cubic feet a day, with one well yet to be completed. We plan three offset wells in Duval County, based on this discovery, which will occur, we presume, 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 our original guidance for the quarter. As I’ve discussed earlier, the production shortfall was attributable in large part to factors outside of our control, including downstream third-party pipeline problems and weak prices in the Rockies.

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

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

Mike Rosinski

Before I get into my comments, I just want to make one quick point. I thought, I heard Charlie say 120 million a day, which would be viewed as news. We are still looking at and are unchanged with our guidance at 125 million 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 these curtailment issues in the Rocky Mountains. But again, we are still at $125 million a day for the year. So with that, then, let's go in and talk a bit about third quarter results.

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

And in fact, the $126 million a day we had in the third quarter is up from the $120 million a day we recorded in the second quarter of the 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 day we recorded in the second quarter of the year, so, again, reinforcing the idea of 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 going to see that is a larger number on a September year-to-date basis and even larger number since inception of Rosetta for the performance of the hedge program 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, workover and ad valorem taxes and insurance, was $11.9 million or $1.03 per Mcfe. And you will recall, from previous calls and conversations we've had on an individual basis, we believe on an overall basis that we are going to be in the range of $1 per Mcfe for total lease operating expenses as I've defined it here.

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, we noted that we had an insurance recovery of $2.4 million associated with Hurricane Rita.

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

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

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

General and administrative costs were $12 million for the quarter, including $900,000 for non-cash charges for option expense. During the period, we had a $3 million settlement expense associated with our former Chief Executive Officer.

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

Net income for the period, $12.7 million or $0.25 per diluted 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 of the 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 hedge benefit is a shade under $18 million.

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

Total LOE for the period, again, $1.03 per Mcfe, as it was in 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 a year-to-date basis, in line with the third quarter at $105.1 million, with an all-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 severance costs associated with a former CEO.

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

So, there you have a financial update for the quarter for the 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 began our program, this is from inception we have had a $31 million benefit from our hedging activities.

We have recently added hedges for 2008 and 2009. You may recall 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 of hedges, at an average price of $8.29 per Mcfe. We have also entered into an additional $11 million a day for 2009 at $8.40 per Mcfe.

With the addition of these hedges as we go into 2008, we're now just under $65 million a day of hedges in place. These are all fixed-price swaps. We will continue to look at the market. To the extent that we see opportunities to add hedges, again above $8, I believe you will see us doing that. 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 $42 million a day hedged for 2009 with an average price of $7.49 per MMBtu.

Finally, we will talk briefly about where we stand with the Calpine transaction and transition. We have had some measure of success, as you are aware. The court approved our partial settlement, and we have now finalized our 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 Rosetta associated with that audit.

I also know that you all are interested in the next steps with 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 in mind. November 20th, Miller Buckfire, consultant to Calpine, discloses its revised evaluation. That's important because it adds another data point, if you will, 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 to dismiss on the basis that we expect this to be a full payout plan, that motion having been denied because it is not yet determined for sure whether or not we have a full payout plan.

Again, this Miller Buckfire date is important, because it adds a very significant data point in that process of determining whether or not we have a full payout plan.

November 30th is the deadline for voting on the plan, and it's also the deadline for objecting to the plan. We expect that will be a very interesting time. We do plan on submitting objections, and again, we'll be carefully 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 to achieve 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 have seen, there has been nothing to change our views that this Calpine suit is totally baseless, and our view with respect to defending our position in this lawsuit are unchanged.

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

Randy Limbacher

Thanks, Mike and good to everyone. Let me just say first it's a pleasure to be on the call today. I'm very pleased and excited to assume the President and CEO role here at Rosetta. Let me start, though, by acknowledging Charlie, Mike and the entire management team for just the outstanding leadership that they have provided at Rosetta during this transition period.

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

One, I want to talk a little bit about why I came to Rosetta, 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 the next couple of months.

So first questions first. Why did I come to Rosetta? After being approached by the Board, let me just say I went through a very careful due diligence process. Really, I focused the thoughts around that on five items.

I took a hard look at the people with the company, number two, the company's financial position, number three, thought a lot about the asset base, thought a lot and did a lot of due diligence around the Calpine lawsuit, of course, and finally, gave a lot of thought to the potential for increasing the shareholder value of the company.

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

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

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

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

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

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

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

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

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

So now, if I move to the question on where am I going to focus my time over the next several months, I would say you're probably not really going to hear any surprises in this. But there's a couple of areas that I'm going to be keenly focused on.

One is obviously I want to get around and meet all of our employees. 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 reassure our employees that their management team is fully committed and fully engaged to making sure that we have a successful future for our company.

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

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

And then, based on the assessment of those data points, sit down with our team, and we want to put together a kind of a going-forward plan and 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 to continue to aggressively defend the Calpine issue. I'll be heavily involved and engaged in that over the next several months as well. So I would just conclude my remarks by again reiterating that I think this is a company with a very bright 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 the moderator to take your questions. The way we're going to work this today is that, obviously, because I'm very new at the company, questions pertaining to the operating results, the financial results, our history, litigation details.

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

Question-and-Answer Session

Operator

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

Robert Rodriguez - First Pacific Advisors

Well. Good morning I didn’t expect that. But I just really wanted to wish you welcome, Randy, and best of success in joining the organization and going forward. But I was curious if you could cover two areas for me.

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

Randy Limbacher

Okay. Rob, yeah. Thanks for the well wishes. Again, I am looking forward to it. Your first question was as to what consideration we would 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 very early days. But when I think about the acquisitions, it's all about sustainability for the company. And, so what part of the assessment will be going in is getting a real good handle on what's our, let me back up a bit. I mean there's a couple components to building a sustainable company.

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

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

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

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

What are things that would have significant running room for the future to build for a sustainable company? Of course, I always look at the value proposition on that. It's hard to go into a whole lot more detail until I'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 go to the other…

Randy Limbacher

Sure.

Robert Rodriguez - First Pacific Advisors

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

Randy Limbacher

Well, it's probably too soon in the process to include or exclude 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 skillsets and opportunities are. When you look at the size of the Company’s and you look at the opportunities around North America, there are certain things that we're going to be a player in and certain things that we are not likely to be a player in, just because of the size and capabilities of the organization.

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

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

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

But again, very early days and I don't want to foretell something yet that I haven't had a chance to work appropriately. So we are anxious 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 there that 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 an attachment 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, one of the things that I wanted to have was significant exposure to the Company's equity and when I looked at the Company going forward and the opportunity and what I was interested in, in coming onboard, was obviously we had a compensation package that's competitive with our peers.

So, I think it's a market-based package, but I would say it was heavily weighted toward the equity side of the component as opposed to the cash 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 SunTrust Gerdes 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. One of the concerns that I think the market has had regarding Rosetta is the sustainability of the growth profile of the firm, the depth of the drilling inventory. Maybe a few comments and potentially for Charlie a couple specifics on saving some of those concerns.

Charles Chambers

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

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

Another area is the D-J Basin. We hold 80,000 acres in D-J now. We've got some significant inventory still to drill. It's low-risk type opportunity, so that helps and then in California, our second core area, we have purchased the OPEX acquisition at the first of the year and if you will recall, 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 the acquisition market. We're continuing to look at opportunities that are available, but we've got to pick our time to do it. I think it's critical that Randy gets familiar with what we're doing, that we get his stamp on the program going forward with support from the Board. But Mike has kept a clean balance sheet for us. We've got the wherewithal to do some pretty sizable things going into 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 our number was 90. We're talking about drilling a 30-well program for 2007; we had 90 locations. During the course of the year, and in fact at mid-year, we updated that location inventory to 120 and as you know, we brought the program up to 43 wells for this year.

So we have already seen a growth in our backlog, our organic backlog 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 some of these recent acquisitions of both seismic data and acreage that were mentioned in this most recent release.

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

John Gerdes - SunTrust Gerdes Group

That's helpful. That 10,000 acres you mentioned in your press flow, is that fairly contiguous to the acreage that you have been currently working?

Charles Chambers

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

John Gerdes - SunTrust Gerdes Group

One last question regarding inventory. Mike, you have raised it here a bit. Is there a sense of a goal where organizationally, maybe Randy into this as well, where you would like to go in terms of the presentation to the 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 the reasons for the market attraction in terms of the expensiveness they are willing to pay for the enterprise is the depth or the perceived depth of the inventory. Is there a goal, per se, in mind organizationally on depth of drilling inventory in units of years?

Charles Chambers

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

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

In my mind, the transition to Randy, to the new CEO, is an opportunity for us to build. We've, quite frankly, had to be in a maintenance mode here during the transition period and I just say I believe that's going to be 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 in a package of two or three different things. One is the base assets and so that's a key and that’s what’s the inventory on those base assets?

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

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

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

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

But in coming that the Company, one of the things that I wanted to look, take a hard look at was how much running room do we have upfront? So how fast do we have to tackle this problem? What I would say is I feel pretty good about it coming in, that I would say we have a healthy level of inventory and the kind of assets that are going to allow us to regenerate that 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 to your leadership. A couple of quick thoughts here. On the front of a little bit more concrete strategic kind of plan for Rosetta, is there any timeline that you have in mind?

Sometime early next year, middle of next year?

Randy Limbacher

Well, I'm actually coming at a pretty good time, in that this is the time of year when we put together budgets and long-range plans. So I don't want to tie myself to a specific time period now. But it makes sense over 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 we want to specifically take it.

So that's one of the key issues that I am really going to be focused on over the next three or four months. So we are not going to let the grass grow very much by doing that. That's one key area. So hopefully, very quickly 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 for Charlie. For you, Randy that your recent experiences have been with much larger enterprises, Burlington and Conoco and coming down to Rosetta. Any kind of particular challenges that working with a smaller enterprise than what you have been used to in the near past, recent past?

Randy Limbacher

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

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

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

So you can think about those things in a little different terms. But I would say that over 22 years at Burlington, I had the chance to watch that grow from a pretty small company and through a lot of those different business opportunities and I, in a lot of ways, liken this to that challenge 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 have changed for the better or the worse over the last 20 years that will affect your strategic plan?

Randy Limbacher

Well, I think that the issues have certainly changed over 20 years. I think the things that impact industry today, such as the cost of services, the availability, access to new resources and opportunities, what are state and federal governments going to do around regulatory and policy issues that 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 was the exit rate for production for the third quarter? Maybe what else could come online during the quarter that would help me get a feel for where we are headed for on fourth quarter production?

Mike Rosinski

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

Charles Chambers

That's right.

Mike Rosinski

Secondly, Sabine Lake, our technical people say, well, we know what we have. But as far as what we can do day in and day out, we are bringing that up on a gradual process, and there might be a little bit more there, 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 of nice wells coming on there, Charlie.

Charles Chambers

Right.

Mike Rosinski

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

Charles Chambers

Perdido as well.

Mike Rosinski

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

Charles Chambers

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

The important thing is we've installed pipeline infrastructure to put these new wells to sales quickly, so we think we'll have some quick input there.

Mike Rosinski

So Rehan that's a long answer. The short answer is we've got some 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 go back and attempt one?

Charles Chambers

I'm sorry, we Sacramento Basin deep. Oh, the deep? Well, we currently have a Winters well drilling. That's our deepest interval out there that 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 the perimeters of the field, and we're incorporating the data we acquired on the OPEX transaction with that data as well.

So that's an area that Randy mentioned is regenerating opportunities. With all the intervals that we produce from in Sacramento Basin, 16 in total, each well adds new data, new seismic, particularly outside the field area gives us opportunities. So we think that's an area we can add in inventory as 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 thought process and deciding to come on and take the job. I just had a few operational type questions, I guess. With the Sabine Lake coming on, I guess that would get you a little bit more oily on the production side?

Charles Chambers

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

Mark Lear - Sidoti & Company

I guess you guys just sell off a little bit in your oil production 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 of Mexico, in our property out there. So we had some down hole problems with one interval on one of our platforms. We've got our rework scheduled for that platform, that particular well bore.

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

Mark Lear - Sidoti & Company

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

Mike Rosinski

The answer is, kind of echoing Randy's comments, we are beginning 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 give preliminary numbers but rather, once we have gone through that full process with the Board and got approval on their part, then we will come out with a full 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 Dahlman Rose.

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 about shooting the seismic and maybe you already touched this; I dropped off for a second, how quick do you see or perceive yourself doing some activity after evaluating that seismic, I guess, is what I'm asking?

Charles Chambers

The data that we have already acquired, 80 square miles of data, has already proved beneficial. We've drilled several wells that are imaged by that data. The additional 100 square miles we're going to shoot after the first of the year will cover some of this new leasehold to the west and north. So, we're already seeing benefits from the first package that we acquired. In fact, we have added significant amount of locations to our drilling inventory.

If you'll recall, there was a point where we weren't doing so well in Lobo, and that was based on drilling the perimeter of our leasehold and 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 than the first part of the program, so we expect that to continue to generate quality inventory.

Neal Dingmann - Dahlman Rose

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

Charles Chambers

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

This is sort of an area that's unique that we had no production in, in late ‘06. So we think it's got more running room and more drilling to do. We've got the infrastructure down there, pipeline and gathering-wise. So I think this will continue to be a significant add to our overall Sacramento Basin production that we see.

Neal Dingmann - Dahlman Rose

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

Mike Rosinski

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

Almost from the beginning, Calpine has taken the position that they wanted to roll the non-consent property question into the overall settlement with respect to this lawsuit. We have no alternative but to work with 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-consent properties 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 from Mike Gelblat, with Onex Credit Partners.

Stuart Kovensky - Onex Credit Partners

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

Charles Chambers

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

Stuart Kovensky - Onex Credit Partners

Okay.

Charles Chambers

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

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

We've added two more take points in there, so we feel the curtailment because of Cheyenne Plains is fixed. So we've got some backup there. We've had a little bit of shut-in production offshore for operational reasons 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 taking care of.

Mike Rosinski

The only thing I would add to what Charlie said is you're asking on a percentage basis, and remember, our original guidance for the quarter 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 those costs us, nicked us, let's say, for $1 million a day or so. So it was spread evenly over a couple of areas where we had issues. It was not a problem unique to one specific area.

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

Stuart Kovensky - Onex Credit Partners

So the issues that were in the South Twitchell bypass pipeline 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 from Chris Chaice, with Southpaw Asset Management.

Chris Chaice - Southpaw Asset Management

Hi, thanks for taking my call. I have a clarification question, 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 been preferred by Calpine to tie it into larger settlement discussions. Is that an indication of ongoing talks, or is that with respect to?

Mike Rosinski

You either I misspoke or you misinterpreted. We have never indicated there's been anything in the way of settlement talks going on. My point is that in, let's call it, the public communications and dialogue that takes place and I think there has been correspondence filed with the court and so forth.

But in effect, the above board and known communications that has been Calpine's position from the very beginning, that the non-consent properties are entwined with the settlement of the fraudulent conveyance question.

Chris Chaice - Southpaw Asset Management

Got it. Thank you.

Mike Rosinski

Okay.

Operator

And there are no further questions at this time. I would like to turn the conference back over to Mr. Randy Limbacher for closing remarks.

Randy Limbacher

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

Operator

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

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Source: Rosetta Resources Q3 2007 Earnings Call Transcript
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