Approach Resources Inc. Q2 2008 Earnings Call Transcript

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 |  About: Approach Resources Inc. (AREX)
by: SA Transcripts

Approach Resources Inc. (NASDAQ:AREX)

Q2 2008 Earnings Call Transcript

August 6, 2008 11:00 am ET

Executives

Curtis Henderson – EVP and General Counsel

Ross Craft – President and CEO

Steve Smart – EVP and CFO

Analysts

Jack Aydin – KeyBanc Capital

Irene Haas – Canaccord Adams

Operator

Good morning, everyone. Welcome to the Approach Resources second quarter 2008 earnings conference call and audio webcast. Today’s call is being recorded. A replay of the earnings conference call will be available on the company’s web site immediately following the call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session at the end of today’s conference call.

At this time, I would like to turn the call over to the Executive Vice President and General Counsel of Approach, Mr. Curtis Henderson. Please go ahead, sir.

Curtis Henderson

Thank you. Good morning, everyone. Thanks for joining us today. Our remarks today will include forward-looking statements. These statements are subject to many factors that could cause actual results to differ materially from our expectations as expressed in those statements. Those factors are described in our SEC filings and I refer you to our web site or to the SEC web site to review those filings. We undertake no obligation to publicly update or revise any forward-looking statements. Also, during this call, we will refer to certain non-GAAP financial measures. Reconciliations of these measures to the most directly comparable GAAP measures are contained in our second quarter 2008 earnings release, which is posted at our web site at www.approachresources.com. I will turn the call over to Ross Craft, our President and CEO.

Ross Craft

Thank you, Curtis. Good morning to everyone. With me on the call today, we have Steve Smart, our Chief Financial Officer; Curtis Henderson, our General Counsel; Glenn Reed, EVP of Operations; Ralph Manoushagian, EVP of Land; Megan Brown, Investor Relations and Corporate Communications; Vienna Hameeda [ph], Director of Financial Reporting.

Before Steve gets in to the financial results, I’d like to just briefly summarize a few of them. Productions in the second quarter increased 63% from the same period last year to 2.0 Bcfe of gas. Production growth in the second quarter was partially offset by compression downtime in all of our three producing fields. Also as we noted in May, we postponed the growing of our Ozona Northeast project during the April and May period while we closed the acquisition of the deep rights in Ozona Northeast and reprocessed 3-D Seismic data.

We also delayed the drilling of our second series of five wells in North Bald Prairie during parts of the first and second quarter of 2008 pending partner approval of drilling locations. As we will discuss later, production for July has increased to 24.3 million a day equivalent and our exit rate in July 31 was at all-time high for the company at 25.1 million a day.

Given the commodity price environment in the second quarter, the rate of return of our development drilling wells in Ozona Northeast and Cinco Terry were more than satisfactory. A 63% production increase combined with a 48% increase in realized prices over the same period last year resulted in increase in revenues of about $24.4 million, which represents 149% increase. Likewise, cash provided by operating activities increased 36% to $24 million for the first six months of 2008 compared to the first six months of 2007.

Second quarter highlight included expanding our acreage in Cinco Terry, acquiring the deep rights in our Ozona Northeast field and reprocessing interpretation of 3-D Seismic data over Ozona Northeast.

We are currently evaluating the size and scope of our planned Cinco Terry 3-D shoot in hopes of maximizing coverage while minimizing cost. These projects provide a solid framework for us to build on for the remainder of 2008.

With that, I’ll turn the call over to Steve and he’s going to discuss the financials.

Steve Smart

Thanks, Ross. Net income for the second quarter of 2008 was $928,000 or $0.04 per diluted share on revenues of $24.1 million compared to net income of $3 million or $0.29 per diluted share on revenues of $9.7 million for the second quarter of 2007.

As you know, we use financial swaps and collars to hedge our oil and gas production and to mitigate commodity price fluctuations.

Net income for the second quarter of 2008 was impacted by a pre-tax unrealized loss on commodity derivatives of $9.7 million. Excluding this unrealized loss on commodity derivatives and the related income taxes, adjusted net income for the second quarter of 2008 was $7.3 million or $0.35 per diluted share compared to $1.9 million or $0.18 per diluted share for the second quarter of 2007. This illustrates the impact of volatile commodity price movements on our mark to market positions. At June 30, 2008, the current long-term portion of our unrealized loss on commodity derivatives on our balance sheet totaled $13.7 million.

At July 31, 2008, we estimate this total unrealized loss on our balance sheet to be only $300,000. On our statement of operations, as we reported our pre-tax unrealized loss on commodity derivatives in the second quarter was $9.7 million. For the month ended July 31, 2008, we estimate this pre-tax unrealized loss to swing to an unrealized gain of $13.4 million.

EBIDTAX for the second quarter of 2008 was $19 million or $0.91 per diluted share compared to $7.2 million or $0.70 per diluted share for the second quarter of 2007, representing a 30% year-over-year increase in EBIDTAX per diluted shares.

For the second quarter of 2008, lease operating expenses were $1.9 million or $0.91 per Mcfe compared to $1 million or $0.83 per Mcfe in the second quarter of 2007. On an absolute basis, the increase in LOE over the prior year quarter was primarily a result of an increase in the number of wells in the ongoing development of Cinco Terry and North Bald Prairie, and the acquisition of the Neo Canyon working interest and our Ozona Northeast fields in November of last year. On a per Mcfe basis, the increase in LOE was primarily due to increased compression and treating costs in Cinco Terry and North Bald Prairie, as well as an increase in general maintenance cost in Ozona Northeast.

Depletion, depreciation and amortization expenses in the second quarter of 2008 was $6 million or $2.93 per Mcfe compared to $3 million or $2.41 per Mcfe for the prior year quarter.

On an absolute basis, the increased DD&A was primarily due to increased production and higher capital cost in the 2008 period. On a per Mcfe basis, higher DD&A was primarily due to, one, higher capital cost incurred in North Bald Prairie fields where we carried the capital cost of our working interest partner on the first five wells and number two, reserve revisions in Ozona Northeast at December 31, 2007.

In the second quarter of 2008, exploration expense totaled $987,000 or $0.48 per Mcfe compared to $10,000 or $0.01 per Mcfe in the second quarter of 2007. Exploration expense in the second quarter results are primarily from the extension of lease terms in Ozona Northeast. This charge decreased second quarter earnings by $0.03 per diluted shared.

General and administrative expenses for the second quarter of 2008 were $1.8 million or $0.89 per Mcfe compared to $1.2 million or $0.97 per Mcfe in the second quarter of 2007. Severance and production taxes for the second quarter of 2008 were $1.2 million or 5% of revenues compared to $373,000 or 3.8% of revenues for the second quarter of 2007.

So while we have benefited from higher commodity prices, we also have experienced an increase in operating capital costs, specifically LOE, depletion, and exploration during the first half of 2008 that had partially offset these higher commodity prices.

Installing and calibrating compressions in Cinco Terry and North Bald Prairie, extending leases in Ozona Northeast, general maintenance cost in Ozona Northeast, and fulfilling our capital commitment in East Texas, all contributed to higher operating costs on a per Mcfe basis. We’ve addressed our compression issues in Cinco Terry and East Texas, and I anticipated that our per unit cost for Cinco Terry and North Bald Prairie will decrease as production from these two fields increases.

With that Ross, I’ll turn the call back over to you.

Ross Craft

Thank you, Steve. Now I’m going over our second quarter operation results. I’m trying to give everybody an update of what’s going on. Last Thursday, we stimulated our first vertical Bossier Shale well in our North Bald Prairie field. We’re optimistic that the information obtained from this vertical shale completion will help in our stimulation design on future completions.

We anticipate drilling our first horizontal well in this field during the fourth quarter of 2008. As we’ve mentioned in previous discussions, our North Bald Prairie project consists of two primarily targets, Cotton Valley Lime and Bossier Sand, with the secondary target being the shallower Cotton Valley Sand.

Based on the information obtained while drilling our first eight wells and encouraging results from our recent shale completion, we hope that the Bossier Shale drops to our primary target list as well. We have completed our reprocessing of our 3-D Seismic Data and should have our new Ozona Northeast geological model completed by next week. Results obtained from our reprocessing and micro filtering of the data is encouraging and should facilitate a more focused targeting of individual Canyon Sand channels as well as deeper, more structural Ellenburger and Strawn intervals, thereby increasing our drilling efficiency.

Further, we recently drilled and completed our first Strawn well in Ozona Northeast since we acquired the deep rights. Initial 24-hour flow rate from the J.R. Bailey A 313 Strawn completion was 987,000 cubic feet of gas, with a flowing pressure of 1,700 psig, as well just slightly under a million a day in production which is very, very good to this area.

In addition to the productive Strawn interval, we also encountered expanded Canyon Sand section. This expanded sand package should facilitate expansion of our field boundaries, thus adding location to our drilling program. We have also identified several attractive Canyon recompletion opportunities from the acquisition. We are incorporating the recompletions to our existing stimulation schedule and we’ll start this program in the third quarter of ‘08.

We currently have five rigs running, including two in Ozona Northeast, two in Cinco Terry and one in North Bald Prairie. Our average daily net production for the month of July has increased to 24.3 million equivalents per day. Our exit rate at July 31, 2005 was 25.1 million equivalent cubic feet per day and this sets the record high for the company.

Given our existing drilling inventory in Cinco Terry, our deep rights – our deep targets in the Strawn and Ellenburger as well as our new geological model for the Canyon Sands in Ozona Northeast, and our Bossier Shale and Cotton Valley Lime potential in our North Bald Prairie field, we believe we are well-positioned to organically grow shareholders’ value in 2008 and beyond.

That basically concludes our prepared comments. At this time, we will open the call up for Q&A. Thank you.

Question-and-Answer Session

Operator

(Operator instructions) We go first to Jack Aydin with KeyBanc Capital.

Jack Aydin – KeyBanc Capital

Hey, Ross.

Ross Craft

Jack.

Jack Aydin – KeyBanc Capital

Hello?

Ross Craft

Hey, Jack. Can you hear me?

Jack Aydin – KeyBanc Capital

Yes, I can. Can you hear me now?

Ross Craft

Yes, I’ve got you.

Jack Aydin – KeyBanc Capital

Okay, I thought you were going to do a mid-year reserve report. Did you do it or you decided not to release it? Could you update us on it?

Ross Craft

Yes, we’ve submitted our report to DMM. DMM is finalizing their comments on it and we should have that finalization and their letter back to us probably by the end of August. But, we have finished our end, they’re just about finished with their end and so we should have some results for you. But like I said, it’s by the end of August.

Jack Aydin – KeyBanc Capital

Directionally, you are pleased?

Ross Craft

I mean, it appears to be very close to what we originally thought so. I’m okay with it. It’s right in line with what we thought.

Jack Aydin – KeyBanc Capital

Okay. In terms of cost structure going into the balance of the year, is there anything – should we look at those cost structure in the second quarter or bring them down (inaudible)?

Ross Craft

But we do think, Jack, that the costs were a little bit higher in the second quarter, as we said here, because of compression, the initial compression cost, and getting that up and running in both Cinco Terry and North Bald Prairie. But also, we had, I would say, an inordinate amount of listing and pulling expense in Ozona Northeast which we will have some of that recurring but it was – we had to do quite a few wells in that quarter as well as we were loaded up [ph]. So, from time to time, we will have some of that expense, so I think without really giving guidance, I do think that this quarter was a little bit higher than what we’d expect.

Jack Aydin – KeyBanc Capital

Thank you.

Operator

(Operator instructions) We will take our next question from Irene Haas with Canaccord Adams.

Irene Haas – Canaccord Adams

Hey, guys. I have two questions. Firstly, would you come back and explain to me at Bald Prairie, what was the nature of the partner, why was the delay in getting the agreement, number one. Number two, maybe a little more detail on your footprint regarding the Bossier Shale, as well as [ph] Haynesville. Then the second question really has to do with the New Mexico. Can we have a little color as to what the steps are now, when could we expect you guys to go back to drilling, is that visible?

Ross Craft

Good morning to you. Yes, concerning North Bald Prairie, we submit the AFEs basically to drill and EnCana, our other partner on this deal, being a big shop as they are, they sometimes take quite a bit of time to react to the AFEs and what we were doing more is making sure our locations were exactly where we want them and we had conversations with EnCana over and over about these locations and which one we want to drill first. But once we got that behind us, then we started our drilling program, but that was primarily the reason, just the slow movement of EnCana.

As far as our Bossier Shale potential on our acreage block out there, we have drilled eight wells up to this point. We’re drilling, I think, our ninth well right now and in a lot of these wells that we’ve drilled down the line, we’re seeing some very encouraging gas numbers or gas flood rates out of this shale. And so, although it is early in the development of the shale, and this first vertical well that stimulated last Thursday, it is going to be very key on how we proceed to forward on this. The well is still cleaning up – like I said, we just frac-ed it last Thursday, but the results we’re seeing right now are encouraging. I’m not sure when this well will completely clean up. It could be earlier next week or it could take a couple of weeks. But, so far, the information we’re seeing is encouraging.

Curtis Henderson

It’s Curtis, let me address the New Mexico question. As we reported in late July, the Governor directed the Oil Conservation Commission to initiate a special rule-making for Eastern Rio Arriba County, which is where our leasehold is. There’s one rule making that has been referred to as a sort of precedence for this, which was in Otero Mesa in New Mexico. That was a three or four-month rule-making process, so I think we can look to that and say we’re probably not going to see rules promulgated from the state until the end of the year at the earliest. At that point, we’re snowed out in that area. So at the earliest, I would think we could be drilling up there in the first half. We’re looking at the second quarter of ’09.

Irene Haas – Canaccord Adams

(inaudible) can start work there sometimes during the first half of ’09.

Curtis Henderson

We’re hopeful there. We still have the County to deal with that and would hope that any rules that the County promulgated would not conflict with the state rules, or else we'd have to find ourselves back in a (inaudible) litigation which we don’t expect that it’s a possibility I suppose.

Irene Haas – Canaccord Adams

Okay. What can be done on your side to make drilling more palatable for the locals?

Ross Craft

Well, we’ve laid out a plan in two days of hearings at the Oil Conservation Division where we proposed really a drilling program that went above and beyond the current rules. So a couple of things, close loop system. So with the kind of environmentally responsible program we laid out, I mean that’s the best we can do and we hope that the state will see that. The arguments solicit input from us in terms of what the new rule should look like, so we go forward with the program that’s environmentally responsible and prudent, then we’re confident we can get in there sometime next year.

Irene Haas – Canaccord Adams

Thank you.

Operator

And that does conclude our question-and-answer session today. At this time, I’d like to turn the call back to our speakers for any additional or closing remarks.

Ross Craft

Well, we appreciate everybody on the call today. As always, we welcome your phone calls and thank you again for being here.

Operator

Once again, that does conclude today’s call. We do appreciate your participation. You may disconnect at this time.

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