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Executives

Benjamin W. Hulburt - President, Chief Executive Officer, Director

Thomas C. Stabley - Chief Financial Officer, Executive Vice President

Analysts

Thomas Covington - Broadpoint Capital, Inc.

Leo Mariani - RBC Capital Markets

Marshall H. Carver - Capital One/Southcoast, Inc.

Jack Aydin - KeyBanc Capital Markets

[Ray Beacon] - Pritchard Capital Partners, LLC

Rex Energy Corporation (REXX) Q2 2008 Earnings Call August 6, 2008 10:30 AM ET

Operator

Welcome to Rex Energy Corporation’s second quarter 2008 financial results conference call. (Operator Instructions)

Statements contained in this conference call that are not historical facts are forward-looking statements. Such statements are subject to risks and uncertainties which could cause actual results to differ materially from those in forward-looking statements.

Now I would like to turn the call over to Benjamin Hulburt, President and CEO of Rex Energy Corporation.

Benjamin W. Hulburt

I’d like to welcome everyone to Rex Energy’s second quarter financial results and operational update conference call. I’m here today with Tom Stabley, our Executive Vice President and Chief Financial Officer. By now you all should have received the second quarter earnings press release and we hope you take the time to read through it as it does contain important information. Following the live call an archive of the audio will be available on Rex Energy’s Investor Relations website at www.rexenergycorp.com.

Let me begin by highlighting some of our key accomplishments this quarter. First, average daily production volumes for the second quarter increased to 2,851 barrels of oil equivalent or BOEs per day up 8% from the same period in 2007. Second, revenues for the second quarter increased to a record $20.4 million up 52% from the same period in 2007. Third, our EBITDAX for the second quarter increased $9.5 million up 77% from the same period in 2007. Fourthly, I’m excited to report that our net acreage position in our Marcellus Shale project areas has grown to approximately 61,000 net acres as of August 4.

Additionally, I’m also very pleased to announce that on August 5 we executed a Letter of Intent to acquire the remaining 50% interest we did not already own in approximately 22,000 gross acres or 11,000 net acres in the project area of southwestern Pennsylvania where we drilled our first two Marcellus Shale vertical test wells. As disclosed in our earnings release this quarter, the first two well tests were flow tested with average daily rates of approximately 675 mcf per day per well which was very much in line with our initial expectations. So we’re pleased to be increasing our stake in this project area.

Finally, I’m very excited to report that our ASP pilot projects in the Lawrence field are beginning to show some very encouraging results. In the Cypress Sandstone pilot we have begun to detect the initial response we were looking for which is indicated by an increase in the oil cut ratio in several of the pilot wells. Obviously it is still too early in the process to estimate ultimate recoveries; however, this initial response in the Cypress pilot a month ahead of schedule was obviously very encouraging for the company. The Bridgeport pilot is continuing in line with our initial expectations. Chemical injection rates are continuing as expected. First response has not yet been seen; however, at this point we did not expect to see first response for about another 30 to 45 days.

Before going into our operations in greater detail, I’d like to start by saying that in the second quarter we reported a net loss of $38 million compared with a net loss of $2.6 million for the same period in 2007. The loss was significantly impacted by our unrealized losses on oil and gas derivatives of $65.9 million. These non-cash losses are associated with the mark-to-market adjustments on our outstanding derivatives which grew as a result of the significant increases in oil and natural gas prices this quarter. The unrealized losses on oil and gas derivatives were partially offset by an income tax benefit of approximately $25.8 million also a non-cash item.

In the Illinois Basin production in the second quarter 2008 continued to be adversely affected by severe flooding in certain areas. As a result of this flooding our net oil production fell by approximately 7,500 barrels. Most of the company’s oil properties are now back in production and operating normally. This temporary shut in the production during the second quarter of 2008 did not impact our ASP project activity in the Lawrence field. However, it has caused delays in our conventional drilling programs in the Illinois Basin which I do anticipate will have some impact on our expected production in the third quarter of 2008 which has been reflected in the revised guidance issued in our earnings release.

In the Appalachian Basin we have drilled and fracced two vertical Marcellus Shale wells that are both now producing. We are very encouraged with the flow test rates of both wells. Each of these two vertical wells had flow rates of approximately 675 mcf per day which was very much in line with our expectations. The gas from the two wells is measuring a high BTU content in the range of 1,200 BTUs. Because of the high BTU content, we are in the process of designing and constructing a condensate treatment plant to separate the heavier hydrocarbons.

In terms of our leasing efforts, I had said at the beginning of this year that our goal was to grow our Marcellus Shale prospective acreage position to between 60,000 and 80,000 net acres. Not only am I very excited to report that our current net acreage position in our Marcellus areas has grown to approximately 61,000 net acres but also that as of yesterday we executed a Letter of Intent to acquire an additional 22,000 gross and 11,000 net acres in one of our project areas in southwestern Pennsylvania. We are continuing with our leasing efforts in these areas that we believe will be prospective for the Marcellus Shale.

Last week we began drilling the first of three vertical Marcellus Shale wells in Westmoreland County, Pennsylvania. We are continuing to prepare to drill horizontally in our Marcellus project areas in 2009. For the remainder of 2008 we plan on drilling an additional five to seven vertical wells and coring three of them for further analysis. Additionally, we plan on shooting seismic on two of our main project areas.

Finally today, I’d like to take a moment to say how excited we are to be adding a highly-qualified and experienced individual to our technical team, Mr. Mark Butta. Mark was recently named Vice President of Oil and Natural Gas Marketing and Transportation for the company. A 25-year veteran in the oil and gas industry, Mark will oversee Rex Energy’s Oil and Natural Gas Marketing and Transportation department. Mark comes to Rex Energy from Thermal Ventures where he served as a Vice President of Project Development, and prior to that position Mr. Butta worked for Range Resources where he served as Director of Energy Services and was responsible for business development, sales and gas transportation. Mark brings an extensive amount of experience in the natural gas marketing arena predominantly in the Appalachian Basin and we are very excited to have him join our team.

With that I would like to turn the call over to Tom Stabley, our CFO.

Thomas C. Stabley

This morning I’d like to discuss the second quarter results for 2008. Our revenues for the second quarter of 2008 increased 52% to a record $20.4 million compared to $13.4 million for the second quarter of 2007. This increase was primarily due to higher production with higher average sales prices per BOE partially offset by increased realized losses on derivate activities. Our average realized oil price before the effect of hedging for the second quarter ended June 30, 2008 was $120.48 per barrel compared to an average realized price of $60.70 per barrel in the same period last year. And for natural gas our average realized price before the effect of hedging was $10.96 per mcf compared to the average realized price before the effect of hedging of $7.51 per mcf in the second quarter of 2007.

Switching to our expenses, for the second quarter ended June 30, 2008 total operating expenses were $17.9 million which represented an increase of approximately $5 million over the same period of 2007. Production and lease operating expenses were $7.2 million in the second quarter of 2008 up from $6.3 million in the same period in 2007. The increase in production and lease operating expenses was due to an increase in our active well count this year compared to last year and additionally inflationary increases in many of the materials and services used to operate our fields. Also contributing to the increase in expenses were higher production taxes which can be directly attributable to our increase in revenues.

General and administrative expenses for the second quarter of 2008 increased approximately $2.5 million to $4.1 million from the same period in 2007. Non-cash compensation expenses accounted for approximately $736,000 of the total general and administrative expenses during this quarter. We did not incur any non-cash compensation expenses in the second quarter of 2007 which was prior to our reorganization and initial public offering. The increase in G&A expenses can also be attributed to increased costs associated with being a publicly-traded company including higher audit fees, director fees, public filing fees, consulting fees related to Sarbanes-Oxley compliance, and additional staffing needs in each of our offices.

Exploration expenses for the second quarter 2008 were $969,000 compared to $1.1 million for the same period in 2007. We incurred these expenses primarily as a result of seismic expenses associated with our Marcellus Shale exploration as well as expenses related to geological mapping associated with our ASP project.

Depreciation, amortization and accretion expenses were $5.6 million in the second quarter of 2008 up from $3.8 million in the second quarter of 2007. The increase in DD&A expenses were primarily due to the step up in the book basis of assets caused by the reorganization and initial public offering, an increased asset base, and increased production.

EBITDAX a non-GAAP measure was $9.5 million in the second quarter of 2008. This represents an increase of 77% from the second quarter of 2007. Cash flows from operations for the second quarter of 2008 grew 321% from the same period in 2007 to $7.6 million.

As Ben mentioned earlier in the call, in the second quarter we reported a net loss of $38 million compared with a net loss of $2.6 million for the same period in 2007. The loss was predominantly due to our unrealized losses on oil and gas derivatives of $65.9 million. These non-cash losses are associated with the mark-to-market adjustments on our outstanding derivatives which grew primarily as a result of the significant increases in oil and natural gas prices this quarter. The unrealized losses on the oil and gas derivatives were partially offset by the associated income tax benefit of approximately $25.8 million.

Net income comparable to analyst estimates was $3 million or $0.09 per fully diluted share in the second quarter of 2008 up from a loss of $716,000 over the second quarter of 2007. Net income comparable to analyst estimates is a non-GAAP financial measure of net income which excludes deferred tax benefits, dry hole and impairment expenses, gains or losses on the sale of assets, unrealized gains or losses from financial derivatives, and non-cash compensation expenses.

Lastly, we continue to maintain a conservative balance sheet. Cash and cash equivalents for the six months ended June 30, 2008 were $39.8 million and also for the first half of 2008 we had $0 amount drawn on the line of credit with a borrowing base of $90 million.

With that I’d like to turn the call back over to Ben.

Benjamin W. Hulburt

With that we’d like to open the call up for questions Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Thomas Covington - Broadpoint Capital, Inc.

Thomas Covington - Broadpoint Capital, Inc.

On the Illinois ASP, give me a sense of more specifics on the early response you’re seeing there. What kind of oil cut are we looking at now?

Benjamin W. Hulburt

In the Cypress pilot Tom the oil cut basically started at 0 and it’s gone from anywhere from 0 to 5% to 10%. So ultimately you’re looking for it to peak at around 20% in oil cuts. And as I said, of the five wells three of the five are in the 5% to 10% range now and they started at 0.

Thomas Covington - Broadpoint Capital, Inc.

And you’re expecting what rate so your peak response towards year end I think?

Benjamin W. Hulburt

Peak response was anticipated to be somewhere mid- to late fourth quarter. And although this response is quite a bit quicker than we originally anticipated, we’re not yet changing our guidance on when peak response will be.

Thomas Covington - Broadpoint Capital, Inc.

Are you seeing other indications of response to producers such as pressures in fluid levels?

Benjamin W. Hulburt

We are.

Thomas Covington - Broadpoint Capital, Inc.

In the Marcellus, can you give me a sense of the EURs you expect on the wells that you’re drilling in Butler County where you talked about the 675,000 cubic feet a day rates that were initially produced?

Benjamin W. Hulburt

Honestly Tom, I think at this point we just don’t have enough data yet or enough extended production to really start estimating EURs yet.

Thomas Covington - Broadpoint Capital, Inc.

Is it in line do you think in terms of where you were pre-drilling in this area?

Benjamin W. Hulburt

Yes.

Thomas Covington - Broadpoint Capital, Inc.

What are you doing in terms of water management as you look forward to a more active program in 2009 on the horizontal side, because that’s been clearly the largest issue on the regulatory side that’s been raised?

Benjamin W. Hulburt

Water management I think is a major issue that we’re dealing with and I think all Marcellus players are right now. I do think that we’re on top of this issue as much as anyone can be at this point. We have filed our water management plans with the state as requested for our next round of permits. We are working with an excellent firm out of Harrisburg, an engineering firm that’s assisting us with that. And we are working on water treatment possibilities and looking at constructing our own facilities in the state as well. So it is an ongoing issue. It has not yet stopped us from our drilling plans. But it’s an issue that we continue to work on every day.

Thomas Covington - Broadpoint Capital, Inc.

The vertical wells I assume are permitted already for the rest of this year?

Benjamin W. Hulburt

The vertical wells in Westmoreland County are already permitted; the next round of wells in Butler County are permitted as well; the Clearfield County permits are awaiting approval.

Thomas Covington - Broadpoint Capital, Inc.

On the plant you’re building for the rich gas there, can you give me an estimate on when you expect to complete that process?

Benjamin W. Hulburt

My anticipation is that those wells are able to sell to full capacity through the plant early in the fourth quarter of this year.

Operator

Our next question comes from Leo Mariani - RBC Capital Markets.

Leo Mariani - RBC Capital Markets

Just a follow up to the plant question. How much do you anticipate having to spend for that plant and do you have any kind of estimate of what infrastructure costs will be for you guys or were you able to get third parties to pay for a lot of this? How’s that arrangement working for you?

Benjamin W. Hulburt

The plant Leo is estimated to cost around $1 million initially. It’s initially being designed to handle 1.5 to 2 million a day but it’s scalable. So initially it’s only a little less than $1 million estimate. To scale that up to 15 million a day plant is probably on the order of around $3 million. So it’s not a huge expense.

Leo Mariani - RBC Capital Markets

In terms of what you’re doing over there in Westmoreland County, what are your necessary infrastructure requirements in order to get wells on stream?

Benjamin W. Hulburt

There, although we’ve not drilled there yet, we don’t anticipate getting the condensate fluids so we don’t anticipate needing a stripping plant in that part of the state. We already do have two tap sites in our operations there in Westmoreland County because we have producing assets there as well as rights-of-way to another line. So I think in terms of market outlet, Westmoreland County is probably our best area.

Leo Mariani - RBC Capital Markets

Those first two Marcellus wells that you brought on line here in Butler County, are those currently producing now or are they shut in due to the need for the condensate processing?

Benjamin W. Hulburt

They are currently producing but they’re only able to sell it to a local sales line which usually maxes out at capacity of something like 100 mcf a day. So they actually are trickling a little bit of gas out there but they’re severely curtailed.

Leo Mariani - RBC Capital Markets

How about Clearfield just to kind of round out the picture here in terms of what your infrastructure primers would be?

Benjamin W. Hulburt

In Clearfield County we’re currently up to approximately 28,000 acres. We do have one significant line that runs through the middle of our acreage, the Columbia 1711 line, that we are looking at tapping. We’re also looking at some other opportunities to go to larger lines in the area as well as starting to investigate the possibility of joint venturing with some midstream companies in that area.

Leo Mariani - RBC Capital Markets

Are you guys also still considering the possibility of maybe JV’ing with another E&P in that area?

Benjamin W. Hulburt

We’ve not considered it in that area in particular yet. Frankly, I think it’s our best area and we want to own it 100% for the time being. We are looking at some potential JVs in other areas where we have smaller acreage amounts.

Operator

Our next question comes from Marshall H. Carver - Capital One/Southcoast, Inc.

Marshall H. Carver - Capital One/Southcoast, Inc.

On the pilot responses you talked about the Cypress pilot having 5% to 10% oil cut now peaking at about 20%. Would a 20% peak give you an indication of the 20% type recoveries of original oil and plays, or how do those relate to each other?

Benjamin W. Hulburt

Yes, it would give you an indication of that. So that’s kind of what you’re looking for is that oil cut to peak out around 20%. If it does, that ought to correlate with the very similar assumption to what our base case ultimate recovery percentage was.

Marshall H. Carver - Capital One/Southcoast, Inc.

On the Bridgeport, would you plan on issuing a separate press release when you do see first oil there?

Benjamin W. Hulburt

Yes.

Marshall H. Carver - Capital One/Southcoast, Inc.

Could we get some expense guidance for the third quarter?

Thomas C. Stabley

I think the expenses will be fairly in line with the second quarter as we move forward into three and four as far as lease operating expenses.

Marshall H. Carver - Capital One/Southcoast, Inc.

And DD&A and G&A and things?

Thomas C. Stabley

The G&A will be fairly in line with the second quarter as well; fairly flat.

Operator

Our final question comes from Jack Aydin - KeyBanc Capital Markets.

Jack Aydin - KeyBanc Capital Markets

Ben, you mentioned that you’re in the process of getting that 50% acreage, what kind of price tag are we talking about for that 11,350 acres?

Benjamin W. Hulburt

I can’t disclose the exact price at this point but we’re very happy with the price.

Jack Aydin - KeyBanc Capital Markets

Could you put a broad range?

Benjamin W. Hulburt

No, I think for competitive reasons I’d really rather not Jack. We continue to actively lease in that area.

Jack Aydin - KeyBanc Capital Markets

On the Bridgeport Sandstone pilot, could you elaborate a little bit more why we’re seeing some response from the Cypress and not yet from the Bridgeport?

Benjamin W. Hulburt

I think the easiest answer Jack is that the Bridgeport Sandstone pour volume is quite a bit larger than the Cypress. So it takes longer to get a fill-up time. So basically the Bridgeport Sandstone pilot is almost exactly on line with what we would have expected at this point in the process, but because it’s a bigger reservoir it has a larger fill-up time.

Jack Aydin - KeyBanc Capital Markets

The last time I talked to you, one of your guys was at Denver doing the modeling mathematical modeling with [Cirtech] people. What kind of conclusion did he come up with? Can you share any of it with us?

Benjamin W. Hulburt

Not really. I don’t think they’ve come up with any conclusions that make us change our original assumptions yet. At this point there are a lot of analyses being done on the data but it’s early in the process. I don’t think anybody can draw any conclusions yet.

Jack Aydin - KeyBanc Capital Markets

Are the same people who constructed the pilots still residing in that same location or they left?

Benjamin W. Hulburt

No, they turned over operations at the plant to our employees about a month ago.

Jack Aydin - KeyBanc Capital Markets

So things are running smooth?

Benjamin W. Hulburt

They’re running very smoothly there. We’re very, very pleased. Our guys out there in the field are just doing a fantastic job. I think from my standpoint we couldn’t be happier with that aspect of the project.

Operator

Our final question comes from [Ray Beacon] - Pritchard Capital Partners, LLC.

[Ray Beacon] - Pritchard Capital Partners, LLC

I have a question about your 2009 cap ex budget, if you’ve got any preliminary thoughts there? And how the Marcellus program might look horizontal wells versus vertical wells next year?

Benjamin W. Hulburt

We haven’t completed that planning process yet so I don’t know that we can put it out. I would initially anticipate capital budgets next year being in line with the same size of 08. But what the ultimate mix is between horizontal wells and vertical wells, I don’t know that we’ve concluded that yet. Our objective is to be the vast majority of our wells as horizontal.

[Ray Beacon] - Pritchard Capital Partners, LLC

Do you see any issues with lining up equipment at this point?

Benjamin W. Hulburt

At this point we don’t.

Operator

We have no further questions at this time.

Benjamin W. Hulburt

I’d just like to thank everybody for participating in today’s call. We hope you’ll join us at the third quarter call. Thank you.

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Source: Rex Energy Corporation Q2 2008 Earnings Call Transcript
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