EXCO Resources, Inc. Q2 2008 Earnings Call Transcript

Aug. 6.08 | About: EXCO Resources, (XCO)

EXCO Resources, Inc. (NYSE:XCO)

Q2 2008 Earnings Call Transcript

August 6, 2008 2:30 pm ET

Executives

Doug Miller – Chairman and CEO

Doug Ramsey – VP, CFO and Treasurer

Steve Smith – Vice Chairman, President and Secretary

Paul Rudnicki – VP of Financial Planning and Analysis

Hal Hickey – VP and COO

Analysts

David Heikkinen – Tudor Pickering, Holt

Brian Singer – Goldman Sachs

Joe Allman – JP Morgan

Gary Stromberg – Lehman Brothers

Operator

Good afternoon. My name is Brooke and I'll be your conference operator today. At this time, I would like to welcome everyone to the EXCO Resources second quarter 2008 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions) Thank you. I will now turn the call over to Chairman Doug Miller.

Mr. Miller, you may begin your conference.

Doug Miller

Thank you. I'm Doug Miller, Chairman of the company and we've got with me today – I've got Steve Smith, Vice Chairman. Most of you people know all these people. Doug Ramsey who's our CFO; Hal Hickey, our COO; Mark Wilson, our Chief Accounting Officer; Paul Rudnicki, who most of you talk to about our budgeting. Marsha Simpson and Mike Chambers are also with me, and Justin Clark, our lawyer is here.

We're going to go through this thing and stick with you as long as we need to on questions. We've had quite a busy first half and so we'll get into that. But before we do I'm going to turn it over to Ramsey to read our disclosures.

Doug Ramsey

Thanks, Doug. I would like to remind everyone that you can go to www.excoresources.com and click on the "Investor Relations" tab on the left-hand side of our homepage to access today’s presentation slides. The first page that will come up after you hit the "Investor Relations" tab has a presentation slides link. Just double-click on the link and it will launch the slide presentation that you can follow along with.

The statements that may be made on this conference call regarding our future financial operating performance, structure and results, business strategies, market prices and future commodity price, risk management activities, plans and forecasts, and other statements that are not historical facts or forward-looking statements as defined in Section 27-A of the Securities Act of 1933 and Section 21-E of the Securities Exchange Act of 1934.

Please refer to pages 3 and 4 of the slide presentation for the complete text regarding our forward-looking statements.

In addition, please refer to our web site for the earnings release, which contains additional information regarding our forward-looking statements and the preparation of our financial disclosures, including reconciliations and other statements regarding non-GAAP financial numbers, which will be discussed on today’s call. Doug?

Doug Miller

Thank you. I've been trying to figure out how to lead into this and I think everybody wanted to know why the oil prices are down, while gas prices are down, and why stocks are down, I think I have it figured out. So let me – oil prices have gone from $147 to $118, clearly because Boon started at the spending money lubricating all the cars and everybody has filled their tires up to 40 pounds, so gasoline is down. But there's still a lot of cars on the roads so clearly, EXXON has sent everybody their thousand dollar check already because there's still plenty of cars.

Natural gas is down, it looks to me like because the Haynesville and the Marcellus Shales are producing 3 Bcfe a day already and the LNG shipments are lined up outside, so it's gone from 13 to 8, but also we found out that the Haynesville is overhyped by Aubrey [ph] so we can't quite figure out why it's down so much. But I think really the stocks are down because Citibank and Wachovia went up 30% starting July 15 which means all the oil and gas stocks should be down, so I finally figured that out.

On a serious note, I think many people know that Boon is out campaigning about an energy plan which we totally support. I think it's serious. He is taking very serious. It is getting a lot of traction. We're getting a lot of phone calls as Boon is. And obviously, the government's not taking it too serious because they went on a six-week vacation. So I think it's a serious problem. You know, Boon talks about we're funding both sides of the war. I think it is certain it's going on right now and I think we all ought to take this seriously.

With that, I'll shut up and turn it over to Steve, and we'll go through the financial round of this.

Steve Smith

Thanks, Doug. Let's refer to that hand-out material that was posted on the Internet, the second quarter 2008 review, page six, I'll just hit some highlights and then we'll get into some more detail.

We had a good quarter. Our revenues were up substantially, 26% over the prior year's quarter, and that was after-cash settlements of derivatives. Before cash settlements of derivatives, it was substantially more than that. We had a good net income quarter of $74 million or $0.34 a share which was substantially, of course, more than last year and also substantially more than the first quarter of '08.

Adjusted EBITDA $263 million. We're now running at close to $1 billion annualized run rate, so we got lots of cash flow to do a lot of our drilling with. We are still staying with inner cash flow as far as our capital expenditures, but we're spending a much higher percentage than we have historically because we've got so much to get done in the Haynesville Shale and the Marcellus Shale.

Cash flow after interest was up substantially as well. Average daily production was up about 3%. We produced about close to 36 Bcfe of gas equivalents in the second quarter. Midstream, we've broken midstream out now into a separate segment and there's been a substantial increase in both the income from all parties including us and also the income just from the third party that were hauling and/or selling gas. We'll get into that just a little bit more.

We've increased our – I'll just look back at the same presentation in the first quarter. We've increased our Haynesville Shale acreage by about 20% since the first quarter. Marcellus acreage – Marcellus and Huron, but primarily Marcellus, is up about 14% in the key part of the play, so we've been pretty busy from that standpoint. We have started a pretty active drilling program in the shales that we'll get into as we go and we have expanded the midstream. I'll talk about that.

One of the things that did take place on the – I guess it was the 18 of July really, is we converted the preferred stock into common stock and that's been a huge improvement in our overall balance sheet presentation, shifting about $2 billion into the equity account. So, that has been a – and will be a very big deal. That'll free up another $140 million of cash in the future.

Page 7 just is a very brief update of where we are in the shales. As I said, we've increased our acreage. We've drilled a couple of – actually three very promising vertical wells and have had some excellent tests on those wells. We're moving right away to spud our first horizontal in this month in Haynesville. So we will start getting going in that regard.

In the Marcellus, we've again increased our acreage. We drilled and cased one horizontal well. We've got another one that's made the turn and we should be completing it within a few days. We will complete both of those in the third quarter. So that'll be some exciting activity for us in that regard. Huron, we have drilled also a horizontal there. We got two or three more drilling and we'll be completing a couple of those, if not all of those, in the third quarter.

In the midstream, we acquired a system up in the Waskom area. We call it the New Waskom System which has had a dramatic impact really on our EBITDA on our midstream activities. It's about 30% of our total EBITDA for the first quarter to over 200 miles of pipe and it was a good acquisition at a good price. We've just about completed our 20-mile or rather our 57-mile extension of our existing system in East Texas and we're looking at industry partners, talking to industry partners and pipeline partners on that.

Page 8 is a slide we always present just to show what is going on with our cash margins and in spite of the fact that the commodity increased pretty substantially during the second quarter, our margins stayed roughly in the same range just because we’ve got a very active hedging program going but we still have a margin of $7.62 in spite of the hedging or may be because of it, and in spite of some increases that we'll talk about in operating cost.

Page 9 is – I just wanted to show what the Midstream segment does look like both on a gross basis which is all gas that we transport including our own and then on a net basis which excludes our intercompany gas that we haul and so we're at about $12 million EBITDA for the quarter overall and over $4 million just on third party and that’s kind of an interesting statistic, $4 million that’s with just third party revenues, but it's with 100% of the cost. That's just the way that these numbers are presented. So with that, that’s just a quick summary. I'm going to let Doug Ramsey talk about where we are liquidity wise and our financial position and debt to cap, etc. and then Paul Rudnicki will pick up and talk about our hedging and our guidance.

Doug Ramsey

Thanks, Steve. Focusing on August 1, we'll just kind of fast forward to the current column on the far right. We have about $59 million of cash, bank debt outstanding off of our two credit agreements, $2.2 billion. On July 15, we borrowed $300 million under an unsecured term loan at Exco Operating which used to be our EPOP entity which has got renamed. With those proceeds, the bulk of it went to property acquisition we did in Texas on that same day and, as Steve mentioned on July 18, we converted the 2 billion of preferred stock to common. That added about 105 million shares to the common share base and as of August 1, for anybody that’s doing modeling, our total share count outstanding is 210,883,821 shares and our debt to cap with those changes is 52%, so that has been pretty study versus the end of the quarter. Borrowing bases remain unchanged. It's just under $2.5 billion and the unused portion of that is $256 million. All right, Paul.

Paul Rudnicki

Thanks, Doug. Starting on page 11 just to highlight our current hedge position and one thing I want to point out is we had $1 billion market-to-market at the end of the second quarter and when we re-ran it as of yesterday’s close, that mark-to-market was down to $343 million. So we got back down $650 million roughly in a month's time; whether that’s good or bad, time will tell.

And one thing to point out on page 11, we did enter into some oil hedges that aren't reflected on here and I’ll just to let you know, we’ll update the slide and get it out on the web site after this call. Our Q3 oil hedge is now 388,000 barrels at $72.14. Our Q4 oil hedge is 450,000 barrels at $78.60. ’09 is 1,580,000 barrels at $80.65 and 2010 is 1.2 million barrels at $104.53.

Going on to page 12, we added a new slide where we're comparing our actuals to our guidance and just to add some of the highlights, production came right in the midpoint of our guidance. Oil and gas differentials were better than the midpoint of our guidance.

LOE was $5.8 million worse than what we have guided to and that's comprised of $2.3 million of work-overs that we expensed that were higher than the first quarter, and $3.5 million, the bulk of the rest of it is higher fuel costs and fuel inflation as a well as just the dollar amounts related to some new production. All in all, everything else was pretty much in line. The one thing that I want to point out about the Midstream revenue and expense, that number is going to be pretty volatile going forward as we do buy and sell gas. A lot of the revenue and expenses is the cost of buying gas and revenues from selling gas even though our margin stays pretty constant. Another thing to point out is our cash G&A was about $1 million and that mainly is reflecting some contractor costs that we have for some new IT initiatives that are going on.

And flipping on to page 13 just shows you what the rest– the full year looks like with two quarters of actuals and Q3 and Q4 guidance. Going on to page 14, just to highlight what we’ve changed in our guidance for the third and fourth quarter. We have changed the way that we calculate our gas differentials to reflect the elimination of the intercompany revenues associated with the midstream, so it’s going to raise our gas differentials as we report them going forward. LOE, we’re showing the cost creep that we are seeing out there and as well as cost of higher production going forward. Again, pointing out the midstream revenue and expense, again, this is third party revenues and 100% of the total expenses of the systems. Cash G&A again, we’ve seen a little bit of a creep as we’re also making good progress on hiring a lot of the staff that we need to exploit the shales.

And to wrap up, on the interest expense, it reflects the borrowings that Doug Ramsey just spoke about as well as the non-cash amortization of some deferred financing costs that are going to run about $5.2 million a quarter. Preferred dividends just reflects the $7 million from the end of the quarter through July 18 and just again to point out that our fully diluted shares outstanding will now reflect the full share count. With that, I hand it over to Hal to go over the operations for the quarter.

Hal Hickey

Thank you, Paul. Second quarter for Exco was a quarter that rocked us. I’d like to say with time spent strategically positioning our shales for the future. We’ve done significant leasing, just like Steve Smith said earlier, in our shale plays as well as in our Permian area where we get some significant growth in acreage position around our Canyon Sand Field, I’ll talk about in a moment.

In the shale plays both in the Marcellus and Huron and New Haynesville/Bossier, we’ve done some strategic drilling to help us not only increase our HBP position or held by production position, but also to better understand the plays and how we exploit them going forward. And finally I’d like to say we’ve done some significant hiring. I think I was looking at a number the other day and I talked about with our other managers. We’ve hired 250 people since the first of the year, so very significant growth in lot of fronts.

First we’re going to talk on slide 16, about the Haynesville/Bossier shale. Again, we did some strategic drilling and completing to delineate the shale play this year and we tested – boy, we’re going to complete our fracture in the horizontals as we were drilling and completing in our verticals. We’ve been gathering data for play development. We've joined the core consortium. There is a significant amount of data collection that we’ve been doing and optimizing our procedures for our future operations. A lot of this time has been spent with consultants, service companies, and data gathering by ourselves. So we’re trying to look forward to how we optimize our completions in our flow back procedures in the future.

We’ve had some good success on three particular vertical evaluation wells in North Louisiana and East Texas. We've found average (inaudible) of 200 feet of net pay, very good total organic carbon and porosity contents have been identified, and you can see our IP rates have ranged from 800 Mcfe a day to 2.8 million a day at flowing pressures between 1,000 and 3,200 pounds per square inch.

We’ve added to our drilling inventory or rig inventory one new build, 1,500 horsepower, top drive drilling rig for the horizontal program and it’s actually working for us on a directional well now and it will begin spud of our first Haynesville horizontal here within the next week. I’ll also add that we’ve got a second new build horizontal drilling rig coming in the fourth quarter and three more that we’ve contracted under long-term commitments coming early in 2009. And with the Haynesville shale play and Bossier – Haynesville/Bossier, we hold nearly a 120,000 net acres. We’ve got active acquisition as far as looking at additional acreage. 60% or so of the acreage is held by shallow production and with some of our strategic drilling in some budgeted Cotton Valley wells that were going to take deeper. We’re going to continue to increase our HBP position between now and year end.

Slide 17, I’ll talk about other activity in key areas of East Texas/North Louisiana. The Vernon Field which of course remains the largest single field in our portfolio is a very active area for us. We drilled and completed six wells during the quarter. Our average IPs were still strong at 6 million a day. We’re continuing to identify field limits both to the South and the West. In turn we’ve added a fourth rig and we upped our drill count target there from 24 wells to 31 wells for this year.

We also were looking seismic data on addition of 35,000 net prospective acres in the Vernon area that was part of the acquisition we made when bought Vernon field proper. We’ve been looking at seismic; we are going to spud an evaluation well, build an evaluation well there later this year and we’ll keep you posted on that. In addition to the 35,000 prospective acres we’re going to test, there’s an incremental 30,000 acres above and beyond the Vernon Field proper in this test area that we feel still have an opportunity to look at.

Now while our drilling spud to rig release dates have come down in Vernon and in fact across our portfolio, particularly in East Texas/North Louisiana and the Permian, we've seen some increased cost. Our OCTG products, our casing and our tubulars have gone up. Some of our fuel costs, of course, have risen. We’re seeing increases across the sector. So, some of our drilling costs are increasing. They’re up about 10% in Vernon alone.

Trafford [ph] area, we drilled and completed 28 wells in the quarter. Still having good IPs in the 900 Mcfe to a million a day range, expanding the field limits there particularly in Holly/Caspiana beyond and we're drilling more to the South. We got five rigs running in the area, four in Holly/Caspiana, one are along with Waskom area in (inaudible) County area of Louisiana and Texas, respectively. We’re going to add a sixth rig in this area in October.

And like I hinted at earlier, we’re drilling several budgeted Cotton Valley wells deeper particularly at Holly/Caspiana that’s going to allow us to hold acreage and further dividing the play. As we’re doing that, we’re not completing as much of production in the Cotton Valley zones but that’s okay. There's strategic positioning for us as we move forward. I’ve already talked at Vernon about how our rig spud relief dates are down significantly but again our costs are continuing to go up.

And finally, we are in the last days, if you will, of finalizing the salt water disposal pipeline contract that I’ve talked about with you earlier where we hope to significantly reduce our cost on the significant amount of the salt water that we have to dispose off from our North Louisiana or Northwest Louisiana operations. We think that will bring some of our cost down from in a $1.80 per barrel range for hauling water to $0.85 to $0.90 per barrel.

Slide 18, continuing with some East Texas/North Louisiana more in a general stand. Lifting costs that could've gone up. Paul referenced that. We've had fuel costs. We’ve had work over activity that Paul has already talked about. But we've seen fuel up 40% or more since the first of the year depending on which particular steel products you’re looking at. We've seen costs increasing to 40% to 80% on average. It's probably in the 50% to 60% range, and the work over activities – the conscious activity we’ve undertaken for example at the Vernon field earlier this year. We had three work-over rigs operating in field. Now we’ve got six. And so we’re continuing to focus not only at Vernon but in other areas of the portfolio on how we can continue to arrest the base decline and get some incremental volumes.

In the second quarter, we negotiated and then early and in the third quarter, we actually closed the $244 million acquisition after preliminary closing adjustments of some Cotton Valley properties and Greg, Rusk, and Upshur county in Texas from private sellers. These assets included 12 million-a-day stabilized production. We’ve actually seen it up as high as 15 million a day or more. We’ve got over 11,000 gross acres in the area. The majority of which have deep rights. You can see the reserves that we acquired and then there are more than 500 identified Cotton Valley Travis peak and Rodessa locations. 92 of them are approved. That does not count any potential Haynesville locations or Bossier locations. We’ve got plans to drill a well or more into the Haynesville/ Bossier in this area later this year and continue to determine its prospectivity for Haynesville/ Bossier.

Midstream, Steve's hit on, we’ve increased our throughput significantly from last year to this year as a result of acquisition of the system that Steve talked about earlier as well as continuing to get additional third party volumes stand up and transported through the system.

As Steve talked about, we’re in the last phase of our 57-mile nearly $38 million expansion of our TGG pipeline system that’s predominantly a 20-inch line that’s been added deeper into East Texas from our part of the operations around John Howell [ph] in Harrison County. It will add at least a 100 million a day without compression, and with compression, this system could add more than 200 and we are very, very actively pursuing opportunities and ideas in how we move forward to expand our mid-stream system and capture some of the upside that we believe very strongly is coming from the Haynesville/Bossier development.

Shifting over on Slide 19 to our Appalachian Division, set monthly production record in April and our production for the quarter was up 13% over where it was the first quarter. This is mainly driven by having the full quarter performance of the EOG acquisition in our portfolio that you will recall probably closed back in late February. But we’re also continued to very actively drill here and then, I’ve mentioned before that we continue to see very encouraging results from our artificial lift efforts in Central CA, but we’ve spud [ph] up pump jack and plunger lay outs and we’ve recovered some 150 million incremental volumes year-to-date. So we’ve worked on nearly 90 wells. We’ve got hundreds more that we could continue to operate, or improve operations on, so we’re going forward on that program [ph].

Appalachia, we ramped up our activity. There are periods in the first quarter where we’ve drawn with only one to three rigs, we’re up to nine today, or as of August 1 at least, we achieved 98% drilling success rate on 45 gross wells that we drilled in the area and our nine rigs that we’ve been drilling right now, we’ve got five of them drilling shale or unconventional targets. Four of which we’ve operated (inaudible), four them we’re working on horizontals and one them we’re working on a vertical well.

So, flipping over to page 20 on the Marcellus Shale, nearly 400,000 net acres with what believe to be more than 275,000 net acres in the heart of the play and you recall that’s where we believe there’s more than a hundred of thickness. It’s over pressured.

We’ve spud two horizontal Marcellus wells in Pennsylvania. The first one we cored, we’re very encouraged about what we found, very good thickness, high porosities and good TOC, and completion of both the first and second horizontal Marcellus wells is expected during the third quarter and also we spud and completed and continue to try to understand the play and where our opportunities lie, to drawn some vertical normal pressured Marcellus wells in West Virginia.

And Huron on Slide 21, we continue to be excited about the opportunities there. We think we’re going to see some volumes from there very quickly. We held a 121,000 net acres in this Huron play in West Virginia alone. We’ve drilled one horizontal Huron well in the quarter. We spud three more. We’ve targeted very thick zone, we’ve find a very organically rich formations and numerous drilling breaks and gas shows along nearly 3,000 foot lateral, which really indicates we’ve got some good quality here. So, stay back for news, we’re going to have some completions there very shortly.

So in the second half, we’re going to continue to be very active in both of the shale areas. We’ve drilled two additional horizontal Marcellus wells, four additional vertical Marcellus wells, seven additional horizontal Huron wells, and again three of those have already been spud and we’ve contracted two new-build 1000-horsepower top-drive rigs for first quarter 2009 delivery, long term commitment and the wells we’ll be drilling Marcellus horizontals for. You recall that as we’ve said earlier, that existing equipment in the basement is available for drilling the Huron shale plays.

Slide 22, Permian-Canyon Sand field, still one of our very, most active areas. We’ve drilled 31 gross wells, 100% success rate. We have three operated rigs there. We’ve actually got a partner that’s drilling some (inaudible) wells for us as well. We’ll drill some 124 gross wells here and we’ve also continued to find very encouraging oil targets in clear (inaudible) camp type zones.

In this area, we’ve done a significant amount of growth through a joint venture with a third party who had added 11,000 acres that are contiguous throughout the regional Canyon sand field area. We’ve leased an additional 12,000 acres and so we hold nearly 50,000 net acres in the area and we’re working with 3-D seismic to identify where we best exploit this opportunity.

Rockies, we’re finally going to be able to complete our Birdseye prospect in the Wind River basin. We were held up all summer long due literally to some eagle’s nesting in the immediate area of our operations, and we still believer there’s some substantial potential upside there.

And in the Mid-Continent, again, remained stable. Good business for us. We’ve drilled and completed 12 gross wells in the Mid-Continent area, 100% success rate and we’ll drill some 57 gross wells there through the year.

And the final slide I’ll talk about is on page 23. Our development capital budget totals $943 million, $170 million of that is from Marcellus and Huron shales leasing and drilling and $90 million for Haynesville/Bossier shale leasing and drilling. I’ll also note that we increased our budget through the year for Vernon as we added the fourth rig, but 600 plus drilling projects are targeted. That’s down from what I showed you last quarter. Strategically, we’ve decided to drill a little bit less number of conventional wells in Appalachia and actually increase our activity in some of the shale plays, particularly the Huron, and you can see the bulk of our dollars go to drilling and completion. But this year, more than ever, we’re significantly leasing business up, literally in magnitude from what we typically do and we’re positioning ourselves for the future. We think it’s very bright. So with that, we’ll turn it back over to our management.

Doug Miller

Okay, this is Doug Miller again. One of the things Hal didn't – we’re up to – Hal help me on this – 28 rigs running today –

Hal Hickey

Yes, we have 28 rigs running today.

Doug Miller

– which is up from 23 or 24 at the end of the first quarter. I expect that we’re targeting getting that up to 32 by the end of the year. Again, I think we've discussed this – as prices have gone up and we still consider them up, I might add, that we’re going to push the envelope a little on the drilling with focus on both the shale plays. I think we’re pushing 900 people now, I think that’s up over 100, but I mean the people we’re adding are AAA quality scientists that are helping us in all three of the shale plays, so I think our knowledge has grown a lot, and I think our comfort zone – being able to compete in both areas has been greatly enhanced.

From an acquisition standpoint, we still look. We haven’t pulled the trigger on any. We’ve actually looked – we’re really only focused in two areas and that’s up in Appalachia and East Texas, North Louisiana. We’ve done some small acquisitions, mostly leasing. There’s quite of acreage around up in Appalachia right now. I think Aubrey [ph] kind of left town and all of sudden, everything that was being held up just come flying in, I’d say we’re probably looking at pushing a million acres of potential up there. But we don’t need anymore and HBP is so critical up there because of all the challenges we’re going to have, we’re very content with what we have and if we could find the right acreage that fits, we’ll be looking at it but we’re going to be very, very selective.

Over in East Texas, North Louisiana, we’ve bid on a small deal that had some production and some Haynesville potential that offset our (inaudible) a week ago. I think we bid 40 million, the guy laughed at us, and traded at double. It is what it is, the market over there were still C&A [ph], crude is going in the 20,000 to 30,000 range in the area, and it isn’t just Aubrey buying it, there’s a lot of players over there and this is not a hyped play. I don’t know who pitched it out that Aubrey will hype it but we’re kind of on-board with some of Aubrey’s numbers and in some cases, we think Aubrey might even be low, so there’s the legit play, and I don’t believe that there’s going to be 200 rigs running there by the end of January and we’re going to be at two or three BCF a day, because rig – 1500 – 2000 horsepower rigs just don’t fall from the sky with 50 people.

A lot of these are moving from other place and keep in mind that as we develop and as others develop, you’ve got to get firm transportation out there, so one of our focuses that Steve and Hal talked about is increasing our capability in our pipeline over there. That’s going to be a very, very significant asset and its going to be very costly aligned with our drilling program over there because – drilling forward is one thing, but getting to that and getting it to market is another. We’re going to keep mindful of that, so I think today we have over 300 million a day of firm transportation on our system going out and so we’re ready to go and I think we’re in really good shape for ‘08 and ‘09. And we, by the way, don’t believe that production will be over a Bcf a day in 2009.

With that, I'm going to open it up to questions and anybody else has any comments here? Okay. Let’s open up it up to questions, Brooke.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from David Heikkinen with Tudor Pickering, Holt.

David Heikkinen – Tudor Pickering, Holt

Good afternoon guys.

Paul Rudnicki

Hi, David.

David Heikkinen – Tudor Pickering, Holt

When you think about the Midstream business that’s growing for you both with the acquisition of the pipeline and your expansion, how do you think about where your EBITDA could grow for that business in 2008, 2009, and beyond?

Doug Miller

Okay. I have – I’m probably going to be speaking a little out of my realm on this one. I think with what we have, the 57-mile expansion. We believe internally that without compression that that EBITDA should be running around $50 million a year beginning in ‘09. We’re now looking at another significant expansion that’s 36-inch pipe that goes across the Holly/Caspiana. It could be potentially a $100 million to $200 million capital program, and if that’s the case, it will have the ability and act as a header system throughout and interconnect with six interstates. It could produce, without compression, about 500 million a day. I think it could be in full operation by the end of ‘09. And if that’s the case, it looks to me like, add another $50 to a $100 million of EBITDA. But I’ll tell you this; we spent two hours yesterday going through the plans over there and with all the potential drilling activity that’s going on, I kind of expect that we could have another expansion or two by the end of ’09 and that’s the type of stuff. We’re talking about a margin of $0.25 to $0.30 just for gathering and transporting, but the thing about this, there's three major interstates right now with plans to build pipelines and that’s probably two or three years out. So this pipeline is very critical to us. Did I answer the question right?

David Heikkinen – Tudor Pickering, Holt

You're looking. Sounds like a good answer to me.

Doug Miller

Okay. Sorry.

David Heikkinen – Tudor Pickering, Holt

On the same type of thought, as you look at Appalachia and the Marcellus and Huron, how much pipeline capacity would you install there? Is it third parties that are going to do that or how do you think about that business?

Doug Miller

Well, we’re in a lot of discussions out there. We think that we are now – Wendy [ph] is in negotiations on where we're drilling our Marcellus right now. We’re going to be building our own small pipelines. We’re in discussions with some major interstates there to do some joint ventures. There’s a lot activity up there but again, it’s going to take quite a bit of pipelines to keep miners, 250,000 shallow wells out there low pressure with gathering systems and this is a new animal. This higher pressure, higher volumes, and we are going to spend a lot of time and effort in getting our pipelines ready before we start any significant drilling up there, so –

David Heikkinen – Tudor Pickering, Holt

And money.

Doug Miller

And money. We’re looking at different plans. We’re in discussions with four or five people today, working on where we would do it and how we would do it and we’re willing to put the money up. We love to find somebody to partner with them but we want to have control so our wells get hooked up as we're drilling.

David Heikkinen – Tudor Pickering, Holt

That’s helpful. Thanks.

Operator

Your first question comes from Brian Singer with Goldman Sachs.

Brian Singer – Goldman Sachs

Good afternoon.

Paul Rudnicki

Hey, Brian.

Brian Singer – Goldman Sachs

Hey. Question on production guidance. If we look at – if we take the second quarter production of, I believe, 394 and add the impact of the acquisitions you recently closed, it would seem to put production, assuming the rest were flat slightly above the upper end of your range for the third quarter and kind of into the middle of the range for the fourth quarter and I wonder to what extent you could touch on and then what will the specific assets that maybe growing and declining in any level of conservative's built into your guidance?

Paul Rudnicki

Hey, Brian, it’s Paul. I'll handle that one.

Doug Miller

You always catch Paul, don’t you Brian?

Brian Singer – Goldman Sachs

I try.

Doug Miller

(inaudible) boy.

Paul Rudnicki

With the, as we kind of alluded to in terms of the shale activity we’re picking up on, the big change is going to be in East Texas where we’ve got nearly 20 wells that were planned to drill to the Cotton Valley. They're going to be drilled to the Haynesville and that's taken us a little longer. We’re doing a lot of testing and we’re still not projecting any kind of shale volumes out here. So I think, with all the variables that are going on both here and in Appalachia, as we’re really beginning the drilling program on those shales, we’re just going to wait and see what happens.

Doug Miller

I think the main thing is even though we’re planning on doing quite a bit of drilling and completing we have no shale production in any of these forecasts, neither Huron, Haynesville or Marcellus.

Brian Singer – Goldman Sachs

And then I guess somewhat following up on that, you test sounded a little bit earlier but how do we think about when your deploying capital into the Haynesville and rigs for that matter as well, what is incremental versus rigs/drilling that is coming off somewhere else?

Doug Miller

Well, I mean, we’re working on that. We have Board meetings. Our normal quarterly Board meetings tonight and tomorrow and we’re heading for 32 rigs. We’re trying to maintain a reasonable drilling program with maybe five or six rigs in the shallow, up in Appalachia and we’re probably trying to get to 10 rigs throughout – including Vernon and the Cotton Valley – just in the Cotton Valley ‘cause we already have 3,000 locations in the Cotton Valley that are damn good locations. Hopefully we’re going to be between three and four rigs at the end of the year and North to four rigs by the end of the first quarter in the Haynesville. So these things still have 30%, 40% IRRs so because our capital program is well within our EBITDA, we’re not doing a lot of switching around.

Steve Smith

Because a lot of these wells that we’re drilling to the Haynesville were all – those rigs were already lined up to drill to the Cotton Valley and we’re just drilling deeper so – it’s not like we’re switching around but we just won’t be making those Cotton Valley completions as quickly as we otherwise would and that’s why there’s a little bit – there’ll be a little lag in production there. Now in Vernon, we’re adding a fourth rig. It has not begun working yet. It is now drilling but it’ll take a little while. We’re trying to arrest the natural decline up there and doing a pretty good job of it but it’s still a chore and this fourth rig is going to help a lot.

Doug Miller

Hey Brian, the thing about the Haynesville is we – across most of our fields over there, we own all rights, so we’re not just drilling deep wells, we’re drilling down through the Huron [ph] and the Cotton Valley and until this quarter those were forecast to come out at 1.5 million a day or so. And so we’re drilling down through, we’re doing some coring, we’re doing some testing in those wells. Even if it comes out good, the way we’re frac-ing those wells, we’re only frac-ing a very small portion of the Haynesville and they’re coming out at 0.5 million to 1 million a day, but for a reason. That’s very good for what we expect instead of the 1.5 million a day. So it’s a little bit of substitution, but we’re not losing any reserves. It’s just kind of delayed like Steve said.

Hal Hickey

And more specific, Brian, this is Hal, is in Appalachia on some of our shallow conventional plans, we moved some $9 million, $10 million, $11 million or so over to the Huron, so there is an incremental add there in Huron.

Doug Miller

Yes.

Brian Singer – Goldmann Sachs

Great. Thank you.

Doug Miller

Alright, thanks.

Operator

Your next question comes from Joe Allman with JP Morgan.

Joe Allman – JP Morgan

Hey everybody.

Doug Miller

Hi, Joe.

Paul Rudnicki

Hi, Joe.

Joe Allman – JP Morgan

Hey, just trying to get a sense of the pace of development of the Marcellus Shale play and could you kind of just, I’m not trying to pin you down with any numbers, but just what kind of production do you see yourselves with in 2009 and 2010, just the kind of ranges, just to get some ideas of the pace.

Doug Miller

Joe, I think slow is the underlying word. I think what we’re doing right now with these first two, those will be completed hopefully in September, October. We do have a pipeline being laid as we speak where we can take 10 million or 15 million a day. But I’d say this, permitting issues continue to be a problem. We’re working with them. I think we’re sending a whole crew of lawyers and Steve and everything up there. Pennsylvania is going to be slightly slower as we talked about. I think we’re moving the deep rig that we have down into West Virginia maybe after these two wells are drilled. It’s slightly easier to get permits, both water and drilling permits, so underlying slow and I’m not going to give you any production rates right now because we’d love to have four or five rigs running in Pennsylvania the whole year. We do have some coming, but let's delay that.

Steve Smith

We’re going to know a lot more by the fourth quarter and it’s going to take that long to sort through just sort of this permitting. The permitting is actually a bit of a problem right now and that’s why we are drilling two horizontal Marcellus wells in West Virginia, that’s our next two wells will be – our next two Marcellus horizontals will be in West Virginia.

Doug Miller

I think, let us get these things frac-ed and online here and then maybe by the end of the third quarter, we’re doing a lot of work and a lot of negotiating and a lot of schmoozing with both the EPA group and the water disposal people, it is not an easy task. This is not East Texas/North Louisiana.

Steve Smith

But it is doable, it’s just time consuming.

Doug Miller

It’s going to take some time and I’d say slow is the underlying theme.

Joe Allman – JP Morgan

Gotcha. In the permits, you’re talking about specifically, are they water access and water disposal?

Doug Miller

And drilling. I mean, it’s all permits.

Steve Smith

Drilling permits have been put on hold pretty much in Pennsylvania as I understand it. And again, it’s not anything sinister, it’s just – I think the (inaudible) up there is just trying to get their arms around what’s going on. And so we’re – it's slow, they’re very slow coming through with the drilling and the water permits.

Doug Miller

They never had 50 Texans up there with 25 permits waiting in line. It’s a problem.

Paul Rudnicki

Just to finish up on that point, Joe, we never had plans to go to 10 rigs there next year.

Doug Miller

Our plan was another three rigs. We’re still going to get those three rigs. Now the only question is, are we going to be going to Pennsylvania or are we going to be going to West Virginia, and that’s what we’re trying to figure out. We can get permits in West Virginia. By the end of the third quarter, we should be able to give you better answers on that. I apologize for being vague, but let’s don't promise something we can’t deliver.

Joe Allman – JP Morgan

Understood. What have you got in hand right now in terms of drilling permits and water access and water disposal?

Steve Smith

Well, we’re okay on the completion of the two wells that we’ve – the two Marcellus wells that we’re about to complete –

Doug Miller

Both water and disposals –

Steve Smith

Yes, I think we'll say we’re pretty much okay there, but as far as drilling permits, we’ve got several vertical permits and we’re going to go ahead and drill some vertical wells in Indiana and other counties in PA, and we’ve got about three or four Marcellus permits that we feel pretty optimistic that we’ll get those relatively quickly. And then I think we have four horizontal permits in West Virginia that we can move on immediately.

Doug Miller

We’re sending five guys, counting our lawyers, up there to sit down with the different agencies next week. I don’t know if that’s good or bad but they’re going up there to have some discussions.

Steve Smith

At this point, we haven’t had – they just stopped our activities. We’ve been moving along at a pace that we’ve planned all along and we continue to do that. It’s just right now, it’s in a different state.

Doug Miller

And I think the worst thing we can do with everybody is to say that we’re going to run 10 rigs starting in January 1, we don’t know. We would love to get to that point but we’re not there yet.

Joe Allman – JP Morgan

Got you. And then maybe – I missed the very beginning of your call. Are you able to address the progress with the joint ventures you’re looking at?

Doug Miller

No, I haven’t talked about that and we are still in the process. As you know, we hired Goldman Sachs and I’d say many people have been through here, many people have indicated an interest. We’re still in the process and I just can’t talk about it but we have had a lot of discussions in both areas and even a possible partnership in the pipeline. So if this discussion is going to be going out to Board tomorrow, and soon as we make a deal, we’ll be putting a press release up. But there’s still a lot of interest, in all areas, as you can imagine.

Joe Allman – JP Morgan

Very helpful. Thank you.

Doug Miller

Okay. Thank you, Joe.

Operator

(Operator instructions) Your next question comes from Gary Stromberg with Lehman Brothers.

Gary Stromberg – Lehman Brothers

Hi, good afternoon.

Doug Miller

Hi Gary.

Gary Stromberg – Lehman Brothers

You know I’m a bond guy; I have to ask a bond question.

Doug Miller

We’re not calling the bonds tomorrow.

Gary Stromberg – Lehman Brothers

The EPOP loan or I guess we’re calling it the Exco operating note, matures I guess December 15, how do you think about permanently financing that and in what part of the structure?

Doug Miller

Well you’re assuming we have to finance it; we just paid down our revolver by $40 million this week. The joint ventures that we’re talking to if we pull the trigger on one of those have included a lot of cash. A joint venture on the pipeline which we’ve had discussions would include a lot of cash, and we have cash flow. Other than that if you could talk Moody’s and they’ve given us a little better rating, we might do a bond deal.

Gary Stromberg – Lehman Brothers

Okay.

Doug Miller

We’re still at CCC and we just issued a $2 billion worth of equities.

Gary Stromberg – Lehman Brothers

Sorry, now I hear you. And then I guess –

Doug Miller

I don t usually criticize and de-arms [ph] especially when you might be on the call.

Gary Stromberg – Lehman Brothers

I guess that as a second part of that question and I realized that there could be different answers depending on if somebody’s JV’s come through. How do you envision like the cap structure and leverage going forward in terms of bank debt on , do you think this in need of a re deal here with all the different levels and operating companies?

Doug Miller

Yes, we would love to consolidate all into one and that’s what where we’re heading. We danced around the bonds a little one when we were structuring the MLP and it’s a lot easier to dance around to start with than undoing it and so we’re in discussions with the Bank group and Steve and the lawyers were kind of – my goal is to have one company, one bank credit facility, and we’re working towards that.

Gary Stromberg – Lehman Brothers

Okay that’s very helpful.

Doug Miller

Okay. Thanks Gary.

Operator

At this time, there are no further questions, are there any closing remarks?

Doug Miller

Oh, I’m sure I can give some closing remarks. I think, in conclusion we’ve had our busiest quarter and our busiest 6 months in the history of the company. We’re approaching 900 people and I just looked at – with the potential, we have potentially 22,000 to 25,000 development drilling locations in this company. We’re going to have to increase rig activity every year for the next five years, to get that under 20, so we’re active, we’re happy; we have the best portfolio we’ve ever had even though we’re a small company. We’re going to be a factor in the Haynesville and the Marcellus plays. Well keep you posted on it and we’ll look forward to keeping you as share holders. Thank you very much for coming.

Operator

Thank you and this concludes today conference call, you may now disconnect.

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