Edge Petroleum Corporation Q2 2008 Earnings Call Transcript

Edge Petroleum Corporation (EPEX)

Q2 2008 Earnings Call Transcript

August 12, 2008 11:00 am ET

Executives

C. W. MacLeod – VP, Business Development & Planning

John Elias – Chairman, President & CEO

John Tugwell – EVP & COO

Analysts

Mike Sullivan [ph] – Energy Capital Advisor [ph]

Charlie Cheever – Corsair Partners

Sachin Cheksal [ph] – Sandell Asset Management

Presentation

Operator

Good day, and welcome to the Edge Petroleum Second Quarter 2008 Earnings Conference Call. Today’s call is being recorded. At this time I’d like to turn the call over to Mr. C. W. MacLeod. Please go ahead, sir.

C. W. MacLeod

Good morning everyone. Welcome to the Edge’s second quarter 2008 conference call. With me today on this call are John Elias, Edge’s Chairman, President and CEO; John Tugwell, Edge’s Chief Operating Officer; and Kirsten Hink, Edge’s Vice President and Chief Accounting Officer and Controller.

Before we begin our review I need to remind everyone that we will be making forward-looking statements today. Statements regarding the proposed merger with Chaparral, including the benefits, results, effect, and timing thereof, whether and when the transaction contemplated by the merger will be consummated, whether and when the proxy statement/prospectus will be filed, regulatory clearances, common stockholder approval, shareholder value, change in our continuation of current business plan, cash flow, financial condition, forecasted production, derivatives and effects thereof, reserves, estimated volumes, as well as any other statements that are not historical facts in this release are forward-looking statements that involve certain risks, uncertainties, and assumptions, many of which are beyond Edge’s ability to control or estimate and are subject to material changes. Such risks, uncertainties, and assumptions include, but are not limited to, the satisfaction of closing conditions to the merger, market conditions, availability of financing, Board and stockholder approvals, actions by third parties, Edge’s financial and operational results, the availability or (inaudible) of any alternative or transaction, uncertainties caused, and delays relating to transactions, prices for oil and gas, including natural gas liquids, drilling and operating risk, risk related to exploration and development, uncertainties about the estimates of reserves, and other factors detailed in the Risk Factors and other sections of Edge’s most recent Form 10-K and Form 10-Q and other filings with the SEC.

Should one or more of these risks or uncertainties materialize or should underlying assumptions prove incorrect, actual results may vary materially from these indicated. The specific terms, resource potential, or 3P reserves is not meant to be equivalent of the SEC definition of proved reserves.

I would now like to turn the call over to John Elias.

John Elias

Thank you, C. W. Good morning. I would like to make a few comments before John Tugwell and C. W. review our operating and financial results.

As you might suspect, we have been extremely busy preparing together with Chaparral Energy the Form S-4 registration statement that we are required to file with the United States Securities and Exchange Commission, the SEC, in connection with the merger agreement that we announced on July 15^th, 2008. Our target date to file the S-4 is the middle of this month. We expect to be able to hold a shareholders’ meeting during the fourth quarter to vote on the merger but the (inaudible) and scheduling the meeting is how long the SEC will take to review our S-4 filing.

The S-4 will be provided – will provide an overview of our strategic alternative evaluations process, background information on both companies, specifics with respect to the merger agreement, various evaluation metrics that were considered in the process, and other pertinent information that I am sure will be of interest to all of our shareholders. The S-4 will be available for public viewing – review when it is filed with the SEC. As we have stated before, we believe that a combination with Chaparral provides a significant opportunity for us as shareholders of Edge.

Regarding our second quarter results, our cash flow during the quarter enabled us to maintain our capital expenditure program as planned, to take down our outstanding debt balance by $10 million and fulfill other obligations as well. Our capital expenditure for the year are expected to be approximately $66 million. At this expenditure level we expect to drill 27 to 29 wells by year-end, to shoot a 140 square mile 3-D seismic program in our El Sauz project area in South Texas, to maintain an active workover and recompletion program, and to acquire new leases on prospects and/or plays that our exploration team has identified. We expect our fully year production to be in the range of 17.2 Bcf equivalent to 18 Bcf equivalent.

As you are aware from our press release, cash settlements on our derivative contracts has significantly impacted our second quarter results, but the impact is expected to decline with the recent drop in commodity prices. For example, we realized cash settlement losses for the month of July totaling $4.9 million for natural gas. However, our August natural gas settlements were 95% lower totaling only $200,000. We expect our August oil settlements, which was $3.1 million in July, to be lower as well when our contract is settled at the end of August.

We will no doubt continue to be impacted by the volatility in commodity prices as we move through the remainder of 2008. However, the degree to which we will be impacted is uncertain. All I can say is that we have attempted to appropriately account for continued commodity price volatility as well as other – as well as numerous other factors that can influence our ability to effectively execute this year’s program such as the availability and cost of oil field equipment and related services.

I will now turn it over to John Tugwell who will address our current operation and plans for the balance of the year.

John Tugwell

Thank you, John. This morning I will focus my discussion on production, our operating activity to date, and plans for the remainder of the year. Estimated production for the first half of 2008 was 9.7 Bcf equivalent or an average daily rate of about 53 million cubic feet equivalents per day. Production during the second quarter is estimated to be 4.3 Bcf equivalent or an average daily rate of about 47 million cubic feet equivalents per day.

Disposition of properties late in the first quarter resulted in a loss of about 2 million cubic feet equivalents per day. Current expectations are for full year 2008 production to average about 47 to 49 million cubic feet equivalents per day despite operating at a reduced capital expenditure level.

During the first half of the year, we logged 14 wells and have logged one additional well so far in the third quarter for a total of 15 wells logged to-date, all apparent successes. Current expectations are to drill another 12 to 14 wells by year-end. One additional well, the Chapman Ranch #19, not included in the well count above, was spud in the first quarter, but has been temporarily abandoned after experiencing an underground flow before reaching the planned total depth.

Insurance will cover a large portion of what we spent on this well and a significant part of the cost to re-drill the well, which we are currently planning for 2009. The re-drill of this well will test the Anderson sand where we had a significant gas shell and had the underground flow and Howell Hight sand, both of which are prolific producers in the area. We will also have the option to test the deeper section with an exploratory tail if we chose to do so.

Our most active areas has been our Flores-Bloomberg field in South Texas where we have drilled 10 wells to-date, have one rig running, and plan to drill approximately five more wells by year-end. During the second quarter we drilled four wells in this field with working interest ranging from 50% to 100%. Three of these wells have been completed and were brought on line at initial gross producing rates ranging from 3 to over 4 million cubic feet equivalents per day.

The fourth well drilled during the quarter and an additional well drilled in July with working interest ranging from 48% to 50% are currently being completed and are expected to come on line soon. Each of these wells had three apparent pay zones. Current plans are to commingle at least two of the three pays in these new wells. The Flores-Bloomberg field produces from 12 different horizons and typically has two to three productive sands in any given wellbore.

As part of our ongoing effort to capture the potential associated with the multiple pay sands, we also have an active ongoing workover and recompletion program in the field. This program has also yielded positive results with recent recompletions on three wells with working interest ranging from 33% to 50% coming on line at gross producing rates of 1.8 to 3.7 million cubic feet equivalents per day.

We have just reached the planned 11,000 foot total depth on our eleventh well in the field this year, the Samano East Gas Unit #1, and are currently logging the well. We operate this well and have a 31.2% working interest.

Also in the Flores-Bloomberg field, the Texas Railroad Commission has recently approved down spacing which will enable us to more efficiently develop this highly compartmentalized field where we have an estimated 40 to 45 identified future drilling locations.

As a follow-up to this down spacing we are also applying for the tight gas sand severance tax reduction, which, if approved, could significantly enhance our netbacks and the economics of future development in the field.

To-date, we have been very pleased with our results at Flores-Bloomberg where our drilling, workover, and recompletion programs since acquiring the property in early 2007 has resulted in an increase in gross production from 26.3 million cubic feet equivalents per day to the current rate of about 40.7 million cubic feet equivalents per day, or a net equivalent rate of 13.9 million cubic feet equivalents per day.

Our currently planned second half 2008 drilling program also includes spudding several high potential exploratory prospects in South Texas. The 13,200 foot El Fortunado prospect in Adago [ph] County, a 17,500 foot prospect, the Oso Grande prospect in Nueces County, and the 14,500 foot Samano Deep prospect in Starr County, Texas. Edge plans to operate each of these prospects.

Also, in South Texas, as John mentioned, we and our partner are continuing to acquire leases and/or options on identified leads in our El Sauz 3-D project area. We plan to acquire 140 square mile 3-D seismic survey by year-end 2008. We currently have 12,350 gross acres or just under 5000 net acres under lease or option, and are currently working to acquire the surface and mineral permits required to execute the 3-D acquisition. We have a 50% working interest in this project and are operating the seismic acquisition phase of the project.

In southeast New Mexico, the Prairie Fire #1 well brought on line in March of this year continues to perform well. The well is currently producing about 6 million cubic feet equivalents per day after recently installing compression, up from 4.5 million cubic feet equivalents per day before compression was added. Edge has a 50.8% working interest in this well.

During the second quarter we drilled two wells in southeast New Mexico. The Prairie Fire #2 with an Edge working interest of 33.3% was recently completed and is currently to sales at a rate of about 500 Mcf equivalents per day. This well was completed in the Morrow where we found only one quality pay stringer [ph] versus three in the Prairie Fire #1 well.

The Pure Federal #4 with a working interest of 18.8% was also drilled and completed during the second quarter and encountered five pay zones in the shallow oil bearing San Andres, Premier, Grayburg, Queen, and Yates intervals. The San Andres has been completed for 14 barrels of oil per day with plans to recomplete and commingle the Premier zone and possibly a third. This well lies in our Red Lake project areas where we have plans to drill up to four additional wells this year and have 30 to 60 additional potential drill locations in our inventory. One additional well is currently drilling in southeast New Mexico, the South Lovington #1, which we are operating with a 56.8% working interest. This well, which is designed to test the Wolfcamp, Strawn, and Devonian sections, is drilling below 11,500 feet and has a proposed total depth of 12,800 feet.

In Mississippi, we are nearing completion of our reprocessing work on our 72 square mile 3-D data set over the

In Mississippi, we are near in completion of our reprocessing work on 72 square mile data set over the Midway Dome field using third-party processors who specialize in processing 3-D seismic data around salt domes. The goal of this effort is to improve our image of the salt sediment interface. We are encouraged with the preliminary results of the reprocessing efforts and have a number of both shallow and deep leads and prospects at Midway Dome, which we plan to refine with this enhanced data set.

Pending success at Midway, this reprocessing effort to be extended to other 3-D data sets in the basin. Our technical staff is continuing work to identify new opportunities in many of our core operating areas and we are securing leases where required to add these opportunities to our inventory and bring them to drill-ready status.

These new opportunities are coming in large part from areas where we acquired new 3-D seismic data in 2007 and from 3-D seismic reprocessing efforts on these and other shoots we have in our data library.

On the cost side of the ledger, rig rates, after stabilizing for a short time early in the year, are continuing to increase with the strength in commodity prices. Access to tubulars is becoming increasingly difficult resulting in significant increases in cost and longer delivery times. Other oilfield service costs are also trending up along with rig rates.

With that, I will now turn the call over to C. W.

C. W. MacLeod

Thank you, John. Oil and natural gas sales in the second quarter prior to any derivative activities were approximately $49 million compared to $47 million in the same period a year ago, and $47 million in the first quarter of 2008. Second quarter results were negatively impacted by the outstanding derivative contracts. We recorded non-cash net unrealized pre-tax derivative loss of $42 million and had about $15 million of cash settlements during the second quarter. As previously mentioned by John Elias, the August natural gas cash settlement was significantly less than the July settlement. As commodity price volatility continues, it is difficult to determine the impact to our derivative settlements in the future.

At the close of the met yesterday, the 2008 scrip prices for September through November natural gas were below our cap of $9 and above our floor of $7.50 per Mcf. December prices closed at $9.19 per Mcf, which is slightly above our cap.

Our natural gas hedges in 2009 consist of floors of $7.75 and caps averaging $10.04 per Mcf. Approximately 88% of our estimated PDP production is covered by this hedge position.

Oil scrip prices for 2008 closed above our swaps of $66 per barrel with an average price around $115. In 2009, Edge has approximately 56% of estimated PDP production hedged with floors of $70 and caps of $93.55.

The individual components of our cost structure are detailed in the press release. Pro forma net loss, excluding the after tax impact of non-cash unrealized derivative loss, was $2.6 million, and reported net loss was $29.9 million. Obviously, the derivatives had a substantial impact as well as the decline in production due to our reduced capital spending program.

Edge’s borrowing base is $250 million with current level of usage of $240 million. We expect to further reduce our usage as we move through this quarter.

With that, I would like to open the call to any questions you may have.

Question-and-Answer Session

Operator

(Operator instructions) And we’ll take a question from Mike Sullivan [ph] with Energy Capital Advisors [ph]. Please go ahead.

Mike Sullivan – Energy Capital Advisor

Good morning, gentlemen, just a question related to the upcoming merger with Chaparral. What is the breakup fee and then secondly, with the hedges that you described and that are in the press release are any of those hedges new hedges that have been put in position in anticipation of the transaction closing given that I believe Chaparral’s strategy was to hedge a significant amount of the production going forward.

C. W. MacLeod

To the hedges, Edge has entered into no new hedges. These are the same hedges that we’ve had in place for some time in our outline in our financial press release. And the break fee, there are two break fees. There is a $15 million break fee that will be paid if the Chaparral financing is not completed as contemplated, and then there is a $25 million cap on the break fee for all the other reasons that one might break. We don’t anticipate any kind of non-event or we anticipate that the transaction will be completed as envisioned. This will be fully outlined in the S-4 filing as soon as it becomes public.

Mike Sullivan – Energy Capital Advisor

Okay. And so just I guess the drop in commodity prices since the deal was announced (inaudible) hasn’t really changed any of the parameters?

C. W. MacLeod

We are moving ahead as planned and nothing has changed.

Mike Sullivan – Energy Capital Advisor

Thank you.

Operator

Thank you. (Operator instructions) And we’ll take a question from Charlie Cheever with Corsair Partners. Please go ahead.

Charlie Cheever – Corsair Partners

Yes, I wanted to know were there any other offers made for the Company when you guys put it up for sale?

John Elias

Yes, and those will be fully covered and available to all shareholder in the S-4 filing that we expect to make here in mid-August.

Charlie Cheever – Corsair Partners

Okay. And none of those participants or the people that made offers have indicated they are willing to come back and make a higher offer now?

John Elias

No, they have not.

Charlie Cheever – Corsair Partners

Okay. And then the next question is since the hedges are sure [ph] to burn off that was one of the problems with the business. I am not sure why we would support a transaction that is merging in a company or with a company that’s got basically a triple-C rating by S&P. That is not sound like a good business deal from a shareholder standpoint.

John Elias

Well, we – when we – when you see it, the S-4 filing and have a better understanding of Chaparral as well as our sales, and the combination of the two companies I think you will have a better appreciation as to why we think this is of real value not only in the near term but in the future for Edge shareholders. As I have mentioned in previous conference calls, our trust was to find a partner that would give us a representation in multiple core areas, which this does, more predictability in terms of the production stream, not just on a quarter-to-quarter or year-to-year basis but out over time, no concentration in any one well or any one field in term of the reserves and production and a profile that was better balanced in terms of the low to moderate to high risk but an exploration portfolio as we have in our – that can reap real benefits for the entity. Now, they had grown as I am sure recall, previous conference call, from acquisitions, primarily through debt financing. And they have put hedges in place as I am sure their creditors required. And if we were to go forward on a standalone basis we felt like it would be quite some time, three plus years, before we can really put ourselves in a turnaround position that would be beneficial to our shareholders. So I just ask that you look at the S-4 filing and all the background information, the methodology, and our analysis, which included the discounted cash flow analysis, a comparable transaction analysis, also capital comparison analysis. Obviously, the reserves, the production, and the contributing factors were looked at and we didn’t focus in on any one fundamental value but a whole assortment of metrics that laid the foundation for our negotiations with Chaparral.

Charlie Cheever – Corsair Partners

Okay. I think for the record, I think we would support a higher and better offer, and that’s it.

John Elias

Okay, we appreciate that opinion.

Operator

Thank you. We’ll take our next question from Sachin Cheksal [ph] with Sandell Asset Management. Please go ahead. Please check your mute button, your line is open.

Sachin Cheksal – Sandell Asset Management

I apologize. Can you guys talk a bit more about any expected savings and synergies immediately upon the merger of both companies? I don’t know if we see anything regarding – in the last merger conference call you guys had (inaudible).

C. W. MacLeod

Yeah, obviously there will be some synergistic savings with few operations, fewer operations if you will and accounting back office type combination. We – the combined companies will be a bigger south – have a bigger South Texas presence and that’s where you are going to get some synergistics, but again they are expanding more into South Texas, so they will be picking up a good deal of our operations and our personnel in the Houston office to enhance and grow the South Texas position.

John Elias

We don’t have any overlap within – in the mid-continent, the Rocky Mountains. We do in Southern Louisiana, minimal in South Texas and in the Permian Basin. So there are synergisms and savings there. We also should benefit from the fact that they have the necessary equipment and staff to build their own locations for drill site, which I think will be cost-effective. They have rigs which are not applicable to the areas that we are involved in but utilized in their operations. We are also, as John Tugwell mentioned, increasing supply shortage for tubular goods and that sort of thing, which they can provide to us and some of our operations to help us continue to move forward as planned and hopefully expand as we move into the next year. Both of us have staff requirements. We have some opening that we have not filled because of the process we are going through and they have some openings in their office in Oklahoma City they’d like to fill. So we are going to be looking at the blend of that over the next several weeks and trying to put the best and most solid and effective organization to move this Company forward in an effective manner.

Sachin Cheksal – Sandell Asset Management

Okay, that’s very helpful. And Chaparral has had a lot more experience what I understand with enhanced growth related investing in EOR projects things like that. How do you expect I guess the combination to help you from that perspective?

John Elias

Well, for ours, they have made a major thrust into the enhanced oil recovery projects, waterflows, tertiary projects with injects into the CO2. We do have several members of our staff who have come to Edge from big companies where they did have involvement in EOR projects. So, we are not ignorant in that particular area, but many of the fields in the Permian Basin, and as John Tugwell just mentioned, the shallow San Andres, Premier, Grayburg, so on success that we have had out there in the multiple locations, that kind of complex is amenable to waterfloods and tertiary so we will get the benefit of that as well. And then there is an increasing emphasis on the application of tertiary projects here in the Gulf Coast rocks. There are companies that I won't mention at this juncture that who are in the process of moving pipelines into this areas to transport CO2 and of course that CO2 supply base if you have that leveraging that into ownership in fields that have that applicability for them is I think going to be quite beneficial to the combined entity.

Sachin Cheksal – Sandell Asset Management

Okay, great, thanks.

Operator

Thank you. And at this time there are no further questions. I would like to turn it back over to Mr. MacLeod for any additional or closing remarks.

C. W. MacLeod

Thank you very much for joining us today and have a good day. Thank you.

Operator

Thank you. That concludes today’s conference. We appreciate your participation. You may now disconnect.

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