Rosetta Resources Inc. Q2 2008 Earnings Call Transcript

Rosetta Resources Inc. (ROSE)

Q2 2008 Earnings Call Transcript

August 11, 2008 11:00 am ET

Executives

Randy Limbacher – President and CEO

Mike Rosinski – EVP, CFO, Treasurer and Secretary

John Clayton – VP, Asset Operations

Jim Craddock – VP, Drilling and Production Operations

Analysts

Jason Wangler – Dahlman Rose

Mark Lear – Sidoti & Company

Robert Rodriguez – First Pacific Advisors

Geoffrey Stewart – Reed Conner & Birdwell

Presentation

Operator

Good morning, everyone, and welcome to Rosetta Resources Second Quarter 2008 Conference Call. Today’s conference is being recorded and all lines have been place on mute to prevent any background noise. If you are not able to participate in the conference call, an audio replay will be available from 10:30 AM Central on August 11, 2008 through 12:00 AM on August 18, 2008, by dialing 888-203-1112, or for international 719-457-0820, and entering the conference code 8491222. A replay of the call will remain online at www.rosettaresources.com for 60 days after the initial call. To access the replay click on the Investor Relations section of our website and select Presentations and Events.

Prepared remarks will be delivered this morning by Randy Limbacher, Rosetta’s President and Chief Executive Officer, and Mike Rosinski, Chief Financial Officer and Executive Vice President. At this time, I would like to turn the call over to our host, Randy Limbacher. Mr. Limbacher, you may begin your conference.

Randy Limbacher

Thanks, Sean. Good morning and thank you for joining us for our second quarter 2008 conference call.

Before we proceed, I want to take care of a few administrative details. First, I want to introduce you to two members of Rosetta’s executive team that are here with us today. John Clayton, our Vice President of Asset Development and Jim Craddock, Rosetta’s VP of Drilling and Production Operations are sitting in on the call today. They don’t have prepared remarks; however, they are available for question and answer if needed.

As many of you know, John and Jim joined Rosetta about three months ago and they’ve already made a very significant impact on the company. Our next piece of business is to ask Mike Rosinki to read Rosetta’s safe harbor statement. Mike?

Mike Rosinski

Thank you, Randy. All statements other than statements of historical fact included in this presentation are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and are subject to a number of risks, uncertainties and assumptions, which are more fully described in Rosetta Resources annual report on Form 10-K and quarterly reports on Form-Q filed with the Securities and Exchange Commission. These risks, uncertainties and assumptions could cause actual results to differ materially from those described in the forward-looking statements. Rosetta Resources assumes no obligation and expressly disclaims any duty to update the information contained herein except as required by law. By the way, please note that Rosetta filed its second quarter 2008 10-Q last Thursday evening, August 7. It can be accessed via our website under the Investor Relations tab.

Randy Limbacher

Thanks Mike. Our call agenda for today will include a review of the second quarter of 2008 and an update of our guidance for the year including a reminder about our current hedge positions and some comments on our pending lawsuit with Calpine. This material will be covered by Mike and then I will provide an operational update of the quarter followed by some comments about our ongoing priorities and goals for the remainder of the year. And after our prepared remarks, we will go to the Q&A session.

But before I ask Mike to make his remarks, I want to foot our results for the quarter and for the year to date and do some context. We are at the halfway mark in the year for our company and we’ve got a lot to be very excited about. As we entered the year, we were forthcoming about our plans to shift our focus away from high decline conventional programs and towards unconventional types of assets. That is a business we know well and one we think Rosetta is uniquely positioned to undertake. The Rosetta of the future will be all about inventory and execution.

For the first six months of the year, we’ve been busy staffing our organization and putting an unconventional lens on the current assets in our portfolio. As you know, today we have attractive positions in several prolific unconventional basins but they’ve not been studied in the past with a goal of identifying sustainable inventory from zones other than the conventional targets we’ve pursued historically. In addition to putting this new lens on our existing assets, we’ve also ramped up our efforts to screen other basins for possible new play entry and identify attractive bolt-on acquisitions such as the Petroflow deal we announced this quarter. As Mike will report in a moment, our quarterly performance was strong. Most importantly your company met or exceeded expectations for the quarter and that is a core tenet of how we want to do business at Rosetta. Our performance was buoyed in part by healthy prices, but also by solid volume performance which somewhat exceeded our expectations.

All of our core area volumes grew year-on-year and we had sequential growth in the Lobo and Rockies. Sequential declines in Perdido and the Sacramento Basin were impacted by a decision to slow our program pace pending studies. We will put some more color on that in a moment. Our retooling effort has put us a little behind pace on our organic capital spending for the year; however, we do expect to ramp up in a few areas notably South Texas and the Rockies by year-end or early next year.

I wanted to make these opening comments because I think it is important for our stakeholders to understand fully the shift that is underway at Rosetta. It is also important to understand that we are taking the necessary time and measures to implement this program shift to unconventional repeatable programs in a careful thoughtful manner. We believe this patient approach will pay off in the future.

Now I ask Mike to go ahead with his review.

Mike Rosinski

Thank you, Randy, and again welcome to our second quarter 2008 earnings call. I want to remind you that much of the information we will cover today is contained in our recent 10-Q filing. One other point; please note that Rosetta’s revenues and production for the quarter do not include consideration of estimates regarding the Non-Consent properties under the transaction with Calpine that closed on July 7, 2005.

Thanks to strong prices and strong volume performance, Rosetta delivered another very successful quarter. Net income this quarter was $39.3 million, up 200% compared with net income of $13.1 million in the second quarter of 2007, and up 43% compared to $27.5 million in the first quarter of 2008. This quarter’s diluted earnings per share were $0.77, up 198% compared a year ago. Production in the quarter averaged almost 155 million a day, up 29% from the 120 million a day reported in the comparable period of 2007 and up 2% sequentially. Volumes were slightly ahead of our guidance due to stronger than expected performance in the Lobo and from the Gulf of Mexico and State Waters, which are holding up better than expected.

Natural gas processing elections also resulted in better liquid performance. The average realized gas and NGL price for the quarter was $10.30 per mcfe including the effect of hedging, and realized oil prices averaged $124.51 per barrel. Revenues for Rosetta totaled $154.5 million, including a hedge loss of $16.6 million. Total revenues were up 78% from the prior year second quarter and up 20% sequentially.

Total lease operating expenses which includes direct LOE, work over expense, ad valorem taxes and insurance was $14.2 million or $1.01 per mcfe, about $0.14 better than the second quarter of 2007. Direct LOE was $8.3 million or $0.59 per mcfe which is about $0.05 per mcfe better than last year’s second quarter. This variance is attributable to lower direct LOE in the Lobo and Perdido regions as well as the impact of bringing on new volumes in the Texas State Waters.

Work over costs in this quarter were $2.4 million or $0.17 per mcfe for the period. Ad valorem taxes were $2.8 million or $0.20 per mcfe and insurance was $600,000, which is $0.04 per mcfe. Production taxes were $5.8 million or $0.41 per mcfe and treating transportation and marketing charges were $2.6 million or $0.18 per mcfe.

Depreciation, depletion and amortization was $51.7 million based on a DD&A rate of 367 per mcfe. This was an increase versus the same period for 2007, exactly on guidance with the projections we provided in our last quarterly call. General and administrative costs, including noncash stock compensation expenses of $3.4 million, were $13.5 million for the second quarter compared to $9.9 million in the second quarter 2007. This quarter’s G&A includes $1.8 million costs associated with the Calpine lawsuit compared to $500,000 for the same period last year. Adjusting out the Calpine costs and noncash stock compensation expense for both periods, GA& was $0.59 per mcfe this year compared with $0.69 for 2007.

Cash provided by operating activities was $117.7 million for the quarter and capital expenditures were $86.4 million. This resulted in operating free cash flow of $31.3 million. Taking that all the way to the balance sheet, Rosetta entered the second quarter with $70.7 million of cash on hand which positions us very well financially for the future. I might also add that we extended our borrowing base to $400 million during the quarter. This gives us ample capacity to fund our growth plans and be optimistic. We think this is our real advantage compared to companies in this sector who have extended balance sheets. So, it was a very strong quarter for Rosetta both financially and operationally. As Randy mentioned, this year is on track with our expectations and we continue to be focused on delivering strong results.

With that let me iterate our projections for the year and provide an update on our hedge position and our pending lawsuit with Calpine. As we stated in our press release, we are maintaining our guidance on volumes for the year at $140 million to $150 million a day. We slightly exceeded the top end of that range in the second quarter and on a year to date basis are running ahead of this estimate. However, most of the overage compared to our estimate is attributable to stronger than expected performance from our Gulf of Mexico and State Waters properties. We expect those volumes to go on decline in the second half of the year.

By the way, just for your info, Sabine Lake and the Gulf of Mexico were shut in for two days last week during tropical storm at Eduardo. For the remainder of the year, unit cash costs are expected to be in line with the second quarter actual results. This reflects our focus on production optimization. Unit depletion, depreciation and amortization costs are expected to average 3.55 to 3.75 per mcfe.

The company’s hedge position is unchanged. The company has fixed priced hedges as follows; 68 million a day is hedged for the balance of 2008 at an average price of 7.75. For 2009, 52 million a day is hedged at an average price of 7.65 along with 10 million a day for 2010 at an average price of 8.30. Additionally, the company has entered into costless collar transactions of 5 million a day for both 2008 and 2009 with an average floor price of $8.00 and an average ceiling price of $10.27. We continue to monitor the market for additional hedging opportunities; however, we believe we have a full complement of hedges at this time.

We expect our capital spending for the year to be $290 million which is unchanged from prior guidance. However this estimate now includes the nearly $30 million for the property acquisitions in San Juan basin, which is consistent with a slightly lower organic pace that Randy already covered. Randy will cover some of the asset program details more in a moment.

Now with respect to Calpine, the discovery process is continuing, and as you may be aware the PA Consulting Group is one of Calpine’s bankruptcy experts. PA acted as Calpine’s 30(b)(6) fact witness and as we analyze their depositions, which were taken earlier this year, we are surprised to find that Calpine’s $400 million claim includes more than $200 million in value for prospects that Calpine never owned and that Mr. Andrew Ray [ph] of PA submitted an expert report that includes faulty data and inappropriate methodology. This has only served to reinforce our view that the lawsuit brought by Calpine is baseless.

Additional information we uncovered letters to file a motion that contends that PA should be disqualified from providing any opinions on at least two grounds. First in May 2008, Calpine and PA agreed to a revised engagement agreement under which PA’s Todd Filsinger agreed to serve as Calpine’s Interim Chief Operating Officer and thus PA became eligible to receive a success fee. In addition to Mr. Filsinger dual role, PA’s potential recovery of an additional fee effective the outcome of the case in which it rendered expert testimony violates the code of professional responsibility, which we believe, requires PA’s disqualification. Second as the consultants who advised Calpine to file the lawsuit, PA lacks independence and has conflicted from rendering an impartial view on valuation.

We have also filed a letter with the Bankruptcy Court describing the legal deficiencies in Calpine Corporation’s claims and are requesting a conference with the Court prior to filing a motion for summary judgment in our favor as to all claims by Calpine. We are seeking dismissal of the lawsuit given the evidence the transaction by which we acquired the oil and gas business conducted by Calpine Corporation’s subsidiaries establishes that Calpine did not transfer any property to Rosetta and is legally prohibited from challenging transfers made to Rosetta by Calpine’s subsidiaries, Calpine Fuels Corporation and Calpine Gas Holdings. The Bankruptcy Court has not yet set a date for the conference on our motion for summary judgment, but has set August 27, 2008 as the hearing date for Rosetta’s motion to disqualify PA. The bankruptcy court has not set a trial date at this time. The bottom line here is that we see nothing to change our outlook on the Calpine matter and we continue to defend our position that their claims against Rosetta are baseless and without merit.

Now, before I turn the call over back over to Randy, I would like to address the often-asked question, how does the Calpine situation affect our ability to implement our business strategy? My first point is that we are running the business on a day to day basis okay, Calpine is not having a major impact on that front. But it does have a number of significant impacts in that, first, it is a significant management distraction. Second, as you all know, it’s caused us to incur significant incremental G&A costs, and in effect the size of M&A opportunities that we can consider. It also affects the timing of any asset divestitures we might consider. These factors are all reasons why we are working very hard to put the Calpine matter behind us as quickly as we can.

That concludes my comments. I will turn the call back over to Randy.

Randy Limbacher

Thanks, Mike. Let me give you a bit of an operational update now. During the quarter, we drilled 35 gross and 28 net wells with an 87% net success factor. Our year to date drilled well count is 71 gross and 61 net wells with a success rate of approximately 85%. Through six months, our drilling pace is running behind the midpoint of the target wells we’ve projected for 2008 of 190 wells. As I already mentioned, we intentionally slowed our pace in the first half of the year as part of our concerted effort to perform comprehensive assessments of our existing assets that are focused on identifying repeatable program inventory from largely unconventional targets that were overlooked in the past. We’ve made progress on these efforts, including staffing, and we expect drilling activity to pick up in the fourth quarter or early next year.

Now I’ll do a quick review of our core area programs and results. California is one of the areas we slowed down our program pending field studies. As most of you know, the Rio Vista field has significant stack with roughly 16 reservoirs from 4,000 to 12,000 feet. We believe there could be upside here in tighter or unconventional formations that were not previously recognized or studied. Several studies are just now getting underway. However, based on very preliminary study results so far, we intend to reduce our effort in the more conventional low pressure Amy [ph] and Hamilton zones.

At the time of the Rosetta spin-off, we hoped that these conventional programs would yield some upside to proved reserves but the results of our CapEx to date has not shown that to be the case. Our 2008 drill bit program will shift to development programs targeting intermediate depth to infill and extension opportunities like the Capelli and Martinus [ph] as these have been successful in the past. This is a continuation of our extension program to the south.

Late in quarter, we moved our rig back to the Sacramento Basin to begin drilling this programs and we drilled one well, which was successful. Production in the Sacramento Basin averaged 44 million a day for the quarter, up 3% compared with the same period of last year. Volumes were down on a sequentially basis reflecting the slower program pace.

In the Rockies, we continued to expand production through drilling programs in our DJ and San Juan lease hold positions. In the DJ basin, we drilled 12 wells in the Niobara play during the second quarter, ten of which were successful. During the quarter, we successfully implemented an improved frac design to reduce profit flow back and improved well performance. This is also an area where we are actively studying our asset position to identify repeatable inventory that was not recognized in the past.

Some of our early work has been very encouraging. For example recall that the current well spacing in the Niobara play is 40 acres. We’ve evaluated our assets fully or more fully on that spacing and believe we may have close to 500 well locations that we can add to our inventory. Further, we along with other operators in the basin are beginning to evaluate the viability of increased well density. So this is another example of how we are taking a different approach to the business than Rosetta’s historical approach.

In the San Juan basin, we drilled five wells during the quarter; all were successful. And as we recently announced, the company acquired a non-operated interest in a producing property in May 2008 for a purchase price of approximately $29.5 million. This property is adjacent to our existing operated property in the Fruitland Coal play. Production from this property is expected to average 2 million a day net in the third quarter of 2008. So for obvious reasons, we like the San Juan basin, and we will continue to study and build our position there. We’ve organic opportunities, including infill proven coal potential and we will continue to look at bolt-on M&A opportunities.

For the quarter production from our Rockies properties averaged 11 million a day up 21% and 69% respectively from last quarter and the same period last year. For the remainder of 2008, we plan to drill approximately 40 wells in DJ and San Juan as we continue to development of these fields. In the Lobo, we continue to run two rigs continuously in the trend. In the second quarter, we drilled 13 wells, 10 of which were successful for an 83% success rate. We continue to focus on areas covered by 320 miles of 3D seismic data and we look to South Texas where Rosetta has a sizable acreage position of about 90,000 acres as an area to evaluate and test resource play potential not previously identified.

Our production averaged 51 million a day up 34% from last quarter in the Lobo. And for the remainder of 2008, we plan to drill approximately 24 Lobo wells with our two-rig program. In the Perdido area, we drilled 2 wells with a 100% success rate during the quarter. Production averaged 8 million a day during the quarter down from the 11 million a day in the previous quarter. A significant producer in the field went down unexpectedly and is currently being worked over. While production in this area can be expected to be bumpy as new wells come on and older wells experience declines, we expect the overall trend to continue up as development progresses.

In Sabine Lake, we completed drilling the State Tract 30-3 well, a step out to our successful discovery late last year. The 30-3 was completed and tied in in July and is currently flowing about 8 million a day gross. And our Texas State Waters areas, which includes Sabine lake, we averaged 13 million a day for the quarter. In the Gulf of Mexico, production was 15 million a day, down 9% versus last quarter. This is an area where we expect there is downside pressure on volumes, and as you know we are entering the peak of storm season. Also our production in the area is concentrated, meaning several key wells make up a significant portion of the production.

That’s a quick review of our second quarter operational programs and plans. We’ve seen continued strong production performance with the quarter coming in at almost 155 million a day, a bit above the high end of our annual guidance range. Nevertheless as Mike also mentioned, we plan to maintain our full year guidance between 140 million and 150 million a day. The reduced drilling pace we saw earlier this year as we retooled in some areas and increased emphasis on lower rate but more repeatable plays, the potential for volatility in conventional reservoirs like the Gulf of Mexico and the possibility of tropical storm impacts on offshore or inland waters facilities dictates the measure of caution as we project second half volume.

Now that’s a good segue to a review of our priorities for the remainder of 2008. These comments will be very consistent with my opening remarks describing our strategy shift as a company. Of course, our number one priority is to get the Calpine matter behind us. There is not much to say beyond Mike’s earlier comments except to reiterate our position that this is completely and utterly frivolous. Our next priority is to continue building our organizations by attracting and recruiting the right people for Rosetta. We’ve made some very significant progress in this area during the last several months. Our operation senior leadership team is in place with John and Jim, and under their direction we’ve made several key hires.

We’ve also restructured the operations organization into assets teams with functional support. The asset teams consists of petrotechincal staff with responsibility for the full evaluation of our existing assets. So far we’ve created six assets teams and made significant progress in staffing them with a combination of Rosetta incumbents and new hires who bring track records of success at a resource based model. In addition, we’ve created and made good progress staffing a new ventures group that is responsibility for evaluating new basins. Finally, we also created and filled several other key operational roles, including a chief engineer, a procurement manger and a regulatory manager. I am very pleased with our success in building an experienced team to support our inventory and execution thrust. This is work that gets our full attention and is critical to our success.

The next focus area for Rosetta is resource or inventory and I have mentioned inventory on several occasions throughout these prepared remarks. This is critical for our success. We have a preference for opportunities which we hope will be identified from our numerous studies in existing assets and basins of interest. We believe Rosetta is well positioned to be successful in this pursuit. We started with a good set of core properties in Sacramento Basin, DJ Basin, San Juan and South Texas. These are prolific hydrocarbon basins with lots of stack. A high working interest and operatorship in many of assets areas and our early work is producing encouraging results such as in the DJ Basin with plans to test additional down spacing ideas and in the San Juan Fruitland Coal.

Given our very strong financial position, we are also willing to consider inorganic opportunities such as the Petroflow deal that can add inventory in an around our core areas or provide entry to a potential new core area. Now, it is premature to begin discussing specific opportunities; however, we have a few ideas in the late stages of study or negotiation and I look forward to updating you on those in the near future. What’s really exciting about our new inventory approach is that Rosetta is of a size where one or two ideas per year can be very leveraging. Our goal is to have a pipeline of organic and inorganic opportunities at all times. And again you could look forward to ongoing updates on our assets evaluations and possibly new play entry as the next several quarters play out.

The final focus area where we are addressing as a priority is execution in all facets of our business. As I’ve said many times, this is an area where companies can always improve. Several projects are getting underway to address this priority, especially in reserves engineering, strategic planning, procurement and operations analysis. And as I mentioned a minute ago, we have made some key hires recently that will accelerate our progress in building our execution abilities. We’ve got a lot going on in Rosetta and it’s an exciting time for our company. We are implementing our plan 2008 capital program but in a thoughtful way that won’t overcapitalize programs where we cannot generate repeatable inventory to drive sustainable results.

At the same time, we are working very hard to identify opportunities for future investments. Prices have provided a strong boost to our financial performance but we are not resting. It will continue to be a busy year for Rosetta. All of us are very optimistic about the path we are on and look forward to updating you throughout the year.

With that I will turn the call back to the moderator and we will now take your questions.

Question-and-Answer Session

Operator

(Operator instructions) We will go first to Jason Wangler of Dahlman Rose.

Jason Wangler – Dahlman Rose

Good morning, guys. Nice quarter, nice update.

Randy Limbacher

Thank you.

Jason Wangler – Dahlman Rose

Just curious as far as the Calpine lawsuit, is there anything else that they can bring into the lawsuit, is it pretty much on their end going forward everything they’ve addressed and announced that’s all they can go with?

Mike Rosinski

The answer to your question is that there is nothing settles down. I don’t believe that there is an endpoint. We expect them to raise additional points as times goes on, and it’s just a matter of what they come up with, but there probably will be more points from them in the process.

Randy Limbacher

I would say discovery is continuing and there is not a firm timetable to complete that discovery.

Jason Wangler – Dahlman Rose

Okay. And just Mike you gave a great update as far as kind of what the lawsuit is affecting you guys, is it affecting at all the organic operations as far as drilling, or are you guys looking at that as you guys have so much inventory and just taking that kid of I guess separate from the lawsuit?

Mike Rosinski

Inventory is being taken separately from the lawsuit. And as far as our organic activities, we don’t see any significant affect at all from the lawsuit.

Jason Wangler – Dahlman Rose

Okay, great guys. Thanks.

Randy Limbacher

Thank you, Jason.

Operator

(Operator instructions) We will go next to Mark Lear with Sidoti & Company.

Mark Lear – Sidoti & Company

Good morning, gentleman.

Randy Limbacher

Hi, Mark.

Mark Lear – Sidoti & Company

Nice quarter. I was wondering if you could give me a little more detail on the San Juan basin acquisition just in terms of acreage and pud opportunities or probable opportunities as well?

Randy Limbacher

You bet. I am going to let John Clayton answer that.

John Clayton

Yes, Mark. We did the, what we call, our Petroflow acquisition in the second quarter. I will talk a little bit about what was proven and what we see for upside. We spent about $29.5 million and we picked up right at 10 bcf of proven reserves which gives us another 10 to 12 locations to drill on a 160-acre spacing. That’s not why we did it though. If we can down space this asset which we believe is technically feasible to do pending regulatory approval, we will pick up an incremental 70 wells to drill on this location. This location also is right adjacent to our existing properties, so we know quite a bit about the area that we are working.

Mark Lear – Sidoti & Company

Got you. And you mentioned you aren’t the operator, did I hear you right?

John Clayton

No, we are not. We operate the field right next to it, and we picked up a 50% working interest in this acquisition.

Mark Lear – Sidoti & Company

Got you. You – Mike, I guess you made a little mention in terms of Calpine impacting the size of any M&A going forward, I was wondering if there are any specific parameters in terms of size of deals you were looking at?

Mike Rosinski

Yes. We mentioned Mark in our comments that we ended the quarter with $70 million of cash on the balance sheet. We also mentioned that we increased our borrowing base so that under our facility we have approximately $230 million of unused capacity under our revolver. Add the $70 million on top of that, and it gives you a sense of what we think to be the upper end of the range or something we could do readily. If we sauce up things slightly above that, we might be able to add borrowing capacity based on assets acquired. But I think that $300 million gives you kind of a most likely estimate of what we are thinking.

Mark Lear – Sidoti & Company

Got you. Sounds good, thanks a lot.

Randy Limbacher

Thank you.

Operator

(Operator instructions) It appears we have no further questions on the phone at this time. We do have one person signaling, hang on just a moment. Robert Rodriguez with First Pacific Advisors.

Robert Rodriguez – First Pacific Advisors

Hi, guys. Just a housekeeping item in here. Could you just go over a little bit of the accounting on what you are doing, on the derivative accounting instruments on the balance sheet because obviously they changed quite sizably? And secondly how the accumulated other comprehensive loss is working through the financial statements?

Mike Rosinski

Right, Rob. When we began our hedge program, we consciously decided to do cash flow hedges, which means all of the hedges that we put in place are matched up against specific reductions in specific areas. Hedges are priced at the same index that the physical production is priced at in the cash market. Therefore, we again qualify for cash flow hedging. What that means is that the changes in the mark-to-market position of our future hedges is all handled on the balance sheet in other comprehensive income on the shareholder equity section. There is no current income statement impact to any of our hedge activity other than the amount that is settled with our couterparties during the current period. So, that’s the reason why we have been reporting continually improved earnings quarter over quarter. And again as I mentioned in the second quarter of this year, we recorded a $16.6 million hedge loss. Again, that was taken against the current period; everything else that we did in the way of marking to market is another comprehensive income on the balance sheet.

Robert Rodriguez – First Pacific Advisors

So just to clarify that one more time, that $16.6 million hedge loss you’ve seen, that’s what’s flowing through that other comprehensive?

Mike Rosinski

No, that flows through the income – the current period loss flows through the revenue line in our income statement. And those are the hedges that we have in place for the second quarter of 2008. The other comprehensive income on the balance sheet is the mark to market position of our hedges for future periods. And as that mark-to-market position fluctuates, it’s recorded in the shareholders’ equity section of the balance sheet.

Robert Rodriguez – First Pacific Advisors

Okay, so for purposes right now, given that the markets have declined recently, that would be working counter to that comprehensive loss that we bring –

Mike Rosinski

That’s exactly right. You’ve seen on our balance sheet a big negative other comprehensive income as of June 30. And to the extent that – and by the way, we would mention that we were near a peak at the end of the second quarter in pricing. We said in our 10-Q, we were 13.10 on NYMEX and oil prices were above 140. So, we mark to market based on forward curve. To the extent that the curve has come off and stays off, you will see us reverse, if you will, that mark to market position in future quarters and take it down from where it was.

Robert Rodriguez – First Pacific Advisors

And that would be – for example the 13.10 at the quarter, that would be in relationship to the hedge prices that you are using?

Mike Rosinski

Right, but that’s the NYMEX price – no, that’s the Henry Hub price, and as you know our production is in various areas throughout the country, so we’ll hedge –

Randy Limbacher

– basis differential adjustment for the various reasons where we price our –

Robert Rodriguez – First Pacific Advisors

I understand, I was using that as a short-term way of getting to it.

Mike Rosinski

Yes, correct.

Robert Rodriguez – First Pacific Advisors

Okay, then. Thank you very much and keep it going.

Randy Limbacher

Thank you.

Operator

And we will go back to Mark Lear with Sidoti & Company.

Mark Lear – Sidoti & Company

Hi. I just had one more question. It just looks like Lobo just had a nice rip sequentially in the quarter. I was wondering if you could kind of give me an idea there is a backlog of wells that you put on or what was kind of driving that big growth in production there?

Randy Limbacher

Jim, you want to take that?

Jim Craddock

Sure. Yes, Mark. It has been nice; it has been a nice run there. It was really a backlog of wells, but we’ve seen first delivery in some – quite better than typical wells there over the last quarter, and that’s been the main driver behind the improved performance. Obviously, going forward, we’d say we can’t anticipate seeing those better initial rates every time, but it sure not going to happen.

Mark Lear – Sidoti & Company

So, more in terms of you guys think you hit a sweet spot or are you changing kind of what you are doing technically?

Jim Craddock

Yes, I guess you could think of it as a sweet spot. So we have seen wells that have higher – has first delivered at higher initial rates but they offer a high decline as you know. And so those come off pretty fast, but it’s just a function of picking targets and drilling them and we’d expect to see more typical results going forward. But as far as the pace, we are really on that kind of four well a month pace that we mentioned previously, and so it is really not a backlog situation nor will it be going forward.

Mark Lear – Sidoti & Company

Understood, thanks.

Jim Craddock

Thanks, Mark.

Operator

We’ll go next to Geoffrey Stewart of Reed Conner & Birdwell.

Geoffrey Stewart – Reed Conner & Birdwell

Good morning, guys.

Randy Limbacher

Good morning

Geoffrey Stewart – Reed Conner & Birdwell

I had a question about the production taxes, I was just curious if you could explain the some more meaningful chunk definitely on a year-over-year basis but also sequentially when I look at it on an mcf basis in the quarter?

Mike Rosinski

Geoff, we mentioned in the past that most of this production is in Texas. It qualifies for tight credits, in other words, it’s tight gas and so the state will give you credits against your production taxes in the period. (inaudible) advices me that the state is backlog in processing our application and so where we would normally reduce these production taxes for tight sands credits, we have to wait till we get approval from the state. We are taking a conservative approach, we have estimated that those approvals will occur in the third quarter or the fourth quarter at the latest. So, what you are seeing is an anomaly that you should not view as a trend, but rather if you will a fluctuation of the curves based on timing of getting these applications for tight sand credits approved.

Geoffrey Stewart – Reed Conner & Birdwell

Got it, okay. It just seemed relatively high looking back over various quarters?

Mike Rosinski

You are right. In fact I think – I don’t recollect – perfectly recall, but I do believe that second quarter of last year may have been a quarter where did get some approvals. So, apples to apples, you’ve got a little bit of inconsistency that I expect will reverse itself later in the year.

Geoffrey Stewart – Reed Conner & Birdwell

Okay, thanks for the explanation. On just another point, and Randy, when you were talking about as far as focus on California sort of re-shifting sort of the strategy there and what you are looking for, are you having any difficulty or expect to have any difficulties just based upon the kind of formations you are looking at, the kind of places you are looking at doing as far as the necessary rigs or services that you might need in the area?

Randy Limbacher

No, actually, we are not seeing any issues in any of our operating areas as far the availability of rigs and services right now. The only question, Mark, is – Jim can add too, but is on tubulars, we’ve seen the same pressure there as everybody else have.

Geoffrey Stewart – Reed Conner & Birdwell

Okay. So nothing in particular in California though?

Randy Limbacher

No.

Geoffrey Stewart – Reed Conner & Birdwell

Okay, all right. Thanks, guys. Keep up the good work.

Randy Limbacher

Okay, thank you.

Operator

We will go back to Robert Rodriguez of First Pacific Advisors.

Robert Rodriguez – First Pacific Advisors

I just wanted to get a sense after your recent acquisition about how you are going to go through Randy is there a focus there or if there was an acquisitions that became available, say, in the second half of this year since you’ve already quantified a purse of $300 million, can you take me through what your thinking is about how you want to stage these things, or is it going to be more a function of the – an opportunity that presents itself?

Randy Limbacher

I think it’s a combination. But right now, what we are thinking about as far as the M&A piece of it, Mike said that kind of pre-Calpine, we think we could do up to about $300 million transaction. Post Calpine settlement, it could probably be something in the order of $500 million with a plan to sell the assets probably offshore and inland waters in order to bring the balance sheet back in shape. We’ve got our new venture team staffed right now, and so we are out looking for those opportunities. But I think it’s going to be more opportunistic as far as when it hits, but again we are looking for things that can eventually become core areas for us so they have to be big enough that it matters, things that fit our skill set and also things that will generate a sustainable inventory of opportunities which are going to be more of the resource play focus and that of course is going to make economic sense for us at the end of the day as well.

Robert Rodriguez – First Pacific Advisors

Okay, thank you very much.

Randy Limbacher

Thank you.

Operator

We’ve got no further questions on the phone at this time. I’d like to turn the conference back over to Mr. Limbacher for any additional or closing remarks.

Randy Limbacher

Okay. Thank you, Sean. We appreciate the comments and questions and your interest in the company. And so please feel free to give us a call if you have anything else that comes to mind that you want to discuss. Again, thank you and we will talk to you next quarter.

Operator

Again, Ladies and gentlemen, this does conclude today’s conference. Thank you for your participation. You may disconnect at this time.

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Comments

[Urbane Gori...:]

A personal note... At least for me, the product is an expensive waste of time.Take a class at your local Junior College.

jegan ;-)

2008 Aug 17 01:47 PM