SM Energy Co (SM) 2003 Q1 法說會逐字稿

Good morning.

My name is Tonya and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the St. Mary Land & Exploration first quarter 2003 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speaker’s remarks, there will be a question and answer period.

If you would like to ask a question during this time, simply press star, then the number 1 on your telephone key pad.

If you would like to withdraw your question, press the pound key.

Thank you.

Mr. Hanley, you may begin your conference.

Thank you, Tonya, and good morning to all of you joining us by phone and on-line for St. Mary Land & Exploration Company’s first quarter 2003 earnings conference call.

Before we start, I need to read the following statement.

Except for historical information, statements made during this conference call, including information regarding the business of the company may be forward-looking statements.

These statements involve known and unknown risks, which may cause the company’s actual results to differ materially from forecasted results.

These risks include such factors as uncertainties in cash flow and reserves, oil and gas operating risks, volatility of oil and natural gas prices, the need to replace reserves depleted by production, competition, and the potential impact of government regulations, litigation, and environmental matters.

On-line this morning are Mark Hellerstein, Chairman, President and Chief Executive Officer;

Ron Boone, Executive Vice President and Chief Operating Officer;

Rick Norris, Vice President of Finance; and myself, Bob Hanley, Vice President Investor Relations.

I will now turn the call over to Mark.

Good morning.

A combination of high prices, a 30 percent increase in production and reasonable costs, was a formula for record profits in the first quarter of this year.

St. Mary earned $32.8 million or $1.08 per basic share, compared to 2.3 million or $.08 per basic share in the first quarter of 2002.

Included in the current quarter results is a $5.4 million or $.18 per basic share after-tax gain, resulting from the required adoption of financial accounting standards number 143.

And at this pronouncement, we are required to book the present value of our estimated P&A liability.

In our case, we booked a liability March 31st of $24 million.

The reason we have a gain from this change in accounting principal is that the prior accounting method did not consider the estimated salvage value of about 42 million in our [indiscernible] calculation, resulting in too much [indiscernible] expense being recognized.

Although our balance sheet now shows a liability of plugging and abandonment, it does not recognize the salvage value.

With the Flying J transaction and the convertible note issued last year, our financials are a bit more complex and require additional comment.

As you may recall, we issued approximately 3.4 million shares of St. Mary stock acquired most of Flying J oil and gas assets.

In addition, we made about a $72 million non-recourse loan to Flying J, which is secured by St. Mary stock.

On the balance sheet, between debt and shareholder’s equity, the shares of Flying J will be shown as temporarily issued subject [indiscernible] and will be offset by the $72 million note receivable from Flying J. Interest on the note will not be recognized or accrued until it’s actually paid several years down the road.

I believe it’s very important that the readers of the financials account for these items properly in valuing St. Mary’s stock.

If you elect to count the 3.4 million shares outstanding, then you should give us credit for the 72 million note receivable.

Alternatively, both items can be ignored and value in St. Mary.

However, it’s inappropriate to count the shares as outstanding without giving credit for the note receivable.

As you know, we have a $100 million 5.75 percent convertible note outstanding with a conversion price of $26 per share.

For diluted earnings per share, the convertible note is presumed to have been converted with greater shares outstanding and lower interest expense.

Under this formula, earnings are variable while interest expense is fixed.

Because of the extraordinarily high earnings this quarter, the impact on diluted EPS versus basic EPS is more marked -- is larger than in prior periods.

Oil and gas equivalent production increased 30 percent to 18 BCF equivalent of which 65 percent was gas.

Higher production reflects the Burlington Resources acquisition, the Flying J acquisition for two months, and a ramping up of production at Northeast Mayfield, where we have had tremendous success through the drill bit.

Production [indiscernible] St. Mary at Northeast Mayfield has increased from about 9MMcf a day year ago to approximately 25MMcf a day currently.

The average price realized increased 79 percent to $5.33 per MCFE.

Costs generally remain moderate.

Oil and gas production costs increased $.16 to $1.18 per MCFE. $.13 of this was due to higher production taxes, which increased with higher prices.

Our G&A expense increased $.11 per MCFE to $.34 as a result of higher net profits [indiscernible] costs due to higher oil and gas prices which impact both the current payout amount, as well as the mark-to-market adjustment.

We also had higher charitable contributions, which are variable with earnings; higher pension expense due to a reduction in discount rate; higher corporate expense associated with increased insurance and governance costs.

In addition, [indiscernible] increased $.10, but our exploration expense decreased by $2.8 million.

Discretionary cash flow increased 134 percent to $56.9 million or from $.87 per share to $1.87 per share.

We closed the Flying J acquisition in January, as well as the remaining Fort [indiscernible] interest for $5 million.

We have now completed about $78 million of our $90 million acquisition budget.

Our balance sheet remains very strong at 331.

We have 71 million outstanding in our bank credit facility.

Today we only have $40 million outstanding in that facility.

Our current calculated borrowing base is $275 million, of which we have elected a current commitment of 150.

Acquisitions remain opportunity dependent, and because of our strong balance sheet, we are not limited to the targeted $90 million.

We have had approximately 46 percent of our gas production for the remainder of 2003 at a [indiscernible] max equivalent price of 474 per MMbtu.

We have also hedged about 54 percent of our oil for the remainder of the year at a [indiscernible] equivalent price of about $26.

Our forecast is updated and shown in the press release.

With that, we’ll turn it over to Ron Boone, who will go over our operations for the quarter.

We are very pleased with our activity levels and drilling success through the first quarter.

As of this week, we have eight St. Mary-operated rigs running and interest in 12 outside of the operated drilling locations.

A total of 40 wells, of which St. Mary has an interest, are currently either drilling or completing.

We feel the economic environment for drilling with current product prices and rig rates is as a favorable as we have seen in recent memory.

I would refer the listeners to our April 17th release outlining specific completions in the first quarter.

St. Mary participated in a total of 34 wells completed in the first quarter, of which 29 were completed as producers.

Of particular note is the recent development of Northeast Mayfield in the Atoka formation at approximately15,000 feet.

Although there has been scattered Atoke production in the area, the completion of Lavonne 1-20 in September of last year set off a flurry of new wells and re-completions.

Three new Atoka completions and one re-completion were made in 2002, but two of the wells producing have raised between 10 million and 15 MMcf a day.

In the first quarter, the Brothers 2-20, where St. Mary has a 34 percent interest, completed for 11.8 million a day and four additional Atoka wells were drilling or completing at the end of the quarter, including the Dikes 1-17 where St. Mary has a 19.3 percent interest, which is flowing 20 million a day into the pipeline from the Atoka.

In addition to our drilling success, as Mark mentioned, we have closed approximately $78 million of acquisitions in the first quarter and six transactions, the largest of which is the previously announced Flying J acquisition, which closed in January.

The Flying J transition -- transaction added nearly 21 million a day net production to St. Mary and 69 BCF equivalent of crude reserves as discussed in our 12/31/02 and 01/30/03 press releases.

In addition to being in excellent [indiscernible] Nance properties in the Williston, the Flying J acquisition provided an excellent expansion in the Powder River, the Green River, and the Green River basins.

Activity in both these areas expected to ramp up dramatically as our technical team gets up to speed on these new properties.

In the ArkLaTex region, we were very pleased with completion of our first St. Mary-operated James Lime completion at Huxley field, the USA “N” No. 2-H where St. Mary has an 80.7 percent interest completed for 3.8 million a day.

These multi-lateral horizontal wells with 10,000 to 12,000 feet of horizontal section can be drilled and completed for less than a million a day -- excuse me, completed for less than a million dollars and have excellent economics.

We have ten wells budgeted in our James Lime prospect areas in 2003.

At our [indiscernible] and Basin [indiscernible] project, where we control 143,000 gross acres in the northern part of the Powder River Basin, we are closely watching the reaction to the final record of decision issued by the BLM on April 30th.

The long-awaited record of decisions hopefully will open the door for new development on federal acreage in Wyoming and Montana.

Various environmental groups have already filed multiple challenges to the record of decisions.

We have budgeted a program of $1.6 million for testing and coring in our acreage positions in 2003.

Future development in this 150 or 200 BCF project, where St. Mary controls approximately 90 percent,will hinge on future gas prices and favorable results in the pending litigation challenging the validity of the BLM’s decision.

The majority of St. Mary’s lease hold however, are ten-year leases, which provide time for both pricing and legal questions that will resolve, if necessary.

We are starting our completion efforts at the Duchesne Deep prospect in Duchesne County Utah this week.

We have a completion design that we are pleased with and will be testing the well in the permanent production facilities at a new pipeline that we have constructed.

Production testing at this basin centered gas prospect targeting [indiscernible] sandstones will extend over the next 60 to 90 days.

St. Mary controls approximately 12,000 acres in the Duchesne prospect area with an ultimate interest of approximately 66 percent.

At Judge Digby, the major number 4, where we had 11.5 percent went on production in December, establishing production in the deepest field [indiscernible] discovered to date.

Field production levels for the first quarter averaged 178 -- excuse me 179 million a day, and St. Mary’s net production averaged 20.3 million a day and will benefit in the second quarter from the payout of the [indiscernible] Number 4, where St. Mary will back in for a 20 percent interest in the 22 [indiscernible] a day producer.

BP is currently drilling at 16,000 feet in the [indiscernible] No. 1 where St. Mary has approximately 10 percent interest targeting [indiscernible] zones through the C5 in an untested fall block on the west flank of Judge Digby structure.

A second rig is running in the field at the reentry of the IJ Major No. 3 where St. Mary has 11.5 percent interest, which will be deep in approximately 300 feet below the current TD of 21,024 feet to recovered prove reserves in the B8 interval identified in the drilling of the offset major No. 4 well.

The new 3D seismic survey which will cover St. Mary’s entire fee property and provide 3D over a significant portion of the property that has never been [indiscernible] as progressing well.

The total survey covers an approximately 300 square-mile area and St. Mary’s property is roughly the center of the survey area.

The drilling and loading of the charges on St. Mary’s property is essentially completed and actual shooting and recording of data is scheduled to start next month.

Final process data is expected to be available early next year.

St. Mary received a payment of 900 -- I’m sorry, $898,000 the first quarter for options and permits in conjunction with the shoot and has optioned approximately 14,969 acres, retaining a 25 percent royalty and the participation option in any new proposals.

St. Mary will also receive a complete data set covering our property at no cost.

At the carrier prospect, we have elected to terminate our sales effort at this time due primarily to the complexity of the land situation in the area.

We have been unable to make a satisfactory deal on land owned in our prospect area by another operator.

The majority of the acreage in the prospect expires the next 12 months, and we may pursue the prospect at a later date.

We still feel the prospect needs to be tested, but we could find very little appetite in domestic industry today for a prospect with this good profile.

With that, let me turn it back to Mark.

We begin 2003 with record earnings, although oil and gas prices have since moderated, they remain very strong.

Costs remain moderate.

Both our drilling and acquisition programs have gotten off to a fast start for the year with a solid inventory of prospects to be drilled.

In addition, results from our initial Duchesne well will be known within the next several months.

With a good start, good industry conditions, and optimism on our large potential place, we look forward to a successful 2003.

With that, we’ll turn it over for questions.

[Operator instructions.]

Your first question comes from Joe Allman of RBC Capital Markets.

Good morning, everybody.

Good morning, Joe.

Hi.

Sorry about that.

Hey, Mark or Ron, could you just give us an update on what’s happening in the Williston and specifically, on the Burlington properties you purchased, I thought you guys might be shooting a 3D there.

And could you also describe what’s the activity now versus what you expect it to be say six months from now or a year.

I think the activity is ramping up.

We have a number of 3D’s.

Those are fairly small contained 3D’s, we don’t shoot big -- and I think, forget, maybe we have ten or so of those budgeted for 2003.

So there is some delays between when we initiate the 3D’s, get in the field and get shooting.

We also tend to ramp that activity up as the year goes on, primarily because the winters are pretty tough up there in the springs, you’re fighting a lot of mud.

And so our activity tends to be geared up in the summer and fall and that that’s what we’re anticipating.

But, those properties are performing.

We’re doing a lot of work to kind of get them into the shape that we typically operate things and we’re busy.

It seems like that area is becoming increasingly competitive; is that accurate, do you think?

You know, we kind of feel the opposite.

We feel that we’ve really built a very substantial presence up there.

You know, we’re one of the major operators and we’ve had a lot of success up there with acquisitions, large and small the last couple of years, and really feel like we dominate that area much more than some of the other areas, like the Mid-Continent.

So we kind of consider that our playground and we’re kind of the biggest kid on the block.

And I just hear more companies getting active up there or getting a foothold up there.

This is kind of big picture.

I know that you’ve got a good balanced approach to your operations.

You’ve got some critical mass in several different areas.

But, in going forward, where do you think the biggest upside is?

Is it in the Rocky Mountains or is it somewhere else?

Well, I think we see a strong, growing presence in the Rockies and Duchesne is kind of the springboard for that.

One of the things we really liked about the Flying J acquisition was it increased our presence in the Green River, where we see a lot of growth potential.

We bought some properties in the [indiscernible] acquisition a year or so ago and we built on that.

So we like the Rockies as a growth area.

But, we also really believe in our core areas, and clearly the Mid-Continent has been spectacular the last year and into this quarter.

So we like the fact that we’re spread around and when something -- or a particular area -- takes off with a new player, new idea, we have the opportunity to jump in there.

Okay.

All right.

Appreciate it.

Thank you.

Your next question comes from Michael Scialla of A.G. Edwards.

Good morning, guys.

Good morning.

Could you walk me through your discretionary cash flow calculation per share.

What is the diluted share count you’re using there?

I believe it’s 34861 --

On diluted.

-- on diluted and it’s 3354 on the basic.

And what is the discretionary cash flow of 56.7 million?

56853.

Okay.

I don’t -- and you’re coming up with $1.87?

Yeah, that’s basic -- in the basic -- that’s on basic.

Okay.

Let me take you through -- this calculation is close, it’s not -- but, the 32.8 million of net income plus 189 [ph] of DD&A, 900,000 of impairments, 4.1 million of exploration, less the change in accounting principal of 5.4, and then deferred taxes of 5.8.

So on a diluted basis for the -- you come up with $1.63; sound correct?

That sounds about right.

Okay.

And then the Hanging Woman Basin, I know one of the issues up there with the coals is people not been able to co-mingle those with the current completion techniques.

Is there anything you’ve seen there as far as potential improvements on completion techniques there that might sort of unlock that plate for you?

Mike, that’s -- that is a big question.

We have seen some things that encourage us there.

I don’t think we’re over the hump, and we’ve really geared our plan with the assumption -- and running economics with the assumption that we would have to have multiple well borders.

But, I think there’s a very good possibility that we’ll have some success there.

We recently went back and redrilled our Roberts Coal using a conventional through casing completion, which is the type of thing that would enable you to do multiple zone completions in a single well bore successfully.

So we’re feeling pretty good about that, although we do have quite a bit of work left to do.

But, that is a big issue and I think the whole industry is trying to figure out how to solve that problem.

Okay.

Thank you.

Your next question comes from Dan Morrison of Aperion.

Good morning.

On the completion technology front, over in the [indiscernible] Mesaverde in Utah, have you all considered horizontals out there or is anyone else toying with some of the extensive multi-lateral horizontal stuff?

Dan, I think it’s probably too deep to really seriously consider that.

Of course, the completion technology with hydraulic fracturing that they’ve seen.

Specifically, Jonah Field has made tremendous improvements and advances and I really think that’s going to be the way to uncrack those -- or to crack that net and release those reserves.

And we’ve spent a lot of time with fluids, types of fluids, types of [indiscernible] and we’re very confident that we’ve got a good plan there.

I just -- I think, you know, we’re in the 14 to 16,000 foot range --

Right.

-- I just think that’s too deep for horizontal at this point in time just because of the expense.

We also have a number of -- what we have is we have sand packages that develop over about a 4,000 foot total gross interval and those individual sand packages would have to be individually drilled horizontally, which probably would be impractical, and we don’t have a big, continuous primary target such as we have at the James Lime.

So I don’t think it’s a very good application.

Also, out in that area, and a lot of guys that popped out there recently, are you all going to stick to your acres position or are you contemplating swapping around to spread your exposure more geographically?

Well, we’re opportunistic, so, you know, we’ll look at anything that comes across our desks.

We like our acreage.

We are where we are for a specific reason and it would take a project that has some of the same things that attracted us to Duchesne to cause us to want to spread out.

Okay.

Thanks.

Your next question comes from Jack Aydin of McDonald Investments.

Hi, everybody.

I’ve got a couple of questions.

Mark, I’m having trouble arriving on your fully diluted shares.

You did the Flying J close the deal 9th of January.

If you weighted the shares outstanding instead of accounting 33 plus, it comes to less than that.

Then why the share -- you know, I’m having tough time arriving at your fully diluted number of shares.

Yeah, let me take you through that.

Hold on one second.

I think probably the item that you’re probably not including is the convertible note.

And there we do the -- you know, as if its converted method where we basically add back the interest expense and then we presume that the $100 million is converted at $26, giving us an additional 3.8 million shares.

For the quarter, how many shares you accounting for the Flying J?

The Flying J shouldn’t be a difference between basic and fully diluted.

That -- those are outstanding the same on both methods.

It’s really the convertible note that adds the additional shares and fully diluted.

The next question is -- deferred taxes, they came in much lower than we believed.

What -- why is that so much different? [indiscernible] you know, over 50, 55 percent was supposed to be deferred and we came in way below that level.

I think it’s because of our extraordinary earnings in the first quarter.

Basically, your deductible expenses like IDC are basically fixed an amount.

And when you have an extraordinary amount of earnings, all that incremental earnings is current, and based on the initial assumptions that we had early in the year, we had a much lower price stick, and so that resulted in a lower current portion relative to deferred.

As the prices go up, all that incremental is taxed fully.

So what kind of guidance you would give for the balance of the year in terms of deferred taxes?

Right now, using the current strip, which is quite a bit higher than we had before -- let me just divide this out -- hold on.

Yeah, about 37 percent would be deferred of the total taxes.

Ron, this is for you.

On the -- maybe two more questions I have.

On the Duchesne deed, you were negotiating for 8,000 more acres.

First, what is going on there?

Second, did you -- you mentioned the pipeline is built now or you’re building the pipeline?

And third, on Duchesne deed is basically what kind of spacing you might be planning on drilling those, assuming it’s a discovery and productive and economical, what kind of spacing you be using?

You bet.

The first question, the acreage is a very dynamic situation.

The 12,000 is a low-side number and we are actively pursuing acreage on a number of fronts, so that number is going to go up.

The pipeline and the production facilities are in place.

We have recognized in all these [indiscernible] completions that shutting the wells in is very detrimental and very damaging, so we went to the additional expense to get the pipeline in and we will have the capacity to produce the well at whatever we think it is capable of producing.

Third question, what was it?

Spacing.

Spacing.

The initial development will be done on 640 acres to try to get the acreage earned.

We expect that ultimately that will come down.

Of course, you know, some of the fields like Jonah are 40 acres playing with 20 acres.

So this -- that’s a big ultimate question.

I think our reasonable expectation at this time might be certainly that we’ll see it ultimately on 160 acre spacing or less.

So if you’re successful, you’ll be talking in excess of 250 wells to be drilled.

Potentially that’s right.

Okay.

Are you still holding to the potential that net reserve from that area could amount to half a B -- 500 [indiscernible]?

It’s certainly not difficult to get to that number, you know, the gas is in place, Jack, but these are -- these are tight reservoirs and really is going to be a function of our ability to stimulate them and produce them.

And that’s the huge question that we hesitate to be very aggressive on, certainly until we’ve seen the results of the production testing we’ll do over the next 60 to 90 days.

But, we’re very optimistic and that’s exactly why we’re in this [indiscernible] in the first place.

A final question, if you don’t mind.

Flying J acquisition, based on your having it almost two months or three months, are you happy with the performance or there is, you know, you have to tweak it a little bit here and there to get better or can you give us, you know, a review of that acquisition.

I think everything at this point in time is consistent with our expectations.

The activity level on some of the outside operating stuff is higher than we initially expected.

I think it’s very early on, but there isn’t anything that we’ve seen that I would call a negative.

So I would say that everything looks just fine at this point in time.

It is pretty early.

You know, we’re talking about 540 wells, and so it’s a lot of work and we’re still, frankly, getting our arms around it having just closed it at the tail end of January.

Were there people or you got rid of the people?

We -- of course, we split that up so Flying J kept some of their properties, so they had a core staff that they kept.

There were a few people that came to work for us, mostly in the field.

And we have hired some new people in the Nance office to handle some of the additional vacancies.

Thanks a million.

Once again, I would like to remind everyone in order to ask a question, please press star then the number 1 on your telephone key pad.

Your next question comes from Ellen Hannan of Bear Stearns.

Hi.

This is actually Scott Burk with a question here.

Just on your oil and gas production, gas came out a little bit higher than I thought, oil was a little bit lighter.

Did you guys -- were you stripping liquids from the -- or keeping the liquids in the gas stream during the first quarter, take advantage of the high gas prices.

You know, we typically don’t have the flexibility to change those.

Most of our arrangements are selling at the well head.

We don’t really do any processing.

So that isn’t something that we will typically be able to control.

Okay.

How about going forward in the -- could you give me a split out, potential split out for the guidance going forward for the rest of the year, second quarter --

Between oil and gas?

Yes.

Gas is about -- for the whole year is about 64 percent.

Okay.

All right.

And then, I was wondering, just kind of went through, added up kind of the production impact of all these wells that have been coming on line.

And you mentioned on the call the Judge Digby well, you’re going to get a higher percent of working interest.

And it looks to me like the production had increased significantly more than the high end of the guidance.

Is that -- what kind of decline rate do you have?

What’s kind of the end of the line decline rate that was offset --

Well, Judge Digby specifically is on a reasonably high decline rate.

Those wells come on very fast.

And, you know, our plan at Judge Digby is always just try to maintain it as well as we can.

We feel pretty good about this year given the fact that we have this reversionary interest on the [indiscernible] 4 coming in on the second quarter.

We think that this deepening of the major No. 3 where we have 20 percent interest should happen sometime in the late second quarter.

And, of course, you have the drilling well as drilling at 16,000 feet that will probably be down in the third quarter.

But, our -- internally with respect to Judge Digby, we’re just -- we’re hoping to keep that reasonably flat to offset the historically fairly high decline.

And I think when we do put our forecasts, our goal is to shoot at the middle of the target.

We don’t try to bias it one way or the other.

So when we put out the forecast, that’s basically our best guess at this point in time.

Okay.

Thank you very much.

Your next question comes from Larry Busnardo of Petrie Parkman.

Good morning.

Bob, on the diluted share count, going back to that on these convertible notes, will those be included going forward because from looking back at the past quarters, they were not included.

Well, I think they were included.

It’s just that they didn’t necessarily apply because of the revenue versus the interest rate.

The interest rate remains fixed.

And so -- but, I think going forward, we’re going to have a similar share count, maybe a little less.

Yeah, the one thing that you do is you go through and you compare whether it’s dilutive or not, so does the add back of the interest and then have a broader share base, does that result in a lower per share amount, and if so, then it’s dilutive.

And if your earnings are very low, it may not be dilutive.

If your earnings are very high, it could be -- it becomes dilutive.

And the higher the earnings are, because the interest add back is a fixed number, that bigger impact it has of a spread between basic and full diluted.

And this time, it showed up as being greater because our earnings were so large this first quarter, that that differential is probably as large as it’s ever going to be because of the fact that your interest add back’s fixed and this earnings was a record high number.

All right.

So those shares that you have convertible at $26, those were included in the fourth quarter diluted share count of 28.6 million?

Yeah, but last year, they were anti-dilutive, so they were not included.

Okay.

All right.

But, going forward, you expect it to be more closer to the level of --

Yeah, certainly with our internal forecast --

Right.

-- we except that [indiscernible].

So it can fluctuate between the two?

Right.

Okay.

All right.

That helps.

Thanks.

Once again, I would like to remind everyone in order to ask a question, please press star then the number 1 on your telephone key pad.

We’ll pause for just a moment.

Mr. Hanley, there are no further questions.

Do you have any closing remarks?

Thank you again for attending today and look forward to the next quarter.

Thank you very much.

This concludes today’s St. Mary Land & Exploration first quarter 2003 earnings conference call.

You may now disconnect.