St. Mary Land & Exploration Company has reported its financial results from the second quarter of 2008 and has provided a brief update of its financial condition and operations.
Tony Best, President and CEO, commented, “The second quarter was a strong quarter for St. Mary. Year over year, we grew production 15% from our retained properties. Commodity prices were very robust during the quarter, which allowed us to generate strong cash flows. For the year to date, we have exceeded the production goals that we set out at the beginning of the year. We are executing well on our business plan and our portfolio is improving every day. I am pleased with how we are positioned as we enter the second half of the year.”
SECOND QUARTER 2008 RESULTS
Earnings for the second quarter of 2008 were $33.6 million, or $0.53 per diluted share, compared to $59.2 million, or $0.91 per diluted share, for the same period in 2007. Adjusted net income, which adjusts for significant non-recurring and non-cash items, was $80.8 million, or $1.29 per diluted share, for the quarter versus $55.3 million, or $0.85 per diluted share, for the second quarter of 2007.
For the second quarter of 2008, adjusted net income includes significant adjustments related to the change in the Net Profits Plan liability for the quarter and bad debt expense recorded as a result of the bankruptcy of SemGroup L.P., a purchaser of a portion of the Company’s produced crude oil, which is discussed further below. The adjustment related to the non-cash charge resulting from the change in the Net Profits Plan liability was $43.3 million, or $0.69 per diluted share, on an after-tax basis. The Net Profits Plan liability increased significantly during the quarter as a result of the increase in forecasted oil and natural gas prices from March 31 to June 30, 2008.
The Company’s adjusted net income also includes an after-tax adjustment of $6.3 million, or $0.10 per diluted share, for bad debt expense recorded in the quarter as a result of the bankruptcy of SemGroup L.P. Based upon information contained in available court filings made by SemGroup L.P., the Company believes that the bankruptcy of SemGroup L.P. may be attributable to circumstances unique to SemGroup L.P., including significant margin requirements for large futures and options trading positions by SemGroup L.P., which are not representative of the liquidity and financial position of other companies in the mid-stream sector.
Accordingly, St. Mary believes that the circumstances that led to the SemGroup L.P. bad debt expense are highly unusual and unlikely to occur in the future with respect to receivables from other purchasers of the Company’s produced oil and natural gas. See the header SemGroup Exposure below for more discussion on this topic. Complete reconciliations of adjusted net income to the nearest comparable GAAP financial measure for all comparable periods are presented in the accompanying Financial Highlights section at the end of this release.
Discretionary cash flow increased to $211.9 million for the second quarter of 2008 from $153.8 million in the same period of the preceding year. Net cash provided by operating activities increased to $173.6 million for the second quarter of 2008 from $156.2 million in the same period in 2007. Adjusted net income and discretionary cash flow are non-GAAP financial measures – please refer to the respective reconciliation in the accompanying Financial Highlights section at the end of this release.
Reported daily oil and gas production for the quarter increased 10% year over year to an average of 313.7 MMCFED in the second quarter of 2008 from 286.1 MMCFED in the second quarter of 2007. Adjusting for properties that were sold in January 2008, total oil and gas production from the retained properties increased 15% or 3.7 BCFE year over year. The Company’s oil and gas production growth between the periods is being driven by development of the Cotton Valley and James Lime programs in the ArkLaTex region, drilling in the horizontal Woodford shale program in eastern Oklahoma, drilling in the Wolfberry tight oil program in West Texas, successful offshore activities in the Gulf Coast region, and the acquisition and subsequent development of Olmos shallow gas assets in South Texas.
Revenues for the quarter were $356.9 million compared to $247.2 million for the same period in 2007. Average realized prices, inclusive of hedging activities, were $9.97 per Mcf and $88.40 per barrel in the second quarter of 2008, which is an increase of 30% and 47%, respectively, from the same period a year ago. Average prices, excluding hedging activities, were $10.83 per Mcf and $120.20 per barrel during the quarter. These prices were 53% and 97% higher, respectively, than the second quarter of 2007.
Lease operating expense, including transportation, increased 19% or $0.26 per MCFE between the second quarters of 2007 and 2008 on a per MCFE basis. Recurring lease operating costs were up approximately 8% or $0.09 per MCFE year over year. Consistent with many companies in the exploration and production industry, St. Mary has been experiencing higher recurring lease operating costs in recent months. This is a result of strong commodity prices and high levels of activity in many basins coupled with supply limitations for goods and services. In particular, services that utilize fuel, such as water handling and salt water disposal, have seen significant cost increases.
Between the comparative periods, workover expense was up $0.13 per MCFE year over year. Workover expense was driven higher primarily by several major workovers in the Gulf Coast and Mid-Continent regions. Production taxes increased 70% year over year, driven upward by higher commodity prices. The increase in depletion and depreciation expense between the two periods reflects the higher finding cost environment experienced by the industry in recent years to acquire and develop properties. The increase in exploration expense in the second quarter of 2008 is due to two exploratory dry holes drilled by the Company testing completion designs in a potential resource play.
General and administrative expense increased year over year primarily due to compensation-related costs associated with increased headcount. Costs such as salary and cash bonus have increased with the number of employees, particularly as competition for employees has grown. The Company also saw an increase in cash payments made to participants in the Net Profits Plan due in large part to the increase in commodity prices between the periods.
St. Mary recognized $9.9 million in bad debt expense before income taxes in the second quarter of 2008 as a result of the bankruptcy of SemGroup L.P. The Company sells a portion of its oil production to affiliates of SemGroup L.P. and as a result of the SemGroup L.P. bankruptcy, the receivables due from affiliates of SemGroup L.P. have been reserved – see the header SemGroup Exposure below for more details on this item.
As of June 30, 2008, St. Mary had total long-term debt of $582.5 million, comprised of $287.5 million in 3.50% Senior Convertible Notes and $295.0 million drawn under our existing long-term credit facility. The Company has a borrowing base of $1.4 billion and a commitment amount of $500 million under its credit facility.
On July 22, 2008, SemGroup L.P. and certain North American subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code. Affiliates of SemGroup L.P. purchase a portion of our crude oil production in the Williston Basin, Oklahoma, and Texas. As a result, the Company increased its allowance for doubtful accounts and bad debt expense by approximately $9.9 million for June 2008 production that was recorded in the six-month period ended June 30, 2008. St. Mary believes that it has maximum additional potential exposure of $6.8 million with this purchaser for a portion of production in July 2008. The Company is monitoring the bankruptcy cases closely to pursue the best course of action to obtain payment of the amounts owed and to continue crude oil sales in the affected producing regions. This matter does not have a material adverse effect on the Company’s liquidity or overall financial position.
In the Williston Basin, the Company is operating two drilling rigs. St. Mary is currently drilling its second grass roots horizontal Bakken well in Burke County and is in the process of completing the first grass roots well which was drilled in northern Mountrail County. The pilot hole for the first well was drilled through the Bakken formation and logs confirmed the presence of the Three Forks formation. St. Mary is also currently completing its first horizontal Bakken re-entry well in McKenzie County. Additionally, the Company has entered into an agreement to acquire additional leasehold in North Dakota. The acquisition will increase the Company’s acreage position in the basin by approximately 6,200 net acres in eastern McKenzie County and 18,500 net acres in northern Divide County.
In the Arkoma Basin, St. Mary will be adding a third rig in the horizontal Woodford shale in mid-August. Earlier this year, the Company increased the planned 2008 capital investment for this program by $20 million based on improved results in the program. The average EUR of the last ten wells drilled is approximately 3 BCFE per well, which is marked improvement over the EURs of the Company’s first ten wells.
The Company has two rigs operating in East Texas and northern Louisiana that are currently drilling Cotton Valley and James Lime wells. The location for St. Mary’s first horizontal well targeting the Haynesville shale is currently being prepared in DeSoto Parish, Louisiana and drilling is expected to begin in September of this year. The Company has 50,000 net acres with potential in the Haynesville shale.
The Company’s operations in its other key programs continue to progress according to plan with no material changes to report. St. Mary currently has 16 rigs operating across the Company.
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