Amplify Energy Corp.
Q3 2015 Earnings Call Transcript

Published: 6 Nov 2015

[Operator:]

Good morning. My name is Brandi and I will be a conference operator today. At this time, I’d like to welcome everyone to the Midstates Petroleum Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] Thank you. I would now like to turn the call over to Mr. Al Petrie, Midstates’ Investor Relations Coordinator. Please go ahead, sir.

[Al Petrie:]

Thank you, Brandi. Good morning, everyone, and welcome to Midstates Petroleum’s third quarter 2015 earnings conference call. Joining me today as speakers on our call are Jake Brace, President and CEO; Mark Eck, Executive Vice President and COO; and Nelson Haight, our Executive Vice President and CFO. Jake will begin today’s call with an overview of the quarter and brief operational and financial highlights. Mark will follow with additional details on operations, then Nelson will review the financial details for the third quarter and provide guidance for the fourth quarter. After Nelson, Jake will make some follow-up comments, and then we will take your questions. Before we begin, let’s get the administrative details out of the way with our Safe Harbor statement. This conference call may contain forward-looking information and statements regarding Midstates. Any statements included in this conference call or in our press release that address activities, events or developments that Midstates expects, believes, plans, projects, estimates or anticipates, will or may occur in the future are forward-looking statements. These include statements regarding reserve and production estimates, oil and natural gas prices, the impact of derivative positions, production expense estimates, cash flow estimates, future financial performance, planned capital expenditures, future potential drilling locations, resource potential, and other matters that are discussed in Midstates’ filings with the Securities and Exchange Commission. These statements are based on current expectation and projections about future events and involve known and unknown risks, uncertainties and other factors that may cause actual results and performance to be materially different from any future results or performance expressed or implied by these forward-looking statements. Please refer to Midstates’ filings with the SEC in the third quarter Form 10-Q that will be filed shortly for a discussion of these risks. Also please note that any non-GAAP financial measures discussed in this call are defined and reconciled to the most directly comparable GAAP measure in the tables in yesterday’s earnings release. I will now turn the call over to Jake for his comments.

[Frederic Brace:]

Thanks, Al. Good morning, everyone. Thank you for joining us today and thank you for your interest in Midstates. The third quarter was another solid quarter for us and let me review a few of the key highlights. As has been our focus since early 2014, we generated adjusted EBITDA in excess of operational CapEx of $25 million during the quarter, bringing our total to $62 million of adjusted EBITDA in excess of operational CapEx for the first nine months of 2015. We expect this trend to continue for the remainder of the year and we are currently on track to meet our guidance of adjusted EBITDA exceeding CapEx by $75 million to $100 million in 2015. Additionally, our capital cost management initiative has been very successful thus far in 2015. At the beginning of the year, we established a multi-disciplined team to tackle our DC&F cost structure and set a goal to reduce well costs from $4 million where it stood at the end of 2014 to $3.3 million by the end of 2015. We met that goal as we talked to you about back in July, six months early, and now have exceeded that target and are currently AFE-ing wells for $3.1 million. At this new well cost and even at the current strip pricing, our Miss Lime wells are generating IRRs greater than 35%. Production for the third quarter came in at approximately 32,600 BOE per day, after a roughly 650 BOE per day impact from a temporary production interruption on one particular pad in the Miss Lime. Our new wells in the Miss continue to perform as expected and we have also been successful in optimizing our base production to help mitigate production declines during 2015 with reduced drilling activity. As a result of our strong performance on both fronts, we are narrowing our full-year production guidance to 32,500 BOE per day on the low end to 33,500 BOE per day on the high end. That increases the low end of the range by 1,000 BOE per day from what we last communicated to you while keeping the high end unchanged. In addition, I’m quite pleased with our LOE and G&A performance. We are beating our LOE targets and our G&A performance has been particularly strong. You will hear more about that from Nelson. On the balance sheet side, as a result of our lender semiannual review, our borrowing base under our revolving credit facility which we affirmed at $252 million in October. This allows us the flexibility to continue to develop our premier position in the Miss Lime, even at the current reduced pricing environment. In summary, I’m pleased with our results in the third quarter and so far in 2015. We have built a solid foundation to execute our strategy to fully unlock the value of our premium asset position. Lastly, I’d like to thank our teams here in Tulsa and out in the fields of Texas and Oklahoma. We have a very talented and focused group of employees, contractors and suppliers. They have performed exceptionally well, and I want to take this opportunity to thank them for without them none of this would be possible. With that, I’ll turn the call over to Mark Eck, our COO, to give you more operational detail on the third quarter.

[Mark Eck:]

Thanks, Jake, and good morning to everyone. I will start by discussing our capital cost management initiative, then review our third quarter well performance, provide an update on our down spacing wells and wrap up with our operational plans for the remainder of the year. As Jake mentioned earlier, we are very pleased to have exceeded our year-end well cost target in the Miss Lime and are currently AFE-ing wells for $3.1 million. Our operations teams have worked diligently with our suppliers and service providers during this challenging commodity price environment and have been able to reduce our service costs significantly. Additionally, our drilling completions and asset teams all have done a great job driving operating efficiency improvements and reducing cycle times. We have reduced drilling cycle times over 20% from 22 days in 2014 to 17 days currently. With this original additional leg down in well costs, over 60% of our total well cost savings continue to be through efficiency gains and process refinement, which should largely remain in place as service prices eventually rise with commodity price improvement. We are proud of what we have accomplished on the well cost front year-to-date and we will continue to strive to push our costs lower. With that being said, we don’t anticipate our costs getting too much lower than they are now. Our premier Mississippian Lime asset continues to perform well. We continue to produce best in class peak 30-day IPs of roughly 560 BOE per day and our 2015 well performance continues to track well with our year-end 2014 third-party PUD type curve that was increased 25% last year. At October 12 strip pricing, as Jake mentioned, our PUD type curve is generating IRRs greater than 35% with our current AFE of $3.1 million. Through our normal Miss Lime development, we have opportunistically been able to acquire and core up acreage through a combination of acreage leasing, swaps, trades and partner non-consents. This has proven to be an efficient and cost-effective way of adding to our acreage footprint and replacing well locations as we drilled through our inventory. Now, for an update on our down spacing wells, we brought online two wells at the beginning of the year in the Miss Lime to test our theory of 80-acre well spacing being viable on a significant portion of our acreage. The average of the wells continues to track above our PUD type curve for majority of the production curve and the individual production profiles of two wells remain consistent with other wells in their sections. This comes with little to no apparent communication identified to date. Most notably, we haven’t seen any degradation in the production profiles of offset wells or any wells in the section. As we progress this concept forward, we will concentrate our down spacing efforts in the grindstone area, which encompasses roughly 70% of our current acreage position and offers more consistent well performance in uniform geology. Our plans for 2016 currently include a grassroots 80-acre test and with continued down spacing success, we have the potential to add up to 350 locations to our premier PUD fairway. Turning to an update on our Anadarko asset, our focus thus far in 2015 has been on high return capital and expense work over programs designed to offset some natural production decline and to reduce lease operating costs. We continue to monitor or offset operators to expand our geological understanding of the multi-pay zones in the basin and refine our well design in order to improve our type curves and increase profitability when we return to active drilling in the basin. At this point, we do not anticipate drilling in the Anadarko basin in the near future. As previously discussed, we reduced our rig count to three active rigs in the Miss Lime in late July due to earlier than expected drilling efficiency realizations and higher than expected working interest from the partner non-consents. As we move through the remainder of 2015 and into 2016, we will continue to monitor the appropriate level of rig utilization, but at this point, planning to operate a three rig program drilling a mix of proved locations and extension wells on our currently undeveloped acreage in the Mississippian Lime. I am very pleased with our team’s collaboration and performance year-to-date and look forward to continued success to close out the year and into 2016. With that, I’ll turn the call over to Nelson.

[Nelson Haight:]

Thanks, Mark. We were very pleased with our third quarter results. We generated $80 million in adjusted EBITDA, which was at the lower end of our guidance range, even though our production was below our guidance range because of the temporary Miss Lime interruption that Jake mentioned earlier and oil prices that were down about 18% compared to the second quarter of this year. Our operating capital expenditures totaled $55 million and we were at the low end of capital guidance as we continued to benefit from improvements in drilling efficiencies and lower service costs. About $53 million was spent in the Miss Lime and the balance is in the Anadarko Basin. All of our line item costs came in within or below the guidance ranges we provided. Net-net, we generated adjusted EBITDA that outpaced operating CapEx by $25 million, and we are well on track to meet our target of generating $75 million to $100 million for full-year adjusted EBITDA beyond our 2015 operating CapEx figures. For the fourth quarter, we expect our operational CapEx to be approximately $50 million to $60 million with 95% of it invested in the Mississippian Lime and the balance in the Anadarko Basin. These estimates reflect the plan that Mark just described with three rigs working on the Miss Lime. We expect our adjusted EBITDA in the fourth quarter to be in the range of $70 million to $80 million, which will well exceed our expected operational capital. Additional detail is available in our supplemental information package posted to our website this morning. On August 3, 2015, we completed a one-for-10 reverse common stock split. The financial statements included in our earnings release, along with my comments today, give retrospective effect to the reverse stock split for all periods discussed. Adjusted net income for the third quarter was a loss of $6.5 million or a loss of $0.95 per share compared to net income of $19.3 million in the same period a year ago and a net loss of $3.9 million in the second quarter of 2015. This excludes the impact of unrealized gains and losses on derivatives, oil and gas impairments, and any other unusual non-recurring costs, along with the related tax impact. Our report at third quarter 2015 GAAP net loss, which includes a non-cash $487 million oil and gas property impairment due to the current low commodity price environment, was $494 million before $140,000 in deferred dividends. Turning to production, production in the third quarter totaled 32,609 BOE per day compared with 33,893 BOE per day in the second quarter. A temporary interruption of production at a Midstates well site due to a previously reported incident reduced third quarter production by approximately 650 BOE per day. If we add back those volumes, we would have been within our guidance range of 33,000 to 34,000 BOE per day. About 81% of the third quarter volumes, or 26,358 BOE per day, came from our Miss Lime properties with the balance from our Anadarko Basin assets. In light of the current commodity prices, our desire to maximize cash flow and value from our production stream, we continued to reject ethane from our Miss Lime gas production during the third quarter. We expect our fourth quarter total company production to be in the range of 31,500 to 32,500 BOE per day, with roughly 82% from our Miss Lime properties and the balance from our Anadarko Basin properties. For the full-year 2015, we are tightening the range of our production expectations to 32,500 to 33,500 BOE per day. This raises the low-end of guidance from 31,500 to 32,500 BOE per day. Additional details on the product mix of this volume guidance, along with price and transportation differentials, are included in the supplemental information that we posted to our website this morning. Turning to hedging, during the third quarter, we did not add any new oil and gas or gas hedges. For the fourth quarter of 2015, we now have about 1.1 million barrels of oil or about 90% of our projected oil production hedged at $71.56 per barrel and about 4.6 million BTUs or about 65% of our natural gas production hedged at $4.13 per MMbtu. We currently do not have any oil and gas hedges in place for 2016. A detailed summary of our current hedged positions is included in the release and is posted on our website, along with all the guidance I’m providing today. Our hedging strategy continues to focus on providing cost effective downside protection to our cash flow generation to allow us to execute our capital expenditure program. We closely monitor the futures market and will add additional hedges if the market presents the appropriate opportunities. I’ll now review our third quarter expenses and provide guidance for the fourth quarter. Third quarter cash operating expenses, which includes LOE production taxes and cash G&A but excludes acquisition transaction and advisory costs, totaled $30.9 million, which was down 15% from $36.3 million in the second quarter of 2015 and down 11% from $34.8 million in the third quarter of 2014. On a BOE basis, costs also declined. In the third quarter of 2015, cash operating expenses totaled $10.32 per BOE, which was down 12% from $11.75 per BOE in the second quarter of 2015 and down 8% from $11.20 per BOE in the third quarter of 2014. The improvement was primarily due to lower LOE and G&A. On our lease operating work over, expenses totaled $18.8 million, down almost 14% from $21.8 million in the second quarter. Third quarter LOE of $6.27 per BOE was well below our guidance range of $6.75 to $7.25 per BOE. The third quarter of 2015 LOE and work over expenses decreased on a per BOE basis as compared to the second quarter of 2015, primarily due to the sale of our producing assets in Louisiana, where operating costs were relatively higher and lower LOE costs in the Anadarko Basin where we benefited from the results of our 2015 work over program and improved operating efficiencies. For the fourth quarter, we expect our LOE and work over expenses to be in the range of $6.50 to $7 per BOE. Gathering and transportation expenses associated with our main gas processing arrangement in the Miss Lime totaled $4 million, essentially flat with the second quarter. For the fourth quarter, we expect those costs to range between $4 million and $4.5 million. Severance and other taxes totaled $2.7 million or about 3.5% of total revenue before derivatives, which was within our guidance range of 3% to 4%. For the fourth quarter of this year, we are maintaining a guidance of 3% to 4% of revenue. Third quarter total cash and non-cash G&A expense was $6.7 million or $2.23 per BOE, well below our guidance range of $11 million to $13 million and down compared with $11.5 million or $3.71 per BOE in the second quarter of this year and from $9.9 million or $3.18 per BOE in the third quarter of 2014. Third quarter 2015 G&A included non-cash share based compensation expense of roughly $900,000 or about $0.31 per BOE, while the second quarter of this year included $2.1 million or $0.68 per BOE, and the third quarter of last year included $1.7 million or $0.54 per BOE. G&A costs in the third quarter of 2015 also included approximately $300,000 or $0.10 per BOE of expenses related to employee and other costs associated with the previously announced closure of the Houston office and the relocation of the company’s headquarters to Tulsa, while the second quarter of 2015 included $1.3 million or $0.42 per BOE of such costs. The third quarter G&A was also reduced by the capitalization of project-related overhead costs, a portion of which will be recovered from our joint interest owners. We expect total G&A in the fourth quarter to be in the range of $9 million to $11 million with about $1 million to $2 million being non-cash. Our DD&A rate for the quarter of $14.90 per BOE was also below our guidance of $18 to $22 per BOE. We are reducing our guidance range for the fourth quarter of 2015 to $14 to $18 per BOE. This change is due to the oil and gas impairments we incurred throughout 2015 that have lowered our depreciable cost base. At September 30, 2015, capitalized costs exceeded our full cost ceiling, and we recorded an impairment of oil and gas properties of $487 million. We recorded impairments of $498 million in the second quarter of 2015 and none in the third quarter of last year. The 2015 impairments were primarily due to the continued low commodity prices, which resulted in a reduction of the discounted present value of the company’s proved oil and natural gas reserves. Total interest expense incurred in the [second quarter] was $41.5 million, of which we capitalized about $900,000. We expect to capitalize about $500,000 to $1.5 million in the fourth quarter. In the third quarter of 2015, there was no income tax expense. And to the extent we generate financial taxable income in future quarters, we will recognize a portion of our unrecorded net operating loss carry-forwards to offset the related tax expense. As a result, for the foreseeable future, our tax rate will continue to be between 0% and 5%, all of which is expected to be non-cash. Turning to our liquidity and capital structure, as of September 30, we had $417 million in liquidity, consisting of $167 million in cash and cash equivalents and $250 million available under our revolving credit facility. The next regular redetermination date for our revolver is at the end of March 2016. On September 30, all 325,000 shares of the company’s Series A preferred stock mandatorily converted into approximately 3.7 million shares of the company’s common stock at a conversion price of $110 per share. As a result, on October 1, we had approximately 10.9 million common shares outstanding. Our focus in this environment is on controlling our operating and overhead expenses and lowering our drilling costs, while managing our capital activity level to optimize future operating cash flow. To that end, we’re committed to retaining operational flexibility to adjust our activity level to quickly capture benefits from further service price reductions or improvements in commodity prices. And with that, I’d like to turn this call back over to Jake.

[Frederic Brace:]

All right, thanks, Nelson. Like other E&P companies, we’ve started to look at our plans for 2016 and we expect to have a budget finalized in the not too distant future. But given the uncertainty in the commodity price environment, we have been looking at a number of different activity levels and scenarios and have provided a few of those for you on Slide 14 of our supplemental information packet posted on our website. The one we’ve been focused on and I think each one of us has highlighted to you is our maintained production case. With our new standard Miss Lime well cost of $3.1 million, we would expect to keep 2016 production relatively flat versus 2015 by investing $150 million to $200 million of operating CapEx with a three-rig program operating solely in the Miss. This is down from our previously communicated maintenance CapEx range of $175 million to $225 million. With all the scenarios being contemplated for 2016, we are committed to preserving our liquidity through intensely focused capital discipline and continuous improvements in operational excellence. We believe we have the liquidity needed to create value in this price environment and preserve optionality with the recovery in prices which we know will come eventually. We will continue to exploit our premier position in the Miss Lime, while explore avenues to unlock value in the Anadarko. With that, Al, we are ready to take questions.

[Al Petrie:]

Okay, operator, we are ready to take any questions from our attendees.

[Operator:]

[Operator Instructions] Your first question comes from the line of Sean Sneeden of Oppenheimer.

[Sean Sneeden:]

Jake or Nelson, you guys provided some pretty helpful scenarios about next year for CapEx. Could you maybe talk a little bit more about them and maybe walk through what causes you to go with your base plan versus a two-rate case? For instance, are you guys really solving for a specific outspend level for next year or maybe just kind of talk about how you think through each of those scenarios,

[Frederic Brace:]

As we look to the future, what we’re trying to balance is our liquidity runway and maintaining of production level that allows us to benefit when the commodity prices turn. If we were to shut down any drilling activity, then our production will go down. And if and when commodity prices return, we wouldn’t actually have enough production to significantly benefit from it. And so that’s the balance that we are trying to reach. And we think, as we sit here today, that the maintained production, which turns out to be a three-rig case, is the right balance. But we show you those other scenarios because we recognize that things change and that we may not have predicted what the right balance is. And if commodity prices change, there may be a better balance out there. So that’s the thought process that we went through to determine it, but we recognize that we are not smart enough to take a single level and say, hey, that’s the right thing to do. And we got to be nimble going forward and so we showed a couple of other scenarios so you can see how they would affect the liquidity runway and the production. But that’s the thinking we went through, Sean.

[Sean Sneeden:]

And I guess, under those scenarios or maybe even just under the base plan, is there a general sense of how you think about exiting in terms of liquidity for next year or is there kind of a base level of liquidity that you are looking to maintain throughout the year?

[Frederic Brace:]

Again, it’s that balance. But I think at that level – Nelson, check if I am wrong, we don’t tap into the revolver until the fourth quarter of next year at the base level. So that’s how we are thinking about it if you want to sort of gauge how much liquidity we’d have at the end of the year. We would be tapping into the revolver close to year-end.

[Nelson Haight:]

That’s correct.

[Sean Sneeden:]

And then, maybe, Nelson, for you or Jake, but with your third-lien bonds that are trading in the 30s, how do you think about using some of that available liquidity or maybe even slowing down to kind of a two-rig case here and repurchasing some of those bonds help delever the balance sheet and cut some of your interest expense?

[Frederic Brace:]

We think about things like that, Sean. We are very mindful that liquidity is dear to us and I don’t think if we bought back bonds that that would be – they would pay back, particularly quickly, but we don’t rule anything out when you think about these things all the time. But as we sit here today, we think that our liquidity is best invested by drilling and producing oil. And so we think that’s the best path. But that could change too going forward. It’s just not on our front burner at this instant.

[Sean Sneeden:]

And so if I’m understanding correctly, the cash on cash returns, in your minds, are better on Miss Lime wells versus the third-lien bonds at the current levels?

[Frederic Brace:]

I think so. I haven’t done the math on the third-lien bonds recently. But when we are generating 35%-plus return in the Miss, that’s a pretty decent return versus extinguishing interest, I think. But Nelson, let’s go do the math again and we will make sure that’s true.

[Nelson Haight:]

I think the payback, Sean, has a payback period of any investment like that is part of the equation. And I would just like to say, we look at it continuously and today we feel like investing in the asset is probably the best for the stakeholders and the company.

[Sean Sneeden:]

And then maybe for Mark, when you think about 2016 and where you’re going to drill in the Miss, is there a particular focus area within the grindstone north versus south or maybe even Woods versus Alfalfa?

[Mark Eck:]

Yes, I think so. I think clearly we are going to be focused on the grindstone because we feel like we are getting more consistent results and our drilling will be in the Woods County area, primarily. I don’t anticipate any well in Alfalfa. Maybe one or two could pop in, but right now we’re looking at Woods County primarily.

[Frederic Brace:]

Sean, our focus is, I think you’ve heard me say multiple times, is being real consistent and hitting singles, and we think we can hit singles in the grindstone. So that’s what we focus on.

[Sean Sneeden:]

And maybe just lastly, Nelson, can you remind me just the composition of your NGL barrels?

[Nelson Haight:]

The percentage of product – I might have to get – can we take that offline, Sean, if you want to follow-up? I don’t have that right in front of me right now.

[Operator:]

[Operator Instructions] Your next question comes from the line of Steven Karpel of Credit Suisse.

[Steven Karpel:]

Following up on Sean’s question, I want to understand this a little bit better, how you think about it. Your bond documentations allow some buybacks, albeit somewhat limited, of course, but they do allow some bond buybacks. And your contemporaries have [indiscernible] wrong, but your contemporaries have been fairly aggressive in, just this morning, a couple of guys announced additional buybacks. Looking at your unsecured debt in the 60% yield, I’m not sure that we need to do too much math to figure out that that’s a greater return than on an un-risked basis or risk basis than drilling actual wells. So explain to us what the resistance is to actually executing bond buybacks considering the magnitude of debt you have and the need to reduce debt in the structure?

[Frederic Brace:]

I think, Steven, you touched on it yourself, which is the limitations in our documents as to how much we can do. I don’t think we can do very much. Nelson, check me if I’m wrong, but I don’t think we have a ton of flexibility to do that. So that’s not going to be – that may be helpful, but on a fairly limited basis, it’s certainly not a silver bullet.

[Steven Karpel:]

Looking at your documents and looking at the price of the bonds, it appears to us that you actually can do a pretty significant amount of the debt. And maybe it’s not the silver bullet, but maybe, quite frankly, individually, there is not one transaction that’s going to be a silver bullet, but this actually is pretty meaningful.

[Frederic Brace:]

Nelson is here shaking his head, and I’m trying to think. I don’t think we have a ton, but we are happy to look at some more. We’ve been focused on the operation and producing these results in the third quarter. We are not averse to doing smart financial transactions if they are indeed smart and are consistent with maximizing our optionality for when commodity prices rebound. But we will have to take another look at that, Steven. I haven’t done the math on that one either. Sean was talking about second liens and third liens rather, and I haven’t done the math on those and we can certainly do the math on the unsecured as well.

[Steven Karpel:]

So then maybe talk about where the proportion of the business where you are focusing your time in. How do you perceive that the strategic game plan is to work out of the capital structure aside from just an improvement in commodity price. Can you talk about – obviously, you have done a great job with the asset and your operations team has done a great job in proving that you can make returns, but can you walk us through how you work out of the capital structure barring a commodity price – a significant commodity price recovery?

[Frederic Brace:]

I’m not sure I understood all of that. So can you run that for me again?

[Steven Karpel:]

I’d like to maybe understand some of the more tactical things that you are doing with the capital structure given the debt burden that you face. Obviously, if commodity prices recover to year plus levels ago, then you are in a much better position. But aside from that, maybe can you talk about what you are doing?

[Frederic Brace:]

I think we’ve touched on things that we conceivably could be doing, but right now we don’t have a current plan to do anything in particular with the capital structure, although that can change. So we’re looking at the operation. We’re focusing on the organization, obviously, on continuing to hit those singles that I talked about. At the same time, if there is a good opportunity out there to do something smart with the capital structure, then we will do it. But we obviously aren’t going to telegraph any plans on that and right now we don’t have any plans.

[Operator:]

At this time, there are no further questions. I would now like to turn the floor back over to Al Petrie for any additional or closing comments.

[Al Petrie:]

Thank you. I think Jake has a few closing comments.

[Frederic Brace:]

Just briefly, our accomplishments in the third quarter give us a lot to be excited about. We have proven our ability to quickly respond to the downturn, both financially and operationally, and that will have significant time and flexibility to allow us to manage our business in a disciplined way through an extended period of low commodity prices. We thank you all for joining us today and we look forward to talking to you in the next quarter.

[Operator:]

Thank you. That does conclude today’s conference call. You may now disconnect.