Earthstone Energy, Inc.
Q2 2016 Earnings Call Transcript

Published: 12 Aug 2016

[Operator:]

Good morning and welcome to the Earthstone Energy Second Quarter 2016 Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] And as a reminder, this conference is being recorded. Joining us today are Frank Lodzinski, President and CEO; Robert Anderson, Executive Vice President, Corporate Development and Engineering and Neil Cohen, Vice President, Finance and Treasurer. Mr. Cohen, you may now begin.

[Neil Cohen:]

Thank you and welcome to our second quarter 2016 conference call. Before we get started, I need to disclose that the conference call today will contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended. For a complete description of this disclaimer, please refer to our press release issued yesterday. Also, listeners are encouraged to read our quarterly report on Form 10-Q for the quarter ended June 30, 2016 in its entirety as well as all other reports and documents filed with the SEC for more detailed information of the Company. The content of today’s call will include remarks from Frank regarding the last quarter and near term priorities, remarks from me regarding recent financial performance and remarks from Robert regarding operational matters. I’ll now turn the call over to Frank.

[Frank Lodzinski:]

Thanks Neil and thanks to all of you for joining us. As Neil mentioned or the operator -- we have myself here, Robert Anderson, Neil Cohen and a special guest, being Ray Singleton, the former CEO of Earthstone who is joined our executive team and so on. So he is here listening in also. I am going to keep my remarks pretty short. We're focusing on just a handful of items. As most of you know late last year, we decided to hunker down and shutdown our drilling and completion activities and defer other CapEx and as a result of that those activities impacted our first and second quarter production. We’re looking to rectify that now and we’re planning on starting as we previously advised, the 12 well completion program on wells that were drilled but uncompleted. And we’re also planning on starting to drill again towards the end of the year. Our significant activates in the second quarter while planning to get underway operationally is that we closed our Lynden acquisition and we accessed the capital markets. So, Lynden was closed on May 18. We’ve only got a partial quarter in there for Lynden acquisition and in June we issued shares raising gross proceeds of about $50 million and somewhere around $47.5 million or so after fees and costs. Of course initially we do start bank debt and Robert’s going to address what we plan to do the money, the use of proceeds relating to completion activates, drilling activities and so forth. The Lynden acquisition closed as I mentioned on May 18. It brought about 1150 barrels a day of production to us and 5900 net acres in the Midland Basin that is largely held by production. We’ve disclosed that the acquisition cost was some $77.8 million including 3.7 million shares of Earthstone common stock. And we assume the net Lynden financial obligations for the remainder. We’re just very pleased to say that based on area drilling and completions, the potential of the Lynden acreage keeps looking better and better to us than when we struck this deal about a year ago. Not only did we add production and acreage and attractive metrics, we have likely in a vicinity of 100 horizontal locations. And as I mentioned, in the second quarter you only saw a part of this acquisition. So with that I will turn it over to Neil and then Robert will address operational matters, our planned CapEx programs in some level of detail.

[Neil Cohen:]

Thanks Frank. For the quarter ended June 30, 2016 our production averaged 3,759 Boe per day which is a 5% increase relative to the Q1 2016 and a 6% decrease relative to Q2 2015 adjusted volumes. Production consisted of 59% oil, 27% gas and 14% of natural gas liquids. From the financial perspective, we reported adjusted EBITDAX of $4.5 million, a net loss of $11.2 million or $0.69 per share and cash flow from operations before changes in working capital of $0.33 per share. During the quarter, we again focused on preserving our liquidity, enhancing our cost structure with only $4.4 million capital expenditures. Total cash operating expenses inclusive of LOE, reengineering workovers, ad valorem taxes and severance taxes totaled $3.9 million. G&A excluding stock based compensation totaled $2.3 million or $6.64 per Boe, which is a 30% decline from the first quarter. In April, May we layered on hedges opportunistically. From July through December 2016 we’ve hedged approximately 44% of the midpoint of our full year oil and gas daily production at $49.35 per barrel and $2.60 per MMBtu, respectively. In connection with our semiannual redetermination in the Lynden acquisition, our borrowing base was re-determined in May at $75 million. As of quarter end and as of today we had $10 million of debt outstanding under our credit facility. We also recently incurred $5.1 million of unsecured debt related to fulfilling financial obligations owed under our drilling contract that we recently terminated. As previously announced, we stopped drilling in January and entered into an amendment to a drilling contract allowing for a temporary suspension of drilling. With the amendment we incurred a $1.3 million rig idle expense in the first quarter. During the second quarter we continue to negotiate with our contractor, hoping that prices would improve to reestablish the drilling program or otherwise modify the drilling contract. But fortunately commodity prices did not cooperate and on July 8 we terminated the drilling contract which resulted in the recognition of a $3.8 million rig idle and termination expense in the second quarter. To fill this obligation, we entered into an unsecured $5.1 million three-year amortizing note of near pre pay mentalities. The loan allows us to preserve our cash on hand and RBL availability and thereby use such funds for CapEx opportunities that will result in production. With the commencement of drilling operations later this year, we may initiate discussions to utilize this contractor's rigs in exchange for credits or adjustments to the note. In summary, with approximately $80 million of cash on hand and $50 million of debt we have an industry leading balance sheet that can accommodate our growth metrics. I'll now turn the call over to Robert.

[Robert Anderson:]

Thanks Neil. As Neil mentioned, our production for the quarter was up approximately 5% when you compare to the prior quarter, obviously in effect of the Lynden acquisition closing. We did experience production declines in our existing assets due to a lack of drilling and completion activity, and because we chose to differ workover and capital expenditures, this occurred. Generally, we allowed flowing wells to continue to produce at lower rates as a result of postponing installation of artificial lift and we have a few units that were offline for maintenance during the quarter. These natural declines were offset by the Lynden acquisition for a portion of the quarter. We have installed pumping units on a couple of wells, which had a positive effect on flattening our decline rate and we have a couple of other wells yet to go in terms of putting them on pump, which will happen likely in the third quarter. While it’s difficult for us to see our production decline, we choose to prioritize and defer capital and maintenance expenditures during the low commodity price environment that was experienced in the first half of the year. We always work to optimize our field operations. In our operated Eagle Ford asset, our field guys have done a great job of continuing to reduce lease operating expenses, and here we continue to operate our Eagle Ford assets for about $6 per Boe. We expect to start completing wells in the next couple of weeks and we’ll additional significant production volumes in the fourth quarter from our 12 gross Eagle Ford wells that have been waiting on completion. These will result in 5.3 net wells completed to us. We plan on completing all 12 wells sequentially, but we may take a short break after the first six to allow for some upkeep and maintenance on the frac group. We will begin our frac program with the completion of our four well Boggs Unit in Karnes County and then follow that up with our 8 wells that we have in Fayette County. We also intend to reestablish a drilling program, currently planned for late in the fourth quarter of 2016, beginning with five gross wells in Southwestern Gonzales County, which would be 2.5 net wells to our interest. While we have not abandoned our plans to initiate our drilling program, with the recent downturn in oil prices, we may reconsider. Options would be to drill locations where we have a lower working interest or actually defer drilling altogether at the end of the year. So while our drilling and completion activities have been limited, we’re well positioned to achieve economic production growth from our Eagle Ford wells. I want to remind you all that we have accomplished a great deal in terms of preserving our future upside. We’ve converted approximately 60% of our Eagle Ford acreage to help by production status, while improving our lease expiration profile to minimize the near-term expirations. And in doing so, we have preserved upside opportunity associated with the Eagle Ford, Upper Eagle Ford, Austin Chalk, Buda and potentially other formations for the future. In the Williston Basin, nearly all of our acreage is HBP, and held for future Bakken and Three Forks development. Our Midland Basin activity has finally kicked off as our operating partner is drilling in Howard County to test a horizontal Wolfcamp A interval with a 9,000 to 10,000 foot planned lateral links. We’re very excited about this opportunity and hope to see the activity level increase out there. I’ll turn it back over to Frank.

[Frank Lodzinski:]

Okay. I want to wrap up before we open the lineup for questions. We’re very pleased that the market embraced us and we can raise some additional equity. We’re pleased with our Lynden acquisition. We’re anxious to get going on our frac program, and of course we put the caveats of commodity prices, availability of high quality services et cetera. But subject to that, we’re really anxious about getting going drilling again and we’re intent, assuming those things cooperate with us, we’re doing that --starting that in the fourth quarter. We just continue to optimize our cost structure and preserve our upside in our assets, and we’re really intent upon continuing to search for prime and close corporate -- a large asset or a large corporate acquisition that will really be transformative and impactful on the company. That said, from an A&D perspective, we are pretty selective and we’re looking for things that can complement our Company, move us into a new realm of visibility into the markets and build on what we’ve accomplished so far. It appears to us that the acquisition market continues to improve. Clearly some of these are distressed situations, but that doesn’t really apply to the Permian Basin. And so really as I mentioned we’re really being selective, but intent on finding something significant. So all that said, we’ll just open it up for questions and thanks for listing to us so far.

[Operator:]

Thank you. At this time, we'll be conducting a question and answer session. [Operator Instructions] Our first question comes from Jeff Grampp from Northland Capital Markets.

[Jeff Grampp:]

To start with the -- in the Permian, where you guys have spread the Howard County, well, it sounds like -- seen a lot of good results the past week or two out of Howard and just kind of go into the slide deck, it looks like maybe the productivity assumptions you guys have for that first well, especially given the longer lateral might be potentially conservative. Would you guys think that’s a fair characterization of things or just kind of get looking for some additional color on initial expectations for that. And then can you just talk about timing of when you'd expect gross production from that well?

[Frank Lodzinski:]

Jeff, you are right. There has been some really fantastic wells coming out of that area. I hate to bet that our well would be -- I'm hoping it’s better than a lot of other wells, but I hate to bet that it’s the highest well out there. So we just take a look at a lot of wells and kind of come with a tight curve that makes sense versus cherry picking the best well out there or the best handful of wells. So timing wise we ought to be done in 20 days and be -- get in a frack schedule. We don’t know when that’s going to be, so I'm going to hedge my bet a little bit and say that we’re in the beginning of the fourth quarter before we get it online.

[Jeff Grampp:]

Okay, perfect. And then Frank, maybe for your Robert, in terms of just M&A, I know you guys are obviously very active and looking at a lot of deals. Can you just characterize how things have trended over the last several months, with oil kind of taking another leg down into the lower 40s, if that’s kind of impacted things, and widen the bid ask or any kind of commentary on that front and trends will be helpful?

[Frank Lodzinski:]

Well, we just -- okay, lay back up. So there's really two different things here. The Permian as you know is hot, hot, hot, and our angle there is that we’re very good operators even with some of the high prices that are being paid. We take a look at a combination of that with our operational expertise and what we’ve demonstrated by staying within budget and AFE. We feel pretty good about that and so on. That’s going to take some work to get something that we feel is both accretive and impactful on our Company. But what I’m telling you Jeff is that, we’re going to compete out there diligently provided we like the geology the science, and provided that we think we can perform. We are considering what our go forward strategy is. And as you know, we’ve always operated in more than one basin for reasons of taking advantage of price differentials, availability of services, quality of services, cost of services. That’s going to be a big topic amongst the management team here and the Board going forward, particularly, if we land a large transformational Permian deal. So for right now, I’m telling you that generally speaking, we’d like to pursue a Permian -- Eagle Ford strategy. We'd like to bolt on some Eagle Ford things. Now there I can talk a little bit. The bid ask spread or so on in the Eagle Ford is -- the whole dynamics of the A&D and Eagle Ford is just very, very different than the Permian as you know. The Eagle Ford per acre prices are less. And there are some distress -- there's a number of distress situations out there, where we believe our balance sheet track record, operational -- demonstrated operational expertise, transparency. We think that those things lead up to perhaps us taking over a distress situation. I think the bond holders are going to end up owning a lot stuff in the Eagle Ford, and we'd like to appeal to them. So evolving strategy, deals seem to be getting done, and that’s kind of where we’re at them. Sorry, I can’t be more particular than that.

[Operator:]

Thank you. Our next question comes from John White from ROTH Capital.

[John White:]

I was also going to ask about the timing of the Wolfcamp A well, but that’s been taking care of. But you did get me the per cup when you talked about a large transformational Permian deal just a moment ago. With that -- do you want to specify if you have a preference? You’ve already got a footprint in the Midland Basin. Would you seek additional Midland or is Delaware under consideration also? Or do you not want to say?

[Frank Lodzinski:]

No, I'll say, because if I change my mind on the next quarter, the call, I’ll just tell you that. Ideally -- you know how competitive everything is. I wouldn’t rule out Delaware, but I don’t think that’s our primary focus right now. We’re hoping to land something in the Midland Basin that makes sense. And that’s why we -- that’s one of the reasons why we acquired Lynden. If you take a look at the metrics on Lynden, those are quite attractive and we recognize that the metrics on a large operated deal may be quite different. So we will look at asset deals, corporate deals and so forth. But I want rule out the Delaware. But I’m not just going to go to -- right now John, I’m telling you, I am not going to go to Delaware for 6,000 acres or something. If there was something that is large, transformative, we think we can impose our operating abilities to it. To the benefit of all our shareholders we’ll go there.

[John White:]

Well, I appreciate that detail Frank and if you do end up changing your mind, of course that’s the CEO’s prerogative. So no worries there.

[Frank Lodzinski:]

But you know, we’re very really transparent. We’ll tell you guys if we change our mind.

[Operator:]

Thank you. Our next question comes from Jason Wangler from Wunderlich.

[Jason Wangler:]

Was maybe just wondering, in the Permian, now you got the first well going in Howard, do you have any visibility past that yet as far as what the operator’s plans are either later this year or even as you start looking maybe six months down the line.

[Frank Lodzinski:]

Well, I think the short answer is -- not that we’re prepared to talk about right now, because those are continuing discussions that we have had and will continue to have. And obviously with the positive results that I’ve been seeing, and Robert’s been seeing around these acreage positions, we’d like them to establish a drilling program on acreage that we’re involved with as opposed to acreage we’re not involved with. They have large, large holdings out there. We’d like them to dedicate something of our acreage. So, bottom-line is I am babbling add share. We have had some conversations. We think there's opportunities move forward on that, but it’s just too early put on a schedule right now.

[Jason Wangler:]

That’s helpful Frank. Thanks. And I know it’s kind of toughening as you go through it. The only other thing I was curious about it is you were mentioning on a previous question -- as you mentioned on the Eagle Ford, with a lot of I guess less financially strong companies having some issues in going through, are you seeing a lot of things actually come up for bid, or at least you guys are able to look at? Or are those still really going kind of through the courts and maybe that’s something that’s going up down the road as some things get cleaned up. Just curious if I think we’d spoken a while back if that was something you hadn’t seen yet as far as actually having some opportunities, and maybe now we’re getting closer to that, if maybe the courts were allowing that to happen, or as you mentioned the bond holders are starting to own these things?

[Frank Lodzinski:]

Yes, I'll tell you both our perception and some of the feedback that we’re getting from some of the bankers and intermediaries and things like that, is that the processes on some of those things have moved forward. And I don’t want to be demeaning in any way to bondholders, but a little of the shell shock is over. Creditors are starting to understand where they are and the process seems to be moving forward et cetera. We’ve seen some private companies come to market recently, where there were both bonds and RBLs involved. So I would hope that our appeal to the bond holders that might end up, or the other creditors that might end up owning some of these things is what I said earlier, okay. They can try to keep incumbent management. They can try to keep -- they can try to replace management. But we want to get in front of them and say, we got a track record. This is our fourth company. We’ve demonstrated our where's both financially and managerially and operationally, and you need to team up with us. So the good news is we’re starting to get -- do we have anything wind up and ready to close and anything? No, but we hadn’t been thrown out of many offices either. I think the Permian might be a little bit different. I would hope that those qualities that I've harped on would appeal perhaps to some of the private equity guys that are out there, and other potential sellers that are out there. So it’s same kind of MO. It’s just that if you want performance, please consider teaming up with us. So you're starting to see more opportunities in the Eagle Ford come to market and more discussions happen even before these things don’t emerge from bankruptcy.

[Operator:]

Thank you. [Operator Instructions]. Our next question comes from Mike Kelly from Seaport Global. Mr. Kelly, your line is live.

[Mike Kelly:]

I got a question for you, Frank on the M&A side. It's -- ever since I’ve been following you, you’ve never really paid top dollar in the hot play to get in on really kind of where the latest and greatest play is. Do you get the sense kind of that maybe there is something with this cycle or this current environment that is making you think a little bit differently about this? And really I get sense that you want to be part of the Permian in a big way and maybe you'll pay up for. So just kind of want to get your thoughts, and maybe you want to characterizing that right at all. And two just, is there anything different about this cycle that makes you want to be in the very best play in this town?

[Frank Lodzinski:]

Okay. So since I was teasing you and joking with you, take this next comment as a little bit of joke, but with an element of truthfulness in there. Look, I’m going to be 67 years old in September. I don’t have that much more time left. So I got to do something big and transformative, and that’s what excites us around here all the time. Now that said, here is the real underlying fundamentals of that. If you take a look at our history through Hampton, Texoil, GeoResources, the private ones that were in there and now Earthstone, you’ll see that we’ve evolved over time and I’ve evolved over time, but with our folks. So I think the difference these days is at GeoResources, what we prove to ourselves is that we were -- and our acreage wasn’t Tier 1 acreage. Okay. We prove to ourselves the ability to assemble acreage, to drill it efficiently, not just cement a lot of bottom hole assemblies in the hole, to be consistently under AFE, to be one of the better operators that are out there. And from my viewpoint at GeoResources, and then initially with Earthstone, I have the utmost confidence that our staff across the board from geology, geophysics, engineering, operations, frack, land, that we can do things in my view more efficient and better than many. So with that underlying knowledge of things like land drives the play, you got to get that all put together, you got to have an efficient drilling program et cetera, et cetera; I feel that if we pay up, we can compete at least as good as anybody else out there who's paying up, and that’s what gives me a little more confidence to go forth and in the direction that we’re trying to go in. Then you consider the financial ramifications with you gentlemen in the marketplace of what impact that has on the stock valuations. What we’re supposed to do is make good acquisitions that we can perform on, that get reflected in our stock price and the underlying fundamentals of competing out there and operating effectively, so long as the market doesn’t run off away from the Permian and leave all of us Permian and to be Permian guys hanging. That’s what we should be doing for our shareholders.

[Mike Kelly:]

Yeah, fair enough. At 67 you’re still young, especially relative to Clyde Williams [ph] there in the Permian. So you got some years, Frank.

[Frank Lodzinski:]

Yes, I'll be around longer than that, except some of these other guys might absolutely be in charge. So there you have it.

[Operator:]

Thank you. Our next question comes from Neal Dingman from SunTrust.

[Neal Dingman:]

Frank, a question for you or Robert, just on the -- sort of the operation plan you put out there for the recompletes or for hitting those ducks, and then the potential drills for the end of the year. How price sensitive are both of those things? Are you going to almost in this price scenario, or virtually any scenario, you complete the ducks and then you’ll decide to get towards the end of the year how you’ll play that, as far as drill the extra wells?

[Frank Lodzinski:]

Well, I don’t think there's any price sensitivity at all on the completion program. On a go forward basis, which I hate doing because I can’t get historical costs out of my mind. But on a go forward basis, these are very good things to do go forward. Okay? Obviously the drilling is a little more price sensitive. I'm not going to tell you, Neil what our bottom line on flow of a commodity price is unless you tell me where you think the price is going to be in November. But we have locations that I think are -- put up good economics at the current strip. They were better economics when we were out talking to people. It was up starting around 48. So I think we’d be fibbing if we said we were going to go full bore to establish a drilling program, but that’s what we want to do. We have some flexibility down in Gonzalez County and a couple in some locations in Southern Gonzalez, Northern Gonzalez and Fayette that can put up good economics. I tell you, because a lot of our Eagle Ford acreage is HBP, and a lot of it, we’re not under immediate pressure for lease expirations. I think we put in the press release our materials, we’ve got 60% of our Eagle Ford covered. I’ll tell you that in reference to the question earlier, I wouldn’t mind getting few more Wolfcamp wells going. And frankly, I’d like the prices to cooperate so we could do both, but those are going to be decisions that we’re going to make. I’m not going to start drilling program if it looks like it’s going to go back in the 20s and stay there for a while.

[Operator:]

Thank you. Our next question is from a follow-up from Jeff Grampp from Northland Capital Markets.

[Jeff Grampp:]

Just wanted to talk on, if you end up adding that drilling rig towards the end of the year. Given you guys terminated that rig contract you had, what’s the day rates that are out there? If you kind of talk about implications to your cost structure, both through presumably a lower day rate and then any incremental efficiencies from better rigs that you may be able to pick-up today?

[Frank Lodzinski:]

Well, that’s actually a double question. Of course, we were hiring intelligent when we contracted for that rig in '14. And man, it’s a great rig and neighbors has probably got 15 more like that, that they ordered. I forget how many that they built at that time. But the rig has added horse power, skids. It is just great in it. Even though the cost was high, $28,000 a day, it helped us peal days off our drilling and had significant positive impacts on making sure we stayed out of mechanical trouble and getting stock in all that kind of thing. So it’s great. So I guess the second part of the question as we just put that behind us, and if we’re going to try -- and clearly we would talk to them again going forward and see if we can get some credits for that. I’m not so sure that we’d be able to pull that off if we were talking about a small group of wells, two wells here, three wells there. We would just negotiate probably the best rig contract we could do. Now, if we can see our way to pull off something significant, where we can enter into a longer term drilling contract; let’s say we were going to run one rig constantly, then I think we would take a look at availability among numerous contractors. But we would go back and at least talk to these guys, because they have been good with us, and they continue to cooperate with us. So I don’t know how to answer that any bigger than that.

[Operator:]

Thank you. Our next question is a follow-up from John White from ROTH Capital.

[John White:]

Frank, you’ve been talking, there's been a lot of talk about M&A and valuation and how you’re going to pay and how aggressive you might be; how you might be aggressive or you might not be aggressive. But I think it was contrasting the environment in the oil industry during most of GeoResources' history compared to where we are today, -- we were in a bull market during the majority of GeoResources' history. And now we’ve got a market in shambles and you’re talking about negotiating with bond holders. I would venture, and I'd like for you to comment that you feel much more comfortable, even though you don’t like seeing your production decline, but you probably feel more comfortable wheeling and dealing in today’s market than you did with oil at a $100.

[Frank Lodzinski:]

Well, it’s -- you used the word much more comfortable. You’ve known me. I'm never comfortable. I am not comfortable at a $100, I am not comfortable at $25, I am not comfortable at $50. So there you have it John, so there you have it. But I do think that -- I do think if you took a look specifically at GeoResources and how we weathered the storm during the time when the whole financial world crashed at the end of 2008 and it stayed there throughout 2009, and that’s why I am kind of going back to what we’ve learned and so forth. We made some acquisitions in 2009. We raised a little bit of money in 2009, and even though everything was in shambles right then, but between what we put together organically, our drilling our acquisitions the efficiencies that we’ve built in and then boy, the impact of the rising price environment. That’s what -- all of those ingredients with the fundamentals on the acquisitions and the cost control and so forth. So if all the wise guys on Wall Street are telling me that oil is going to be $50 forever, well we better look at that and we better make sure that our operations can put accretive barrels in the tanks at the current scrip prices. But if we can accomplish what we want to do with a big operation, with a big acquisition, and then we get the benefit of a rising pricing deck, well that will be a seller again.

[John White:]

Thank you. I appreciate it.

[Frank Lodzinski:]

Thank you. If there's no others operator, we’ll wrap up this call.

[Operator:]

We have no further questions.

[Frank Lodzinski:]

Okay. Thank you to all.

[Operator:]

Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.