Earthstone Energy, Inc.
Q3 2016 Earnings Call Transcript

Published: 9 Nov 2016

[Operator:]

Good morning and welcome to Earthstone Energy's 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] As a reminder, this conference call is being recorded. Joining us today from Earthstone are Frank Lodzinski, President and CEO; Robert Anderson, Executive Vice President, Corporate Development and Engineering; and Neil Cohen, Vice President, Finance and Treasurer. In addition from Bold Energy Joe Castillo, CEO; and Jim Lawrence, CFO, will also participate on today's call. Mr. Cohen, you may now begin.

[Neil Cohen:]

Thank you and welcome to our 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 and section 21A the Securities exchange Act of 1934 as amended. For a complete description of disclaimer, please refer to our press releases that were issued yesterday. Also, listeners are encouraged to read our quarterly report on Form 10-Q for the quarter ended September 30, 2016 in its entirety as well as all other reports and documents filed with the SEC for more detailed information about the Company. In order to focus on our pending transaction with Bold Energy, today's call will only briefly address financial and operational results related to our third quarter of 2016. So, I refer you to our quarterly press release and to our 10-Q. For the quarter ended September 30, 2016, our production averaged 3,979 Boe per day, which is a 6% increase relative to the second quarter of 2016. Production consisted of 50% oil, 26% gas and 19% NGLs. From a financial perspective, we reported a net loss of approximately $3.9 million or $0.17 per share and cash flow from operations before changes in working capital of $0.12 per share. We also reported adjusted EBITDAX of $2.8 million inclusive of approximately $800,000 attributable to expenses related to the Bold transaction. With respect to operational activities, in late August, we initiated our previously announced CapEx program that includes completing 12 gross or 5.3 net Eagle Ford DUCs by the end of the year. In early October, we brought on line our four well Boggs Unit in Karnes County, in which we have the 33% working interest. In mid October, we brought on line, our two-well well Flatonia Townsite Unit in Fayette County in which we have a 50% working interest. The remaining six DUCs are in two producing units on adjacent pads; we will have those units on line near year-end. Turning to the Midland Basin, our first well, the Tubb A 1HA located in the Howard County has been drilled and is currently flowing back. The well is drilled with 9,900 feet lateral in the Wolfcamp A interval. We will report production results in the near term, on this well. In summary, we are currently producing about 5,100 Boe per day of which 62% is oil, and will be over 6,000 Boe per day by January of next year upon bringing on line our remaining six Eagle Ford DUCs, consistent with our guidance during our equity raise this past June. With respect to our balance sheet and liquidity, we continue to have a clean capital structure with low leverage. As of quarter-end and as of today, we only had $10 million of bank debt outstanding under our $75 million borrowing base. We are currently going through our quarterly [ph] determination process and expect to a favorable outcome. Among the topic of balance sheet and leverage, I'll briefly mention how Bold has similar attributes to us. As of quarter-end, Bold had approximately $7 million of bank debt outstanding under $27 million borrowing base; cash was approximately $150,000. While Bold has no hedges outstanding, we at Earthstone will continue to out hedges opportunistically as we approach closing and thereafter. Further, prior to closing, we intend to work closely with Bold management and may consider our collective hedging strategy. I'll now turn the call over to Frank to lead us into the Bold discussion.

[Frank Lodzinski:]

Okay. Thanks Neil and thanks to all of you who’ve dialed in on this call. As most of you know, since we took over Earthstone at the outset of this industry downturn, we remained under leveraged while maintaining a reasonable capital budget, preserving the acreage that we intend to drill and completing several acquisition including our last maze entry into the Permian Basin via Lynden Energy. While we made progress and maintained a strong balance sheet, we remain focused on securing a major transformational acquisition that could move Earthstone forward in a meaningful way. Our business combination with Bold Energy and an all stock deal is just that, a major transaction which transforms the company, places us in a significant operator position in the Midland Basin. As many of you will recall, this resembles our entry and growth into the Williston Basin while we were building GeoResources. Obviously our actions were successful then, and I believe our efforts and our actions will be even more successful now and in the future. Really, I can't tell you how excited I am about this deal with Bold. So, now that we’ve delivered on our promise to secure a major transaction, I'll go onto boldly say that together with Bold’s capable personnel, we’ll continue to pursue additional transactions of size in the Permian Basin. I want to stress two things that I feel are very important. First, I believe that this is a business combination rather than an acquisition. We intend to maintain a significant Midland office with a local presence. In my view, the Bold employees are capable and dedicated. Further, they are intimately knowledgeable, not only of the existing assets but of the entire Permian Basin. And I believe they can and will contribute significantly to the cost of efficient development of the assets. And then secondly, and this is really important, I believe the Midland based personnel will play a major role in facilitating future expansion through direct land and leasing activities, asset acquisitions, and even more corporate mergers. So from an operation standpoint, it’s business as usual for each of Earthstone and Bold, and I'll let Robert and Joe tell you about the operations. We expect this deal to close in the first quarter of 2017, and we will dedicate significant corporate resources to that end. In the meantime, Robert and I with the assistance of the Midland staff, will continue to search for additional significant acquisitions. I'll turn it over to Robert next and then to Joe, to give you an overview of the assets. And then, when we’re done with that, we will open up the lines for questions.

[Robert Anderson:]

Thank you, Frank. Before I begin, I would encourage all listeners to review the transaction related investor presentation that we posted on our website yesterday morning and read the related press release and all the details involved. This transaction is very exciting and brings significant operated acreage and inventory under the Earthstone umbrella. Bold currently produces about 2,300 barrels of oil equivalent per day made up of about 63% oil from 18 horizontal wells and exciting almost 21,000 net acres in what we consider the core of the Midland Basin. Our internal viewer resource potential totals more than 198 million barrels of oil equivalent with approximately 7 million barrels of oil equivalent of proved developed reserves. 99% of the acreage is operated with an average working interest of approximately 85%. And we currently see potential for approximately 500 gross locations. However, we expect more locations likely as additional intervals of the Wolfcamp become proven, within the existing benches as well as the deeper benches of the Wolfcamp, which we have excluded from our current inventory view. One rig is currently drilling in Upton county and at present two wells are flowing back in Reagan county while one well is being fraced in Midland county, and additional six wells are waiting on completion. In particular, we are very excited about the Reagan county opportunity and the upside that exists. The Bold team has demonstrated major success from improvements on horizontal completion practices and we anticipate further improvements and positive results. So now, I'll turn the call over to Joe Castillo, who is Bold's CEO.

[Joe Castillo:]

Thank you, Robert. Let me just say that everyone at Bold Energy is -- we are very excited about this combination, and working with Frank and Robert and the entire Earthstone team. As we've come to know, both of our teams know how to roll up our sleeves and get the job done while controlling costs and improving results. So, we are looking forward to building value through the drill bit and through the continued acquisitions and bolt-ons. Since Bold turned its attention to the Wolfcamp play in early 2013, we worked to assemble high-quality land position that we are very proud of. As everyone working in the Permian knows, putting quality acreage together in the Midland Basin is hand-to-hand combat and trench warfare fare. And our land and business development team has done a remarkable job of identifying great opportunities and negotiating deals in a pretty highly competitive environment. And as we’ve learned firsthand, Frank and his team, these guys are dealmakers. And with our combined deal-making capabilities, I have no doubt that we’re going to continue adding to our asset base in a very meaningful way. Our operations team alongside of our geotechnical team has done a great job of driving down costs and driving up well performance. The evolution in our drilling practices, completion and hydraulic fracturing designs, and our production operation practices truly puts us in a state-of-the-art category. And this is not entirely due to our own innovation but also comes from paying attention to what we see others doing around that actually works. And so, it's nice to have good active neighbors like Parsley Energy, Diamondback and Permian Resources. So, to highlight where we currently are in our completion evolution, we just drilled and completed two 8,500 foot wells in Reagan county with what are calling our Gen IV completion. As shown on page nine of the investor presentation on the website, this completion has recently worked very well for us in Midland and Upton counties. Now, as to these two 8,500 foot laterals in Reagan county, we fraced both of these laterals with 51 frac stages, placing an each well a total of 18.8 million pounds of sand; we drilled out 50 frac plugs and placed both wells on production in less than 25 days at a total well cost of less than $5.1 million each. And that's not just drill and complete folks; that's drill, complete, equip and on production. So by year-end, we expect to demonstrate another step change in our Reagan county results. Our industry will collectively continue to make advancements in optimizing and completion results. And we expect to benefit collectively from what progress our industry makes. Now, little about Reagan county. In our view Reagan county has tremendous resource potential due to the overall greater thickness of the Wolfcamp section compared to Midland county. And in our investor presentation, we've got a good graphic showing how that thickness compares to Midland county. And we've been observing a recent test by Permian Resources here in Reagan county where they placed 15 horizontal wells within a standup 480-acre unit. They landed those laterals and they had three upper A Wolfcamp A wells, three lower Wolfcamp A, three upper Wolfcamp B, three middle Wolfcamp B, and three lower Wolfcamp B all within a half-mile wide unit. All 15 of those wells were fraced using a zipper method and placed on production within a few weeks of each other. These wells were -- the only reason we know about this is because these wells were drilled immediately adjacent to our own standup 480-acre unit, one of the units that we have there where we have two producing upper Wolfcamp B wells. The Permian Resources frac jobs knocked our two wells offline for around 30 days. When our wells came back on line, they had not only a higher rate but also exhibited a better decline. And so, we thought we'd better find out what these guys just did here and we’re still researching it. But based on the public data, the composite result of those 15 wells was an IP30 of over 14,000 barrels per day and 18 million cubic feet of gas per day. Think about how much oil and gas that is coming out of a single 480-acre unit. So, clearly, owing to its massively thick Wolfcamp section, Reagan county has tremendous potential, and it's all going to be about the landing depths and the completions. To finish up, we will continue to run a one rig program across our acreage over the remainder of 2016 and 2017. One of the benefits of this combination that we see and our Midland team is very eager for is the contemplation of adding a second rig to our program. And so, in the weeks ahead, we will be working Frank and rest of the Earthstone team to come up with a scenario for adding a second rig in 2017. We have a lot of work to do, and we have a great asset to work on. So, Frank, I'll turn it back over to you, sir.

[Frank Lodzinski:]

Okay. Thanks, Joe. I think that was a great summary and giving the callers a good idea of what's been happening in your operations and so on. So, look, just not to be too redundant, this business combination is a significant event that’s come to allow our shareholders and the Bold shareholders to enjoy the benefits of the larger Company with significant growth potential. And if Joe and Jim will allow us to pad ourselves on the back a little bit by management team, and we’ve got a good public track record and know the investors out there and so on, so the combination of the two, I am really quite pleased with. As we indicated in our press release, on a combined basis including our two corporations putting them together and including our entry into the Midland Basin via Lynden, today, we are producing about 7,400 Boe a day, barrels of oil equivalent a day. We have got about 27,000 net acres in the Midland Basin. You add up the locations, which we believe are conservative and we are talking over 700 locations in the Spraberry in the Wolfcamp. We mentioned several times, we believe the location count is going to increase with development and so on. And while we in Huston have significant knowledge and experience in West Texas, the combination with the Midland based personnel is just going to enhance what we are doing with added talented people out there right after we get closed. So, I am just thrilled to be able to establish a real hometown presence in Midland with the existing talented employees. Anyway, those of you that have followed us for years, may know the pattern here. We survived the downturn; we’ve continued to grow during the downturn; we’ve always been able to add or pull off acquisitions or business combinations in prior downturns that have turned out to be significantly successful for us and our shareholders. So, anyway, I am going to dispense a little bit with the prepared remarks and just say that we are excited, we are going to get our heads down and get this deal closed. We will be able to add some color in terms of what kind of production we are looking at and so on, what kind of CapEx budget, so on. But we might be a little skinny on that data because we mentioned in the press release that as we move towards the end of the year, we intend to get out information regarding our CapEx plans, guidance and everything. You guys just got to give us a little bit of time to put it together properly. So, with that, I'll turn it over for questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Neal Dingmann with SunTrust Robinson Humphrey. Please proceed with your question.

[Neal Dingmann:]

Good morning, gentlemen and congrats. It looks like a very nice accretive deal.

[Frank Lodzinski:]

Thanks Neal.

[Neal Dingmann:]

First question, maybe just for Robert. You mentioned in the press release that you talked about a number of these DUCs that you started to knock out, the four at Boggs and a couple of others. Could you remind us either today or to year-end, where you will sit on the existing Eagle Ford acres as far as DUCs and sort of what you could complete early in the year, early for 2017, I should say.

[Robert Anderson:]

Neal, we will have everything completed and on line hopefully by the end of the year and have no frac inventory. So, we will start out the year with unfortunately no frac into our inventory but fortunately more production in cash flow.

[Neal Dingmann:]

And then, Frank, I don’t know how much you want to go into Bold today, so stop me if we don’t want to. I think…

[Frank Lodzinski:]

No, we are happy to answer questions that you have on them. That’s one of the reasons Joe and Jim are here. So, go ahead.

[Neal Dingmann:]

Okay. My first question, so just looking at those slides where you show the comment, I really like that slide eight that shows the Reagan and Upton well performance where you break it out, even specifically I think Joe was talking about this between Western Reagan and Central Reagan and Southeast. Based on I guess what the guys there have seen so far, any -- one might say is there part that acreage that you prefer that you might focus on versus the others? Or I'm just kind of looking at thinking about the 2017drilling plan. Will it be more try to kind of just hold all the acreage or there will be one focus area where you will try to delineate mostly?

[Joe Castillo:]

Well, we feel that we've already delineated the Wolfcamp A and the Wolfcamp B across our acreage in Reagan county. And so, part of what we are looking at is a one rig program to perpetuate our continuous drilling provisions and the acreage. And so, there is not really any particular focus area for us. We like all the acreage, the Wolfcamp A and Wolfcamp B across Reagan county. And so, we’re going to use our obligation schedule to determine where the rig goes. Again, this is a one rig program that if we accelerate drilling next year, then, we’ll be taking looking at what you are talking about which is to implement some additional focus on some of the better areas. But, we're still seeing an application of our Gen IV completion that has just been finished on these two Reagan county wells. And so, we’re eager to see what those results are and that will certainly factor into where we focus in Reagan county as well.

[Neal Dingmann:]

Okay, great; good answer. And the just lastly, Frank, I know you haven’t -- definitely with this acquisition, you certainly haven’t laid out any plans for 2017 yet. How would you think about sort of co-existing between the two? I mean, is it fair to say most of the activity would focus on the new Permian acreage or I'm just wondering how you would think about...

[Frank Lodzinski:]

Neal, that has to be worked out in our capital budgets. With Joe and Jim's cooperation, we’ll let the dust settle here and start talking about all that kind of stuff within a few weeks or so on. If we get this thing closed, say in February, there will be a transition period and we’ll get all that gone. But anyway, I’ll mention, this will -- we’re trying to put out a capital budget. Now, I really think we're going to be able to dedicate clearly on a combined basis, the majority of our CapEx to the Midland Basin. As you know, we have shareholders who are also joint owners in our Eagle Ford acreage. And I think we have some obligations to our partners to sit down and talk about there about drilling in the Eagle Ford. So potentially, I could see five, maybe as many as six or eight wells, maybe a little bit more down in southern Gonzales and so forth. But we just got to work that all up. The point is we're not going abandon our partners in the Eagle Ford but we are going to put our combined money where the highest rate of returns are for the shareholders.

[Neal Dingmann:]

Perfect. Thanks, Frank. And again, congrats on certainly looks like an accretive deal.

[Frank Lodzinski:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Welles Fitzpatrick with Johnson Rice. Please proceed with your question.

[Welles Fitzpatrick:]

Kind of a follow-on on Neal's question. As far as the drilling moving forward, should we look for an even split between the different zones in the Wolfcamp or are you going to be favoring one to the P [ph] clauses or any other reason?

[Joe Castillo:]

Well there are no P [ph] clause issues that we are concerned about. So, our drilling schedule has us drilling Wolfcamp A and Wolfcamp B tests. There’s probably a greater proportion of our laterals that will be landed in the Wolfcamp B. It's a more generally well-known event, although the Wolfcamp B has been delineated across our acreage.

[Welles Fitzpatrick:]

Okay, great. And then on those the Bold Texaco wells,. are those -- is it safe to say that those are Gen III or earlier on the completions?

[Joe Castillo:]

Which Texaco wells?

[Welles Fitzpatrick:]

The Texaco Coates AU 2 -- the 2…

[Joe Castillo:]

Yes, those are early Gen III completions.

[Welles Fitzpatrick:]

And lastly, the non-op portion in Glasscock, is that something that you guys are going to look to build off of or is it more likely to be sold or maybe swapped out of?

[Joe Castillo:]

This is going to be a collective decision by Frank and his group but the Glasscock acreage that we have is under Diamondback operatorship. So, Diamondback is working to continue to situate that acreage where we can drill long laterals on it. And we personally would be very interested in participating with Diamondback in those wells. We think that those are going to be great projects. It's not something that we would advocate selling right now.

[Robert Anderson:]

Hey Welles, this is Robert. That acreage is also not very far to the west of what we closed on in may, which is operated by CrownQuest. So, it's very similar and we are pretty excited to see some more development come thorough there.

[Operator:]

Thank you. Our next question comes from line of Steve Berman with Canaccord Genuity. Please proceed with your question.

[Steve Berman:]

At this point, Frank, for modeling purposes, what's your best guess as to when in Q1 this combination might close, early, middle, late? Any additional color there would be helpful.

[Frank Lodzinski:]

Well, I hope none of the lawyers are listening, but I am going to beat on them to death to get this thing closed by mid February. Okay? Now, it all depends, Steve, on whether we get hung up in the SEC or so on. But I think right now, I’d put a mid-February date. Jim, what would you think. Would you think that’s too aggressive or about March 1st?

[Jim Lawrence:]

That’s my best guess.

[Frank Lodzinski:]

Okay, there you go. Pick one.

[Steve Berman:]

And then, can you talk about any sale restrictions by Bold on Earthstone stock? It’s kind of a complex transaction here, so any color there?

[Frank Lodzinski:]

Tell me what you are talking about, I am not sure I understand what you are asking.

[Steve Berman:]

Well, I mean, Bold is going to own 61% of the combined company. Is there any restrictions on that stock being sold as move forward?

[Frank Lodzinski:]

As we mentioned in the press release, Bold’s a portfolio company of EnCap part of the deal. And what has been common in all of these Up-C see transactions is that all of the shares will get registered post closing. I think any -- I don’t think there is going to be any restrictions on that other than common sense actions that folks like EnCap and Bold and the bigger shareholders and Earthstone consider.

[Steve Berman:]

One more, Neil, housekeeping question for you. I think you said what current production was and you might have given an exit rate to it. I missed that. Can you repeat whatever you said on that, please?

[Neil Cohen:]

On a combined basis, currently we are about 7,400 a day.

[Frank Lodzinski:]

You want to know it on a combined basis or were you asking just standalone?

[Steve Berman:]

I thought you said for current production just for…

[Frank Lodzinski:]

Yes, we are at about, 51?

[Neil Cohen:]

Earthstone’s standalone as of October around 5,100 a day.

[Steve Berman:]

Did you also give some sort of exit rate once you get all the other Eagle Ford...

[Frank Lodzinski:]

The exit rate is not going to be [multiple speakers] the exit rate is not going to -- it’s going to happen in January, maybe the end of the January or so on because we are bringing on those last six wells towards the end of the year. But we should hit about 6,000 barrels a day. It’s just not going to happen on December 31st.

[Operator:]

Thank you. Our next question comes from the line of Jeff Grampp with Northland Capital Markets. Please proceed with your question.

[Jeff Grampp:]

Maybe it’s a question for Joe or Robert. But, when you guys talk about potential acceleration cases adding up to maybe two rigs on, on the Midland side of things. Can you guys just talk about how maybe things set up from an infrastructure need standpoint? You guys feel pretty good about everything on that side of things. And then just maybe talk about how many rigs the asset base could potentially support kind of the medium-term development of the acreage?

[Robert Anderson:]

Jeff, I will say that Joe and his team have done a fantastic job of flying under the radar and have an infrastructure ready for a much larger development that they've handled themselves. And then, I'll let Joe to tell you what they've done.

[Joseph Castillo:]

Right. On every one of our project areas, the first thing we focused on was infrastructure and infrastructure investment. And that includes frac pits, water supply wells, salt water disposal, wells and access to commercial salt water disposal . We set up our infrastructure to handle horizontal development. As far as gas pipelines and access to oil market, here in the Midland Basin, we have no issues being able to get our product to market. So, we're well-situated to easily handle a two-rig program. And if we had to or wanted to -- if oil goes to $100 a barrel, I honestly believe we could handle a three or four-rig program.

[Jeff Grampp:]

Great, okay. Thanks for that. And shifting over to maybe the Eagle Ford real quick, with these current county wells, the IP rate certainly looks good on those restricted chokes. But I guess kind of referencing some of your old slide decks you guys were talking about, maybe a 700 plus Boe a day 30-day rate. Is the difference in that the delta more related to just kind of the really conservative chokes that you guys are employing there, or can you just kind of talk about how these results stacked up your expectations?

[Robert Anderson:]

Yes, Jeff, they are all related to the chokes. I mean, we typically bring our wells on -- we baby them when they come on. After a month, they are right on our projected forecast of the performance that we thought going into drilling those wells. So, we’re pretty pleased. The first month is a little lower but we are right on target. So, our decline rate isn’t as steep as what we had originally projected when we had a little higher initial rate. So, we’re happy with the outcome.

[Jeff Grampp:]

Okay, great. And then just one kind of more housekeeping one. On the inventory that you guys talked about with the Bold assets. Can you guys give us a sense for kind of the spacing assumptions between laterals and then, if you guys have a kind of a ballpark average lateral length to that inventory?

[Neil Cohen:]

Right. The spacing that we’ve settled in on which I believe our industry has settled in on as well is about 660 foot spacing within a bench. And of course, when you are completing multiple benches, we can take the well spacing across different benches down to 330 feet. The average lateral length in our inventory is about 7,100 feet and that includes laterals ranging from over 5,000 feet to 10,000 feet but the medium is around 7,100 feet.

[Operator:]

Thank you. Our next question comes from the line of Jason Wangler with Wunderlich. Please proceed with your question.

[Jason Wangler:]

I was just curious, Frank, as you’re looking out, obviously having a lot of Permian acreage and activity, you've now got Permian, Eagle Ford, Bakken. How you see kind of that plan, at least from high level, as you look at your spending next year? Does anything kind of look at something where you look at in monetization or just how you are looking at just kind of managing that portfolio?

[Frank Lodzinski:]

Yes, I think that we will -- we also have a few other properties. We've got some little tiny properties in South Texas and then Southeast Oklahoma that were starter kit properties for us when we put this thing together. Those are clearly the smaller ones, are clearly going to be on the divestiture market. I think collectively with the Bold folks and with our Board, we’ll consider our strategy going forward. But clearly, it's hard not to take into consideration the premium valuations that Permian based companies are getting. So, it is clearly a possibility that the Bakken could be sold at some time and on the Eagle Ford, there is a possibility that also. However we've got an AMI 50% partner. So, we're going have to sit down and talk about them. But we are going to put the vast majority of our money where the highest takers are, or the highest returns are and where the markets rewarding that the most. That’s what we need to do for our shareholders. So, I can’t give you a timing. I can tell you that selling the Eagle Ford and selling Bakken at sometime will be contemplated and discussed. But I can tell you right now, they’re throwing off good cash flow. And subject to talking to Joe and his folks and our Board, my decision is I’m not selling them right now. We’ll let the cash flow help us develop things.

[Jason Wangler:]

And then, I think Neil mentioned in his opening remarks about the credit facilities of the two companies. But I guess as you look at next year and get the deal closed mid-February, early March, how do you see that playing out as far as getting a combined facility to use as you then start that drilling program?

[Neil Cohen:]

Sure. Obviously, it’s going to be a function of what our development plan’s going to be next year. So therefore that’s going to influence what our cash outspend might be. But on closing, we will have sufficient liquidity under our borrowing base. But to extent needed, obviously we are not opposed to using equity. We used equity for most of our transactions, also in June to help fund our Eagle Ford development. But generally speaking about leverage and just balance sheet management, I think you guys know Frank and team well enough that we are not going to -- we won’t be overlevered generally, two times or south there of debt to EBITDA is kind of our comfort zone. And we will have a prudent balance sheet whether as we’ve done with Earthstone with generally a one rig program in Eagle Ford the last few years or as we ramp up on Bold assets.

[Operator:]

Thank you. Our next question comes from the line of Mike Kelly with Seaport Global. Please proceed with your question.

[Mike Kelly:]

It's nice to have Joe on the line here. And Joe, I would love to hear your thoughts on what drove you guys at EnCap to get linked up with Frank here versus potentially sell out to somebody else, what I would have to imagine would be higher per acre price, at least next initially. Maybe you could just give a little bit background of how this came together and why you went down this path? Thanks.

[Joe Castillo:]

The last two years, we have been in pretty low commodity price environment. And our objective is to make as much money as we can. And so selling in $40 to $50 commodity price environment just wasn’t a very attractive option for us. When Frank and team started looking at our assets and we started talking with them, it became clear that as far as a longer term progression for our company, this would make a lot of sense. So having access to public markets and capital for a longer development program that goes beyond what a typical private equity company like us contemplates, that just made a lot of sense.

[Mike Kelly:]

It just doesn’t sound like this was a widely marketed deal; it that fair?

[Joe Castillo:]

I would say that’s fair.

[Mike Kelly:]

Okay.

[Frank Lodzinski:]

I would say from my perspective, I agree with what Joe said. I guess the real question is do you take the money off the table right now or do you have a little bit of forward-looking to see if -- I think in our presentation, with one rig here and two rigs, we could be looking at 7,000 barrels a day next year coming off the Bold property or 10,000 barrels a day. So, you take a look at -- also at if we ever see increased commodity prices again. But the combination of development, adding additional locations, improved -- even without improved commodity prices and valuations in the public markets, do you take it now or you take it gamble and take hopefully a lot more or later on. So, I think that was part of the discussions, if you will.

[Joe Castillo:]

Absolutely. And we view this as a win-win combination for all of those reasons.

[Mike Kelly:]

Yes and getting linked up with Frank is at least from a fun factor got to give you a couple thousand per acre. Frank?

[Frank Lodzinski:]

Did you say fun?

[Mike Kelly:]

Absolutely. Frank, my follow-up for you…

[Frank Lodzinski:]

Next time, I see you, get ready man. Okay?

[Mike Kelly:]

Prepared. You mentioned a few times in your prepared remarks that that's not done on this front too. I'm just curious just how the strategy shifts now, if it all on the acquisition front here in the Midland and if you've got any other aces up your sleeve like this? Thanks.

[Frank Lodzinski:]

Well, you never really have any aces up your sleeve, you’ve just got to get up every day and go to work and try to find that next deal and so on. And I'd be remiss if I didn’t say that our shareholders expect us to find that next deal and that next deal and that next deal, okay? And look, if there is others out there that have done that the combined team here can do that also. So, if you let me be just a little cocky, we've got this deal done, we’ll start hammering on all the accounts and the lawyers to get the SEC stuff. And Joe and Jim and Robert and I’ll start looking for the next deal right now. That's kind of the plan. Plus, I think Joe you might just tell him a little bit of your presence in the basin, how you do trades, how you picked up the last deal that you did and so on. So, we are not stopping here.

[Joe Castillo:]

Sure. I mean, Frank, actually what he didn’t tell you, he already has us looking for the next deal. As I've said in my prepared remarks, putting stuff together in the Midland Basin and the Delaware Basin as well for at least quality acreage, it's hand-to-hand combat. And the devil is in the details on the land work. And we've got an exceptional land team that can get down to the grassroots of ownership and we’re able to identify who owns what and go out and try to facilitate deals. And so, you start with that knowledge base to do that. In addition, there are quite a few owners of the properties in the Midland Basin that have thought about and are thinking about participating in the horizontal market and there is different ways for them to do that. So, a lot of the deals that we've done had been joint ventures where our drilling team had a great reputation from their days at EOG. And so we leveraged their reputation into joint ventures that is come and drill wells on your land and let us earn a position there. And then, you also have acquisitions where people think that the market is hot and are willing to go to the market and try to capture value. And we have to participate in that as well. It's an all of the above approach that we have to take to putting acreage to -- or assembling greater position in the Permian Basin. A lot of what we've done successfully has been bolting on where we take a small piece of acreage and then tails off to bolt on north and south so that we can drill long laterals. We've got several great examples of how that's worked and we will continue to pursue that approach as well.

[Frank Lodzinski:]

Yes. So, the bottom line is you sit around in the office waiting for the bankers or the brokers to bring in deals. You get out there and search for them every day and we're going to continue to do that.

[Mike Kelly:]

Sounds good. Congrats again.

[Frank Lodzinski:]

Thank you.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Joel Musante with Euro Pacific Capital. Please proceed with your question.

[Joel Musante:]

I just had a few question, just talking around 2017. You talk about one rig program at least initially. I was just wondering how many wells could you drill with one rig and what kind of cost assumptions should we be using?

[Frank Lodzinski:]

I'll let Joe correct me if I'm wrong. But I think you could run -- I mean, you can basically drill two wells a month. I got to factor in mobe and demobe. So, you’re talking 20, 24 wells a year. So, split the difference and call it 22, unless you disagree. And I think Joe mentioned that he was at about $5 million or $5.1 million.

[Joe Castillo:]

These are higher than that but yes, we are drilling well, completely equipped for about 5.1.

[Jim Lawrence:]

But the cost assumptions you should use are on page eight of the presentation.

[Frank Lodzinski:]

Yes.

[Jim Lawrence:]

So, if you bake in an average cost of 5.75 that probably gets you there.

[Frank Lodzinski:]

Wait a minute, Joel, I want to correct Jim, since this is the first time for us really kind of working together. So, they are doing it for 5.1, the AFE [ph] is 5.7. We got to set goals, man, 4.8. So, Joel, you can use 4.8. But I think on those costs, we are talking about an average 85% working interest. So, you got to scale that back by 15% or so.

[Joel Musante:]

Okay. And then, is there like an integration period that you might have to go through before you add a second rig, just on a minimum I guess?

[Frank Lodzinski:]

Oh, boy! I don’t know how to answer that. Let me think.

[Joe Castillo:]

If we decide to go to a second rig, we will pick up a second rig. What you don’t know is that we have been running two rigs here for the last 45 days. And we’ve just finished the short, the small program that we had for that second rig, and we are now back down to one rig but going to a second rig just not a problem at all.

[Frank Lodzinski:]

I guess the way I would say it, we were in a joint meeting with EnCap and the folks the other day, the beauty of this is that we can start sitting down monthly and kind of start planning out what we are doing and take a look at what collectively, what the budget’s going to look like for next year. And just in working with Joe so far, we are going to have a discussion if you want to go to a second rig. And if the rates return and the commodity prices do that, I’m on favor of it.

[Joe Castillo:]

Absolutely, it's going to be predicated on what the economic results are going to be at the current commodity price and current well cost. But we are working through that now through our own analysis. And my understanding is -- Frank is whipping us to get this done here pretty quick. But I think by the end of the year, we are going to have a forecast to what the two-rig program looks like and we will determine if that’s what we want to do.

[Frank Lodzinski:]

Like I always tell you, Joel, give me a priest deck and I’ll tell you what we are doing. But really, the plan is for right now, and we will get the guidance out. On the Earthstone side, finish our DUCs, maybe as many as I don’t know, about 10 or 12 Eagle Ford wells but we would have in that probably an average 40% working interest. So, you might say 12 or even 15 Eagle Ford wells with an average 40% working interest, if they’re not deferred, maybe as little as six. I think running one rig constantly in the Midland Basin makes some sense. That said, Joe runs his company like we do. Commodity prices don’t cooperate. We can scale that back or whatever have you. But as far as I’m concerned, I would like to get after it, run two rigs out there next year.

[Joel Musante:]

Alright. And on the Eagle Ford side, would the goal be to keep production flat there at least?

[Frank Lodzinski:]

Once again, being smart alec, the answer is yes, and maybe some modest increases and so on and so on. The bottom line is I think we still have about 60% of our acreage up in the AMI, HBP. There is no competition for leases there. We can maintain the leases. As you know, Sanchez is focusing further to the south and so on. So, we don’t have to really worry about it. So, we could drill -- Robert, help me out of here. We could drill say six wells on the one next door to the Boggs, and how many up to the north?

[Robert Anderson:]

Five to six wells to the north.

[Frank Lodzinski:]

So, call that 12 wells and then maybe a couple of more like at the Richards South or somewhere. So, call it 14, 15 wells with an average 40% working interest. And we don’t have to do -- well, we don’t have to do any of those because we can perpetuate the acreage with the reasonable lease -- we see there HBP or we can perpetuate the acreage with reasonable extensions. And we just kind of talk about that side with our partners. So, John, if you are listening, we need to talk about this at so time.

[Joel Musante:]

Alright. And if I can just add a few more questions. Could you -- just talk about the repeatability of the results. I mean, we've seen a dramatic improvement in results year-over-year using the new completion techniques. And I was wondering how repeatable how you think that is. And if there is maybe some areas we should risk a little more, maybe for instance because there is some vertical well drilling there that might cause some pressure issues or something like that or faulting or something like that?

[Joe Castillo:]

Yes. We have a very good handle on the geology across our acreage. This is not an explanatory area. It's a well-delineated area. So, issues with faulting and geological hazards like that, we’re fully cognizant of them. And we don’t have any serious issues across our acreage. As to vertical wells, the majority of -- the development in the Midland basin of course over the last 20 years has been Wolfberry completions where wells are drilled through the Wolfcamp and even to some deeper horizons and the whole section has been completed in Reagan county, the predominance of completions have not gone into the Wolfcamp. So, we're not dealing with a whole a lot of issues with offset vertical wells in the Wolfcamp. From our view point. in Reagan county, in particular in the eastern side of Reagan county and the southern side of Reagan county, we initially thought that we were going to see some differences in reservoir of performance. And on a normalized basis, we’re not. So, we view that the Eastern side of Reagan county to be basically the same quality asset whether we’re in the northern piece of our acreage on the east or the southern piece on the east. Hopefully, that answers your question.

[Joel Musante:]

Yes that's encouraging so and then.

[Jim Lawrence:]

I wanted to add, on page nine, you see a Gen III well on there that was drilled in an area with vertical wells that was fully developed. So, the vertical wells actually have had no impact on our well results. And our partner that owns some of those vertical wells has been pleased because those wells have picked up in their performance after our work.

[Joel Musante:]

Okay. And just one last one, just can you -- you gave kind of a wide range for returns that you do expect. I just wondered if you can just give us tighten up that range just for the wells that you are kind of planning on you are drilling now, given maybe -- I don’t know whatever price assumption you want to use $50 or oil or $60 oil?

[Robert Anderson:]

Hey, Joel. This is Robert. The range is kind of because of what area specific type curves are used. It's not fair to say that they are all going to be Midland 100% or depending on what price deck you use, rate of returns. So, I'm not sure how to answer -- I'm not sure we would understand how to answer your question.

[Joel Musante:]

Okay.

[Robert Anderson:]

If we did all the drilling in Midland county, we’d expect the 100% rate of return on every well we drill. How about that? Does that answer your question?

[Joel Musante:]

Alright. I just figured...

[Frank Lodzinski:]

It's also the difference in the well cost between what we’re forecasting conservatively. Am I missing something here at 5.7 versus what you guys are putting them in the tanks at?

[Joe Castillo:]

That's right, but the other I think equally maybe most important issues is the application of this Gen IV completion. We have seen it have stellar results in Midland and Upton county, and we have just now applied it to Reagan county. So, we have to see what the uplift there in Reagan county is, how Gen III compares to Gen IV. We see how it works in Midland and Upton county but we are just now going to be seeing what that looks like in Reagan county. We are anticipating that these rates of return for Reagan county are going to go up as a result of this higher intensity completion.

[Joel Musante:]

Okay. Well, that’s all I had. I appreciate the time.

[Frank Lodzinski:]

Okay. Well, thank you all for attending, and we will conclude our call right now. You know where we are. Thank you very much.

[Operator:]

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