Falcon Minerals Corporation
Q3 2021 Earnings Call Transcript

Published: 6 Nov 2021

[Operator:]

Good day, ladies and gentlemen, and welcome to the Falcon Minerals Q3 2021 Earnings Call . At this time, it is my pleasure to turn the floor over to your host, Matt Ockwood, CFO of Falcon Minerals. Sir, the floor is yours.

[Matt Ockwood:]

Thank you, and good morning, everyone. Thank you for joining today's call to discuss the Falcon Minerals Third Quarter 2021 results. Before we begin, I would like to remind you that during this call, we will make certain forward-looking statements that address our expected future business, financial performance and financial conditions. Actual results achieved by the company may differ materially from those made or implied in any forward-looking statement due to a wide range of risks and uncertainties, including those set forth in our SEC filings. The company expressly disclaims any obligation to update or revise any forward-looking statements. Additionally, this discussion also includes non-GAAP measures Reconciliations of these measures to the most directly comparable GAAP measures are included in the earnings release, which is posted on our website. And with that, I will now turn the call over to Falcon's President and Chief Executive Officer, Bryan Gunderson, for his remarks. Bryan?

[Bryan Gunderson:]

Thanks, Matt. Good morning to those on the line. We appreciate you joining Falcon Minerals Third Quarter 2021 Earnings Call. I'm joined today by Falcon's Chief Financial Officer, Matt Ockwood, who you just heard from; and Falcon's Chief Operating Officer, Mike Downs. After my remarks, Matt will speak to our financial results for the third quarter, and then we will take questions from those on the line. We were pleased with the way the business performed during the third quarter, which was in line with what we expected. The business generated $0.16 of free cash flow per share, which exceeds the high end of our $0.13 to $0.15 cash flow per share guidance range that we shared in August. Production during the quarter was 4,535 BOE per day with approximately 47% crude oil and 61% total liquids. The business generated $14.7 million of EBITDA with greater than 70% EBITDA margins. These results are reflective of the quality of our position in the Karnes Trough, which continues to be among the best performing and lowest breakeven reservoirs in the United States. Additionally, we saw significant benefits from our position in the Marcellus Shale this quarter, including $1.1 million in lease bonus revenue as operators in the basin saw to take advantage of the rising prices for natural gas. The free cash flow that Falcon generated from this performance allowed us to declare a quarterly dividend of $0.155, which represents a payout ratio of approximately 97% in and sequential increase from the second quarter. We are excited to see our shareholders immediately benefiting from Falcon's industry-leading payout ratio and the strong commodity backdrop we've experienced in the second half this year. The third quarter dividend on an annualized basis translates to $0.62 per share, which we believe represents a compelling yield for investors. Looking ahead to the remainder of 2021, we anticipate that production volumes will continue to moderate through year-end, while still allowing free cash flow to remain healthy in this supportive commodity price environment. Based on current strip pricing, we anticipate free cash flow to be 0per share to be approximately $0.13 to $0.14 in the fourth quarter of 2021. While we are excited for Falcon's prospects in 2022, it's too soon for us to give any specific guidance for the full year. However, we're optimistic knowing that the key operators on our assets are working to finalize their own capital budgets in the midst of very strong commodity prices. The component of 2022 will likely be development activity on our Hooks Ranch asset. The Hooks Ranch is a world-class shale asset with exceptionally strong operator economics, and we are pleased to own the entire mineral estate under this property. As we have previously discussed, ConocoPhillips permitted 6 wells in the third quarter 2020, which will be drilled across unit boundaries from the Hamilton Trust B unit into the Hooks Ranch, where Falcon holds material NRI. During our last conference call, I noted that ConocoPhillips development of these wells was delayed due to difficulties regarding the location of the pad with the surface owner on the Hamilton Trust B unit. While Falcon is not involved with this dispute, we are optimistic that the parties are nearing resolution and development activity could begin during the first half 2022. It is our strongly held belief that the Hooks Ranch assets will be developed over time and will deliver meaningful returns to shareholders. While we remain enthusiastic about our existing portfolio of core Eagle Ford acreage, I continue to believe that Falcon could benefit from being a larger entity with a more diverse portfolio of properties. Enhanced diversity and scale provided that it comes largely from Tier 1 assets and Tier 1 operators can serve as an engine to grow free cash flow on a per share basis. The market continues to provide avenues to express this view, and we will explore them as we seek to maximize shareholder value. Above all, our core focus remains an unwavering commitment to generate industry-leading shareholder returns to free cash flow growth on a per share basis and the distribution of this cash flow to our investors. We will continue to be thorough and disciplined as we manage the existing portfolio and as we consider opportunities to grow the business. With that, I'll now turn it to our CFO, Matt Ockwood. Matt?

[Matt Ockwood:]

Thank you, Bryan. During the third quarter, our assets generated $20.2 million in royalty and lease revenue. We recognized a cash loss of $1.3 million from our commodity derivative instruments during the period. Production for the third quarter was 4,535 BOEs per day compared to 5,034 BOEs per day in the second quarter. The sequential decline in production during the third quarter is consistent with our expectations from the second quarter earnings call as the robust pace of development activity in the early part of the year moderated into the summer and early fall on a net basis. The sequential increase in revenue we experienced this quarter was driven by higher pricing and revenue associated with lease bonuses in the Marcellus. During the third quarter, we saw 0.31 net or 62 gross wells turned in line compared to 0.51 net for 55 gross wells during the second quarter. This brings our total wells turned in line year-to-date to 2.05 net wells or 177 on a gross basis. Falcon's average realized price for oil during the third quarter was $59.61 per barrel. The average realized price for natural gas was $3.65 per Mcf and our NGL realizations averaged $33.92 per barrel. We have generally seen more favorable realized pricing as differentials have tightened across our assets in Texas, while Marcellus differentials widened as the benchmark Henry Hub prices rose during the third quarter. Also during the quarter, Falcon entered into new commodity derivative instruments through costless collars related to natural gas for the months of November 2021 through March 2022, which provide forward prices of $4.20 per MMBtu on the hedge volumes. Falcon is unhedged on crude oil volumes in 2022. Associated pricing and volumes for all of these hedges are laid out in our investor presentation, which is available on our website. Cash operating costs for the third quarter of 2021 were $1.5 million, ad valorem and production taxes comprised approximately $1.1 million of this figure for the quarter. Marketing and transportation expenses were the remaining $0.5 million or about $1.12 per BOE. Cash G&A expense was approximately $2.7 million for the third quarter, which excludes approximately $0.5 million of noncash stock-based compensation expense recognized in the period. Adjusted EBITDA for the third quarter was $14.7 million, which represents an increase of approximately $900,000 from the $13.8 million reported in the second quarter of 2021. The increase was largely attributable to increased realized pricing across all 3 product streams as well as an increase in lease bonus income. At the end of the third quarter, Falcon had $36.5 million of debt outstanding on its revolving credit facility and approximately $3.6 million of cash on hand resulting in net debt of approximately $32.9 million. Falcon continues to have a conservative approach to leverage. We held the revolver balance flat quarter-over-quarter and Falcon's net debt to LTM EBITDA has decreased to 0.74x. We see that ratio tightening further as we close out 2021 under current commodity pricing. The reported third quarter net income of $5.8 million on a stand-alone basis and $10.5 million inclusive of noninterest. Reported third quarter net income of $5.8 million is inclusive of a gain of $1.7 million associated with the revaluation of the company's warrant liability. GAAP income tax expense of $1.3 million for the quarter is mostly attributable to the utilization of our deferred tax asset. This is primarily due to the tax benefit of a basis step-up related to the assets that Falcon acquired as part of the transaction with Royal Resources in 2018. Falcon expects that more than 50% of the dividends paid to Class A shareholders for 2021 will be classified as nondividend distributions. This treatment will generally result in a nontaxable reduction to the tax basis of shareholders' common shares until the time when an investor basis is fully recovered. This reduced tax basis will increase shareholder capital gain or decrease shareholders' capital loss when the shareholders sell their common shares. Pro forma free cash flow per share was approximately $0.16 for the quarter. On November 3, 2021, Falcon declared a third quarter dividend of $0.155 per share. This dividend is payable on December 8, 2021, to shareholders of record as of November 23, and reflects a payout ratio of approximately 97%. We define pro forma free cash flow as adjusted EBITDA inclusive of noncontrolling interests, less interest expense and cash payment. And with that, I will now turn the call back over to Bryan Gunderson.

[Bryan Gunderson:]

Thanks, Matt. Dan, you can open up the line for questions.

[Operator:]

Our first question comes from Kyle May.

[Kyle May:]

Bryan, maybe to start out. One of your peers announced an acquisition this morning. And Bryan, you touched on scale in your opening remarks. Just wondering if you can give us an update on maybe the opportunities that you're seeing and how Falcon is thinking about potentially growing the asset base?

[Bryan Gunderson:]

We obviously saw in print this morning. Look, we're focused on driving free cash flow on a per share basis as we've said. I think that as we've said as well, there are a number of assets that are in private hands that are looking to migrate into the public hands. You're seeing that area unfold. I think for us, we continue to be focused on strategic level of transactions. We're being opportunistic on it, but we have our -- we don't bias towards core basins. And so that, for us, that really means the Midland and the dollar.

[Kyle May:]

And then you also touched on the dispute at Hooks Ranch, and I believe you mentioned development activity could begin in the first half of next year. Any preliminary thoughts about maybe when that production could begin to flow or kind of how you guys are thinking about the timing of that?

[Bryan Gunderson:]

I mean, look, we're optimistic that it's nearing resolution. We anticipate -- we're optimistic and we anticipate that we're going to see development begin in 1H. I mean that implies a second half certain time line.

[Operator:]

Our next question comes from comes from Pearce Hammond with Piper Sandler.

[Pearce Hammond:]

With the improvement in price of gas as well as the leases that you imported in the Marcellus, are you expecting a higher gas mix as we move forward into 2022?

[Matt Ockwood:]

I think the short answer is a consistent mix. We saw Marcellus volumes grow Q2 to Q3 by a low double-digit percentage, so not insignificant. It's not clear to us if that kind of growth rate will be sustained. But given what's going on in the Marcellus and the lease bonuses we've got, a lot of those have some nearer-term potential production associated with them. I would anticipate we'll continue to see a little more gas in the mix.

[Pearce Hammond:]

And then line of sight wells have been ticking down ticked down this past quarter. So net wells at about 1.57 and then NRI at 1.12 and NRI's a little higher than it was last quarter. Just curious, number one, do you see the line of sight wells started to increase, maybe more from the permitting standpoint or what can you -- is there anything you can do? Or what's your preference on how much line of sight that you have in front of you? Because I think this quarter, you completed like 0.3 net wells. So it just seems like it's starting to narrow between the net wells and the line of sight versus how many were completed in the quarter.

[Bryan Gunderson:]

Yes, I'll start and then I'll let others jump in. I mean I think one of the things we're focused on is that at this time of year, we don't have the line of sight fully repopulated yet as our core operators are really in the middle of budgeting process, we would anticipate that -- it to come up as those budgeting processes unfold …

[Pearce Hammond:]

more color. Sorry, go ahead.

[Bryan Gunderson:]

I think that's right. On a gross basis, we've been pretty consistent. On a net basis, it was -- we had some really high NRI pads early this year, and it's -- the gross activity has just hit lower in our high pads in the summer and into the fall. So activity, broadly, is strong. We even saw EOG at a rig here very recently. It's a question of when and how that lands on us in a material net way. And that's really been the story of first half or second half in 2021.

[Operator:]

Our next question comes from TJ Schultz.

[TJ Schultz:]

You keep a higher ratio on the dividend than some of your mineral peers. Just any thought on retaining more cash? If you see more acquisition opportunities or your kind of general view on where that payout ratio may trend to longer term for you all? And kind of how you're thinking about financing potential acquisitions?

[Bryan Gunderson:]

I'll take the payout ratio portion, and then I'll let Matt jump in on the financing portion for acquisitions. I think with payout ratio, we've been really clear in the market that we want to keep that high payout ratio. And as you've seen, it's been 90-plus -- kind of averaging around that 95%. We see the way to hand back cash to shareholders and a constructive share price. I mean a constructive commodity price environment that we think it's an attractive value proposition on a yield basis to the -- to our shareholder base. As it relates to the financing acquisitions, Matt do you want to jump in?

[Matt Ockwood:]

It really even dovetails with the payout ratio. There's some materiality portioning here that affects our thinking. Our focus, as Bryan articulated, has been on more strategic level opportunities where the payout ratio, even a little lower payout ratio wouldn't be very impactful relative to the size of strategic things that we're focused on. So we really wouldn't want withhold that cash for shareholders in the short term. As the financing is very dependent on the nature of an asset should we find the right one that we acquire. As you can imagine, we're looking for right asset, right basin and right value first, and we'll build the capital structure that fits around that with our guiding principles. Those principles being we aren't looking to over leverage the balance sheet and we're also not looking to unnecessarily dilute shareholders. So we'll let the asset lead and build the cap structure around that. Does that make sense?

[TJ Schultz:]

No, that all makes perfect sense. I guess just lastly for me. What's your expectation for hedging more or not hedging more moving forward into '22 and '23 prices?

[Bryan Gunderson:]

Obviously, you saw that we layered on some winter gas hedges. So we do have hedges going into March on the gas side. We're totally unhedged on the crude side in '22. And I think that's where we're going to be. But Matt, anything to add?

[Matt Ockwood:]

Yes, just that we're not -- we're obviously completely unhedged on oil next year. The fact that we haven't decided to layer in hedges is a conscious decision that we've made. I tend to -- back to the acquisition question, we think a lot about hedges in the context of any outlays of capital. So there may be a distinction in our mind between what we do with, I'll call it, the base business. And if we have the opportunity to make a material investment, subject to the timing of the cash flows and how we've underwritten it, I think using hedges tactically to protect returns and underpin the investment that we're underwriting would make a lot of sense. But in the absence of that, we aren't, today, looking to put on oil hedges for 2022, at least not in the immediate term.

[Operator:]

Our next question comes from Jon Evans.

[Jon Evans:]

Bryan, I was just curious, can you talk a little bit about -- I guess, because the curve is so backward aided -- I mean, it's unbelievably backward aided. And I'm just curious if that's cause bids asked to be pretty wide relative to the acquisition market? And then how should we think -- I know you've said that -- and acquisition is going to be accretive, but how do you think about -- I mean do you envision this that we'll see a couple of like smaller transactions? Or is it just a major transaction? Or what do you guys kind of planning for?

[Bryan Gunderson:]

I mean on a bid to ask -- and Jon, I appreciate the question. about bid asking, the reality is that the industry value is at strip. And so with the backward-aided dimension of it's baked into every PV count that you would go through. And so I don't necessarily see that as being a big distinction. On the -- on a big deal versus small deal, I think we're focused on the bigger stuff, just because I think it will really move the strategic landscape for Falcon more. We're not averse to something small and if things come across our desk, which they do that are really, really attractive, we'd be open to doing that. But it's really just not where we spend most of our time.

[Jon Evans:]

And so when you think of that, is that $100 million or more or is it $50 million? Or what can you give us -- like what's a big deal in your guys' mind?

[Bryan Gunderson:]

50-plus is like what we would think of as big. I mean -- when I say I'm not focused on the smaller things, I mean, I'm not focused on the $200,000, $500,000, $2 million type deals.

[Jon Evans:]

And I mean, before you've seen like you want to be in the Permian, you want to be pretty oily I mean, with what's happened to gas? Does that change at all? Or is it still primarily you want to be in the Permian and be oily?

[Bryan Gunderson:]

Really primarily Permian and oil.

[Operator:]

Our next question comes from Lee Cooperman.

[Lee Cooperman:]

It's Lee Cooperman. I guess the question I have with all the dialogue that's been on focused on buying, have you guys thought about the possibility of shelling since we saw the discount to private market value?

[Bryan Gunderson:]

We thought about it. I mean I think that the answer is that we're open to it if the right opportunity presents itself.

[Lee Cooperman:]

You're not concerned about this environment of high price that's about paying down your debt at all?

[Bryan Gunderson:]

No, we have a really conservative balance sheet, Lee -- we have really conservative balance sheet, Lee. And we see it trending down further over the course of the year.

[Operator:]

It looks like that was our final question.

[Bryan Gunderson:]

Thanks. Thanks for everybody for joining the line. I look forward to speaking to everybody over the coming months and on the 4Q call. Thanks, everybody.

[Matt Ockwood:]

Thank you.

[Operator:]

This concludes today's conference call. We thank you for your participation. You may disconnect your lines at this time, and have a great day.