Falcon Minerals Corporation
Q4 2018 Earnings Call Transcript

Published: 27 Feb 2019

[Operator:]

Good morning and welcome to the Falcon Minerals Fourth Quarter and Full Year 2018 Earnings Results Call and Webcast. Today's call is being recorded. At this time, all participants have been placed in a listen-only mode and the floor will be open for your questions following the presentation. [Operator Instructions] It is now my pleasure to turn the floor over to Brian Begley with Falcon Minerals. Sir, you may begin.

[Brian Begley:]

Thank you and good morning, everyone. Thank you for joining us for today's call to discuss Falcon's fourth quarter and full-year 2018 results. With us today on the call is our President and Chief Executive Officer, Daniel Herz; and our Chief Financial Officer, Jeff Brotman. Now before we begin, I would like to remind everyone that during this call we'll make certain forward-looking statements and in its context, forward-looking statements often address our expected future business and financial performance and financial conditions and also contains -- contain words such as expects, anticipates, and similar words or phrases. Forward-looking statements, by their nature, address matters that are uncertain and are subject to certain risks and uncertainties, which can cause actual results to differ materially from those projected in the forward-looking statements. We discuss these risks in the quarterly report on Form 10-Q and our Annual report on Form 10-K. I also like to caution you not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Company undertakes no obligations to publicly update our forward-looking statements or to publicly release the results of any revisions to forward-looking statements that may be made to reflect events or circumstances after the date hereof or reflect the occurrence of unanticipated events. Additionally, in our earnings release, we have provided a reconciliation to the non-GAAP measures we refer to in our public disclosures such as adjusted EBITDA and pro forma free cash flow. We have also provided a supplemental presentation to our earnings results, which can be found on the Company's website on the Events and Presentations page of the Investor Relations section. With that, I'll turn the call over to our CEO, Daniel Herz, for his remarks. Daniel?

[Daniel Herz:]

Thanks, Brian. Welcome everyone and thank you for joining the Falcon Minerals Corporation fourth quarter 2018 conference call. President Abraham Lincoln once said be sure you put your feet in the right place, then stand firm. We at Falcon believe we are in the right place. Falcon Minerals launched during 2018 which was, to say the least, quite a year for energy. We saw oil prices rise meaningfully during the first half of the year and then we saw those same oil prices decline very quickly and materially in the fourth quarter of 2018. But through this period of volatility and increased uncertainty, we saw the inherent strengths of Falcon which reflect its enormous stability. We are a business that requires zero capital that receives on average approximately 1% of the revenue from wells developed across our 250,000 plus gross unit acres in the core of Eagle Ford Shale with acreage developed by some of the best oil and gas operators in the world. Just as importantly, we are a very low cost business, which means that even in a declining oil environment we generate substantial free cash flow, the vast majority of which we hand back to our shareholders in the form of a dividend. This business is an enviable model for energy companies and all businesses broadly; high quality assets, world-class operating partners, meaningful revenue recog -- revenue generation driven in part by premium pricing, low operating costs, and very minimal debt. In addition to these many strengths, which benefited us during the fourth quarter, we were able to further take advantage of the upheaval in the market to acquire additional core minerals. Later, Jeff Brotman, our Chief Financial Officer, will provide an overview of our financial results. In summary, in the fourth quarter we generated net production of approximately 6,100 barrels of oil equivalent per day, EBITDA of $21.6 million, free cash flow per share of $0.23, and provided a dividend of $0.20 per share for the fourth quarter of 2018. Importantly, as we compare full-year 2018 to full-year 2017 on an apples-to-apples basis, production grew 22% year-over-year. We have a substantial base of production from over 1,700 wells in the Eagle Ford Shale and have primarily grown production through our operators' development of our high -- of our higher net revenue interest units operated by ConocoPhillips, EOG, and now BP/Devon by way of BP's acquisition of BHP's position. We continue to see robust activity by top operators in the Eagle Ford Shale. Recent remarks by senior management had our operators provide clarity to their plans. Conoco remains committed to 20% year-over-year growth. Conoco has stated publicly that they plan to pause growth in the Eagle Ford during the first half of 2019 with growth resuming in the second half of the year. Additionally, ConocoPhillips is also big beginning to publicly discuss enhanced oil recovery pilots as well as refracs of older wells. BP/Devon is also focused on the development of our position. As a reminder, BP closed on its acquisition of certain shale assets including the Eagle Ford just a few months ago. Through this, BP and Devon are joint venture partners. BP recently said that they would prioritize Eagle Ford development within its acquired portfolio of assets and will increase rigs in the Eagle Ford from two to five to six rigs; of which we expect four rigs across our position by the end of 2019. More specifically Devon, BP's partner, has discussed three rigs running in the first half of 2019 with a program to delineate their Austin Chalk position. This work has already begun with their initial Austin Chalk well expected to come online in the second quarter of 2019. The development of the Austin Chalk by BP and Devon could yield significant upside for our business and we are encouraged by the work Devon and BP are doing in the early days post BHP. As a reminder, we have had highly favorable Austin Chalk development from EOG across our position. We are quite encouraged by the potential that exists for us and the immediate focus by BP and Devon on that upside to our business. Additionally, Devon has discussed a refracing program with approximately 20 wells to be refraced initially. Further, Devon has discussed the potential to add up to 1,000 BOE per day per well with this program. Previously we've discussed enhanced oil recovery across our acreage, but refracing is another way to get more oil from our position. We are happy to have both and of course as a reminder, we have no -- none at all required capital investments. We simply get our portion of the revenue from what the operators spend to extract the additional oil. All of this information comes directly from the operators themselves in public statements and releases and positions our business well going forward. As I mentioned earlier, we have a very solid base level of production. We estimate that our base level of production would remain flat if we simply have the current level of activity with only our average 1% net revenue interest developed. We of course have a good number of higher net revenue interest units operated by ConocoPhillips, BP/Devon, and EOG across our position. And as those units have been developed and are developed in the future, we have seen and expect to continue to see significant growth in our base level of production. Coupling this with the acceleration of drilling by BP, development of the Austin Chalk, enhanced oil recovery, and refracing provides significant growth potential for us later in 2019 and beyond. 2018 was a great example of this as we saw year-over-year production growth of 22% driven primarily by the high net revenue interest activity including Hooks Ranch, but also including several other pads. A couple of weeks ago, we issued first half of 2019 guidance for production and all factors which should allow you to model our business from revenue to earnings and free cash flow. This six month guidance allows us to provide what I believe is a clear view of what our results are likely to be given the line-of-sight wells we currently have and the corresponding net revenue interest in those wells. Given Conoco's announced pause in their growth in the first half of 2019, expected higher net revenue interest wells being delayed from the first half of 2019, and the closing of the BP acquisition from BHP; we expect that our production growth would be pushed out later in 2019 and beyond. Over time I believe this delay in timing will meaningfully help our overall cash flow as we benefit from Conoco's Generation 5 frac design, BPs acceleration of rigs from two to four on our position, BP and Devon's development of the Austin Chalk and their work on refracs to name a few of the items. Our business is strong and we expect meaningful growth as we move forward. Now when it comes to acquisitions, as I have stated previously, we are targeting $10 million per quarter of organic acquisition growth. I'm pleased to report we have already acquired approximately 60 net royalty acres for an aggregate price of $10.7 million. Most notably, 47 net royalty acres of the acquired assets covered 3,394 gross acres and are in Eastern Karnes County, Texas and are currently being developed by ConocoPhillips. This Karnes County position has 14 producing wells with over 50 additional undeveloped Lower Eagle Ford locations. With respect to strategic acquisitions, we will remain extremely disciplined focusing our efforts on the core of the core of top oil weighted plays driven by top operators that likely means the Eagle Ford Shale and the Permian Basin. If and when we do a strategic acquisition, I would expect that an acquisition would drive our free cash flow and net asset value per share meaningfully higher. Of course we are in a very favorable position of not having to make any acquisitions to see significant value appreciation. Through this, we will remain dedicated to a pristine balance sheet. In summary, the turbulence of late 2018 had little impact on our fourth quarter and the future of Falcon Minerals remains well positioned to generate substantial free cash flow from our base of 1,700 producing wells and then meaningfully grow our production and cash flow as higher net revenue interest wells are developed and we see the impact of our operators' increased drilling activity, improved completion design, refracing, and enhanced oil recovery. Now I would like to hand the call over to Jeff Brotman to cover our financial results. Jeff?

[Jeffrey Brotman:]

Thank you, Daniel. Falcon's fourth quarter of 2018 net income was $14.6 million. Our adjusted EBITDA for the quarter was $21.6 million, which was up 12% from the fourth quarter of 2017. The fourth quarter was our first full period of operating as Falcon Minerals Corporation and as we transitioned from externally managed to internally managed, we did incur additional G&A costs. The amount of such costs was approximately $800,000, which resulted in total G&A costs being significantly higher than we expect to see going forward. Our balance sheet is absolutely pristine. We ended the fourth quarter with working capital of $19.6 million and liquidity of $101.3 million consisting of $94 million available on our line of credit and our cash balance of $7.3 million. Our fourth quarter dividend of $0.20 per share will be paid tomorrow to shareholders of record on February 21st. Also I remind you that our Up-C structure results in our being taxed only on the approximately 53% of our consolidated earnings that are attributable to units that we own in the operating partnership that owns all of our mineral interests and none of the provision for income taxes is allocated to the non-controlling interests nor is any amount related to any period prior to the transaction date of August 23rd 2018. With these comments complete, I will now turn the call back to Dan.

[Daniel Herz:]

Thanks, Jeff. Keith, why don't we open the call up for questions.

[Operator:]

[Operator Instructions] We'll take our first question from Jeff Grampp with Northland Capital. Please go ahead, your line is open.

[Jeffrey Grampp:]

Good morning, Daniel. Thanks for all those comments.

[Daniel Herz:]

Good morning, Jeff.

[Jeffrey Grampp:]

Was hoping to start first on the organic acquisition front and I guess just kind of curious to get your sense of kind of how you saw the dynamics of negotiating those during a pretty volatile commodity tape for the last several months. So would you say of the $10 million odd of acquisitions, were most of those done kind of before, during, or after the recent pullback in oil? If there's any way to kind of characterize the pace of those acquisitions, if you will?

[Daniel Herz:]

Yes, that's a good question. Most were done during the pullback and after the pullback in oil prices. So as far as the negotiations with these -- with the specific transactions that we were working on, we -- the people who we were able to execute with were committed to selling a portion of their minerals or all of their minerals. We did have other opportunities that we did not complete given the volatility and our discipline in the pricing that we're looking to achieve and the returns we're looking to achieve for our shareholders.

[Jeffrey Grampp:]

Alright, great that's really helpful. And just from a kind of high level strategical perspective on those acquisitions, can you talk about -- it seems very I guess very clear that leverage is not something you guys really want to lean into at all. So, what would you say is your level of interest in maybe flexing the distribution to cover any period? Say you guys were really successful on organic acquisitions, you don't want to ramp up leverage so I guess that kind of leads me to think about maybe flexing the distribution to cover that or do you guys maybe tap the brakes on acquisitions if that market heats up for you? Just kind of wondering the gives and takes on that strategically.

[Daniel Herz:]

Sure. And our targeted payout ratio is 90% and greater and that's what I would expect us to maintain. We're a business that generates substantial free cash flow as you know from our base assets with operators; including and especially EOG, Conoco, and BP; who are dedicated to developing across our position where these assets are meaningful to them. We are going to pay out that cash flow we generate and pay it out in large quantities 90% plus while at the same time remaining extremely disciplined with respect to our balance sheet.

[Jeffrey Grampp:]

Understood. And last one for me if you have it. On those line-of-sight wells that you guys disclosed, do you have kind of what the average royalty interest is? Is it kind of in that 1% average range or is it any different than kind of that longer-term number you referenced?

[Daniel Herz:]

I think people should assume 1% is the average over time that we -- that we have across our position.

[Operator:]

We'll take our next question from Betty Jiang with Credit Suisse. Please go ahead, your line is open.

[Betty Jiang:]

Thanks. Good morning. Dan, could you help me reconcile sort of your comments about production flattish this year versus the first half '19 production guidance of 5,300 barrel per day to 5,800 barrel per day? So, if you could just talk about how should we be thinking about the production trajectory through the year and then what type of visibility that you're currently seeing for second half.

[Daniel Herz:]

Also a very good question, Betty. Thank you. The -- as I think we made or I hope we made clear a few weeks ago with our guidance, we tried to make clear again in the release. Our operators have said they have -- and ConocoPhillips represents a significant portion of our business, they have delayed their growth into the second half of 2019. That's number one. Number two, of course with BP closing on October 31st, they're really just beginning with Devon to ramp up their rigs and their activity. So, we wouldn't expect that to really begin to impact the business in the first half of the year. And then of course with Austin Chalk also, the first pilot well coming on in the second quarter for Devon and then the refracing 20 or so wells from Devon this year; obviously we see more of an impact in the second half of this year from all of those activities. I couple that with -- and this speaks to Jeff's question earlier about the percentage and what percentage on average in higher net revenue interest wells. We've also talked about the delay of higher net revenue interest wells from the first half of the year and pushing that into the second half of 2019 and beyond. So, all of those factors combined allowed us to put forward the guidance range that we put forward and tried to put forward a range that we think is a very reasonable range for us to be able to achieve and for investors to feel comfortable with.

[Betty Jiang:]

Great, thanks. So, if I could just clarify on the point. Would that mean sort of a stepdown in 1Q, but then second quarter would be fairly flattish from the 1Q level or based on the guidance of 5,300 barrels per day to 5,800 barrels per day, you actually see the higher point in 1Q and then a lower point in 2Q?

[Daniel Herz:]

Appreciate the desire for a finer point on this. We tried to put forward what we think is appropriate six month guidance and we'll continue to roll that guidance forward every quarter. But I think you can extrapolate the pace of production, but we see -- I mean as I see it, I should -- I can't even say we; but I think as we see it, we have a very nice solid base of production that should exist for the first half of this year, which should provide a very nice amount of cash flow and dividends to shareholders.

[Betty Jiang:]

Great. Thanks for all those comments. And then my follow-up was on the acquisition outlook that you mentioned. You said Permian and Eagle Ford are the top tier basins and they're candidates for future acquisition. Can you talk a bit more about what you're seeing today as it relates to opportunity in the Permian versus what you're seeing in the Eagle Ford?

[Daniel Herz:]

Yes. Very good question. We -- it's a very, very different market. I would say consistent with what you would imagine, the Eagle Ford is a more mature market from a minerals perspective relative to the Permian and so we see -- we see on the larger strategic opportunities a number of opportunities in the Eagle Ford, which could be very attractive. And we have a very defined by target area given what we think is our best-in-class position in the Karnes trough -- in Karnes, DeWitt, and Gonzales and we're going to stay disciplined within that position. So, we have a very clear set of targets within that by area and within our target by area in the Eagle Ford. With respect to the Permian, I'd say we have especially good insight given our executive team at Falcon to both the Midland Basin as well as the Delaware. There are larger packages of opportunities that have been and are being put together by private equity firms who over time of course will look to exit those positions. That larger opportunity I think could bode very well for us over time that's not to say necessarily in the next month, two, three months. We will be disciplined and we'll be very much opportunistic to find that right opportunity that really is one that I hope brings everybody out of their seats and cheering because it's so value enhancing from a cash flow perspective and a net asset value perspective and is a true strategic opportunity. With that said, again I'll come back, Betty, to the point that we're sitting on a great position with 3,000 plus undeveloped opportunities with over 100% IRRs to our operators, still taking more capital and getting more wells completed than any other play by EOG. It's a top focus area within BP/Devon, within the US for Conoco. So we just have a fantastic base business and if there is something that can enhance that meaningfully, we'll go pursue it. If there's not, I think we can feel very good that we have a lot of cash flow and a lot of growth to come.

[Betty Jiang:]

Great, appreciate it. Thanks.

[Operator:]

We'll take our next question from Atidrip Modak with Citi. Please go ahead, your line is open.

[Atidrip Modak:]

Hey, guys. Do you have any more clarity on when activity on the Hooks Ranch could commence?

[Daniel Herz:]

Good morning. Not that we're prepared to share and discuss today. I think it's fair to say we remain favorably inclined and optimistic about its near- term development given it sits in the best of the best area within the Eagle Ford. This is public information, which anybody can look up., But if you look at the cumulative production to date for the -- for last year's six Hooks Ranch wells, those wells are in the top 10% of all of the wells Conoco's drilled in the Eagle Ford. And so I think if you were probably waiting and doing some sort of predictive analytics, given its 90% undeveloped, there is a lot of running room with no parent child issues and it's within the core of their position. So, I remain optimistic that we'll see near-term development of the Hooks Ranch.

[Operator:]

[Operator Instructions] And we'll go next to Jeffrey Campbell with Tuohy Brothers. Please go ahead, your line is open.

[Jeffrey Campbell:]

Good morning. Daniel, I thought it was noteworthy that your recent acquisition included locations that Conoco's actively developing. It seems a little counterintuitive that a mineral interest holder would want to sell an asset that's attracting producer investment. So, could you add a little color about how this acquisition came about and also is this strategy of trying to acquire interests where you have some visibility into shorter-term development something that can be repeated in the future?

[Daniel Herz:]

Thank you for the question and I will give the color in the context of how I discussed this on the last call. And I think as you know, Jeff, and others who know us, predictive analytics -- data analytics is extremely important to how we think about our business and how we think about our organic acquisition strategy, our forecasting. And I will tell you our ability to foresee development activity and effectively predict development activity is a leading factor in how we will acquire minerals because of course if we can buy minerals the day before a well is permitted, that's the best day in all likelihood we can acquire those minerals. And so, that's something we spend a lot of time developing. We continue to develop and refine and I'm extremely excited about. And we as an organization are dedicated to being best in class within minerals, within energy, and really within the whole business sectors at being able to use data and use it for best -- really best-in-class investing. That's what that acquisition and those acquisitions have looked like.

[Jeffrey Campbell:]

Great, I appreciate the color. Thank you.

[Daniel Herz:]

Thank you.

[Operator:]

And we'll take our next question from Jon Evans with SG Capital. Please go ahead, your line is open.

[Jon Evans:]

Can you just help us understand kind of the SG&A cost and were there costs that won't be happening in 2019 because it jumped pretty big sequentially and I know last quarter was a stub? But could you just give us a little bit of color there better?

[Daniel Herz:]

Sure. And I'm going to ask Jeff to jump in if he has anything to supplement. So first, as Jeff said, we had about $800,000 for the quarter that were related to the transition from the third-party operator of our business as well as around the closing of the transaction. So, that's number one. And so that $2.5 million excluding those transition costs would have been around $1.7 million. I think more relevant and more appropriate to your modeling, I would lead you to the guidance that we provided which for the first half of the year was $3.70 to $4.20 per BOE of G&A expense. Jeff, would you add anything?

[Jeffrey Brotman:]

No. Just to give just a little bit more granularity to the question of what those costs were. As we built up a staff in order to be able to manage Falcon Minerals internally, we had to start hiring people, we had to pay headhunter fees, and things like that; and at the same time, we were also paying Riverbend until the termination of their services agreement on December 10th. So, there was a duplication that will not be repeated.

[Jon Evans:]

Got it, so can you just maybe -- I think it would be really helpful if we could understand kind of the leverage. And what I mean by that if you start to ramp in the back half and Conoco starts to ramp, production starts to go up, markets go up, you have all these positives that could happen on the production side; how does SG&A have to move because I assume that is the big point that doesn't have to move much where you should get a lot of leverage and really make the distribution accelerate?

[Daniel Herz:]

That's exactly right. We have built out the entire staff. It is what I would characterize as lean of a staff as one can imagine. We have I would say the best professionals in each position who are dedicated to growing this business. As we grow the business and production grows, we see no need -- I see no need to grow that staff and so I think you would see our production per BOE go down meaningfully. And if you look at the type of guidance that I think one can infer from our first half per BOE cost, you should be able to hold what that dollar G&A number is basically flat for the full year In total and then going forward. Now of course if we made substantial strategic acquisitions and grow meaningfully, we might have to add a few more people on the accounting side or engineering side. But this is a company that runs with today less than 10 people who are really all working incredibly hard to make sure we keep those costs low and drive cash flow higher.

[Jon Evans:]

Great. And then just the last question. One of your other public competitors, they've used equity a lot from the standpoint of making transactions and giving them to mineral holders. Do you see that if you do a bigger deal, potentially someone would take your equity or is that something you're looking to do or are you primarily looking to bring more equity to the public markets instead because it sounds like you're debt averse or pretty debt averse?

[Daniel Herz:]

I think there's a lot of people who would like to have our equity. The question is really is there an opportunity in which we would be willing to give up our equity and the only case in which I can see that is one that drives cash flow per share and a deeper share and the overall value of the company meaningfully higher. So I know that there are people, both existing mineral owners as well as public equity investors, who would be very interested in having our equity; but we have to find the opportunity that really meaningfully enhances the value to do that.

[Operator:]

And it does appear we have no further questions, I'll return the floor to Daniel Herz for closing remarks.

[Daniel Herz:]

Great. Thank you all for joining today's fourth quarter earnings call. We look forward to speaking to you next quarter if not sooner. Thank you.

[Operator:]

And this will conclude today's Falcon Mineral's fourth quarter and full-year 2018 earnings conference call. Please disconnect your line at this time. Have a great day.