Transcript
Ladies and gentlemen, greetings and welcome to the U.S. Energy Corporation Third Quarter 2022 Results Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, James Master. Please go ahead.
Thank you, James. Good morning and thank you for joining U.S. Energy's first quarterly results conference call. With this being our first call together, I wanted to spend a few minutes providing an overview of our business, along with our strategy for profitable growth going forward. U.S. Energy is one of the fastest-growing independent oil and gas producers in the United States, having completed 8 highly accretive acquisitions of increasing size in the last 24 months. Since late 2019, we've increased our proved producing PV-10 by more than 14 times, with current PDP reserves well in excess of our current enterprise value. Today, we operate in 4 prolific U.S. onshore oil regions: The Rockies in North Dakota; the Mid-Continent; the South Texas Gulf Coast; and West Texas. These assets represent a diversified portfolio that protects the company from being tied to regional pricing or operational disruptions. Our assets contain 8 million barrels of oil equivalent of long-life, oil-weighted, proved-producing reserves that have a low decline profile. Our current annual PDP decline is just around 11%, which affords us the flexibility of investing minimal incremental capital into the existing business to maintain healthy cash flows. Even though we have grown quickly, we've maintained our capital discipline, allocating free cash flow towards debt reduction, a stable quarterly cash dividend, and organic and inorganic investments. As of September 30, 2022, our debt balance stood at $12.5 million with a year-to-date annualized EBITDA of nearly $17 million, putting our leverage ratio at approximately 0.6x net debt to EBITDA, a very healthy and manageable level for an E&P company of our size. Given the general volatility of the broader commodity markets, we regularly hedge our production targeting greater than 50% of our expected oil volumes in the current year, thereby ensuring relative stability in our cash flow generation. From an M&A perspective, we have stayed very active and opportunistic, pursuing mature assets with consistent production growth, high-margin cash flows, and measurable operating efficiencies. In summary, we believe that U.S. Energy provides investors commodity exposure to a micro-cap E&P story that offers the growth potential, return of capital elements, and balance sheet stability that is demanded in today's environment. Next, I'd like to spend a few minutes discussing our roadmap for growth going forward. U.S. Energy today operates a portfolio of mature producing assets that provide high-margin free cash flow that is critical in maintaining a strong balance sheet and supporting a stable quarterly cash dividend. Despite having completed 8 transactions in 24 months in which we have acquired assets at significant discounts to PDP PV-10, we remain in the early innings of a multistep expansionary phase at the company. In the Energy business, scale is critical to sustained profitability, so our strategy is to continue rolling up high-quality assets and rapidly growing our platform which will achieve the operating leverage required to drive continuous profitable growth going forward. And to that end, as our cash flow scales with new asset additions, we see the potential to develop a more robust return of capital program over time. Finally, while economic returns are always top of mind, we balance these priorities while maintaining a high level of regulatory discipline and environmental compliance across our entire organization. Before turning to our third quarter results, allow me to summarize why we believe that U.S. Energy remains the most compelling E&P microcap story. First, our asset profile: we have low decline, oil-weighted producing assets across 4 of the most important and prolific oil basins in the United States. Secondly, our free cash flow generation. Given the maturity of the production in our asset base, our reinvestment needs are relatively low which allows us to harvest greater amounts of cash flow from the assets and be strategic about how we want to allocate that capital to create and return shareholder value. This leads us to our third point, which is our focus on profitable growth. Growth has become somewhat of a dirty word in our sector because some operators drove themselves right into the ground during the last several cycles and years, ultimately losing their capital discipline. However, we believe that growth done right leads to high free cash flow conversion and superior shareholder returns. We intend to grow the scale of our business, focusing on high-margin cash flow while maintaining a base level of profitability. Turning now to our third quarter results. Production for the third quarter averaged approximately 1,752 BOE per day, of which approximately 59% was oil. This compares to the second quarter which averaged 1,783 BOE per day, of which 66% of the production was oil. Oil volumes declined during the quarter because we shut in wells on recently acquired West Texas properties to perform planned and necessary maintenance. When we closed our January 2022 acquisition, we knew we would have to spend some workover capital in the future in order to maximize the production efficiency of the assets going forward. Much of the work was completed during the third quarter and the wells are set to return to production, which we expect will contribute positively in the fourth quarter. Gas volumes increased during the quarter due to the integration of our most recent East Texas acquisition in July. Total oil and natural gas revenues in the third quarter were approximately $11.8 million compared to $13.5 million in the second quarter. Realized prices for the quarter were as follows: Oil received $94.81 per barrel and natural gas received $7.10 per Mcf for a total realized price of $73.36 per barrel of oil equivalent. This compares to the second quarter where we received $105.74 per barrel of oil, $6.55 per Mcf of natural gas, and $83.09 per barrel of oil equivalent. In total, realized prices declined by 12% in the third quarter. Lease operating expense for the third quarter was approximately $5.4 million compared to $4.6 million in the second quarter. The increase in LOE is primarily due to the increased workover expense incurred in West Texas that I previously discussed. Production taxes of $900,000 during the quarter were approximately 6.9% of total sales revenue, which is essentially flat quarter-to-quarter. Cash G&A for the third quarter totaled $2.2 million which is slightly higher than the second quarter of $2.0 million. The increase in cash G&A expense is primarily due to an increase in nonrecurring professional and advisory fees related to the company's January 2022 acquisitions and the associated share registration statements filed throughout the third quarter. Adjusted EBITDA in the third quarter was approximately $3.1 million compared to $5.1 million for the second quarter. The decrease in the third quarter was attributable to the lower oil volumes, increased workover expenses, and lower realized oil prices. Now to touch on hedging, we are approximately 73% hedged for the balance of 2022 and approximately 54% hedged in 2023 when it comes to our anticipated oil volumes. Given that gas revenue makes up a lesser percentage of our overall revenues, we have taken a more patient approach to hedging that commodity. For the balance of 2022, we are hedged in gas approximately 17% and carry no gas hedges after the first quarter of 2023. Finally, I'd like to give a quick update on the balance sheet before we turn the call over to Q&A. In connection with closing our East Texas acquisition in July, the borrowing base on our revolving credit facility was increased from $15 million to $20 million. Post-transaction, we have $12.5 million outstanding on the revolver, which represents the only debt that we carry. As of September 30, U.S. Energy had approximately $3.1 million of cash on hand or a resulting net debt balance of $9.4 million. As we have previously discussed, we plan to continue using excess cash flow to work the balance down over the next few quarters as well to fund our quarterly dividend payment. Since current management took over in late 2019, the goal here has been to build a company of scale, and I'm very proud of the progress that we have made thus far. During our tenure, U.S. Energy has grown proved reserves from 1 million BOE to 8 million BOE, production from 300 BOE per day to over 1,800 BOE per day currently. Over that same period, the value of our proved producing reserves has increased 14x to more than $175 million or approximately $6.60 per share, more than double where the shares are trading today. On behalf of the entire team, I want to thank you all again for joining us this morning and for your continued interest in U.S. Energy Corp. We consider the initiation of a quarterly conference call with investors a strong step in providing more access to the company and disclosure to our investors. It's a compelling story and one that we are all very excited to be a part of. As one of the few high-quality micro-cap stories that combines low-risk income yield with meaningful upside through M&A, we believe this is an opportunity worth sharing. With that, I'll turn the call back to the operator for questions.
Ryan, I want to ask two questions about your volume trajectory and the underlying dynamics in 3Q going into 4Q. First on natural gas, obviously, you have a big uptick in 3Q, and a big use of that is the East Texas acquisition. But can you give us a sense or what it looks like from your point of view on how that asset package is performing versus your acquisition case on the natural gas side? And how much of that maybe played into how 3Q worked out and what 4Q is going to look like?
No problem. So we closed the acquisition we made in East Texas in late July of the third quarter. So from an accounting perspective, it only showed up for August and September, and the July portion of it was a closing statement adjustment. But so far, it has been wonderful for us. We had some wells in the area already from the January 2022 acquisition that we made. So we already had familiarity with the area and the gas prices where they've been. And this year, obviously, makes these gas projects much more compelling. We thought we bought the asset right on a very attractive cash flow multiple, I believe, 1.7x. So far, we've had no hiccups. I would say it's performed better, but better within a range of probably 5% than what we were forecasting. So it's definitely been in line. It's produced the net cash flow, if you will, off the asset as we forecasted for us to amortize down our credit facility which we drew on to make the acquisition. So it's been strong so far. It's been very low maintenance. I think going into 2023, our plan on it is, on one hand if it's not broken, don't try and fix it and let it keep producing 400 to 450 BOE per day, 60% gas. As we continue to learn more about it and get our arms around it, I do think down the road, and when I say down the road, I mean 2023, there are some potential recompletion opportunities in a number of the wellbores that we acquired in the deal. At early stages, we see some upside, but more engineering needs to be done on it; it is part of our evaluation in our 2023 planning and budgeting process that we are going through right now.
Got it. That's helpful, Ryan. Regarding the oil side, I believe you touched on this in your prepared remarks. The workover program on those conventional Permian assets in West Texas – what kind of production response can we expect? Or was the workover mainly focused on cleaning things up rather than enhancing production rates?
Unfortunately, I would say the latter. It's definitely a mix. But I think it's kind of a two-part answer. In the first half of the year, the capital we spent on our West Texas assets was primarily focused on returning production. We saw decent results but didn’t manage to complete the entire program. I would say that the recent capital we have spent, particularly what's been reported in the third quarter, was mainly for maintenance, which temporarily took some production offline. Currently, I am confident that much of that production has resumed in the fourth quarter. We are still investing in the same project to finalize it and are nearly finished. I expect that production will continue to come back online during the fourth quarter. Naturally, spending on workover and maintenance capital impacts our field-level economics for the year; however, we believe that once we look back on an annual basis, the capital invested in West Texas to bring wells back online will ultimately prove to be economical with significantly improved runtime moving forward due to the maintenance work we are currently carrying out.
So Ryan, if I understand correctly, the volumes will increase because wells are coming back online. However, it's not the case that these wells are coming back online at a higher rate; rather, there will be an increase due to uptime instead of an improved rate. Is that correct?
I think it's both. I mean, taking slush production out of the equation, a lot of the return-to-production wells we were doing work that we were doing were wells that were shut in when we acquired them. So I think it's a mix of both.
Got it. Okay, got it. I have another question but if there's anyone else in the queue, you can go to them.
You can go ahead, if you want to.
I wanted to ask about the current A&D opportunity set. Could you discuss it from two angles? First, what do you observe? How has the opportunity set evolved, positively or negatively? What’s new and different? Second, what is your perspective on the competition from other potential buyers regarding the opportunities you are pursuing?
Yes, it's a great question. The M&A markets are currently complicated and very fluid. What I see is a very clear line, though I can't provide an exact dollar amount for it. Over the past couple of months, larger deals, relative to U.S. Energy, have experienced a recalibration in how sellers and buyers attribute value. Just a few months ago, discussing payments for upside would have led to dismissal; however, there have been a few transactions involving real near-term drilling—where permits, a rig, and crews are in place—where credit is being assigned to that drilling. This isn't a dollar-for-dollar reserve report credit, but we're seeing something like a PDP plus, where the plus includes some upside drilling locations. In contrast, asset-level deals, which range from very small to around $20 million or $30 million, are still being evaluated based on straightforward cash flow multiples, whether they're 24 or 27-month deals. There's been less recalibration between sellers and buyers in that market because, at current commodity prices, private sellers with limited hedging are likely cash flowing their assets very well—much better than in a long time. Many of these sellers are reluctant to sell at 24 or 27 months of cash flow; they prefer to hold onto their assets, resulting in a slowdown and some friction in that market. Regarding competition, there's no doubt that it's intense. For asset-level deals, we face less competition from public companies, as fewer smaller-scale entities are bidding against us. If they do participate, they're usually focused on specific areas. Larger companies often seek opportunities that significantly impact their operations. On the private side, however, there is considerable competition from true private investors—those not connected to private equity portfolio companies—and family office capital, particularly in this space. Therefore, it remains competitive. Additionally, the bid-ask spread in the smaller asset market has remained fairly stable over the past few months.
Congratulations on the quarter. I'm calling on behalf of Ben Piggot with two questions here. Just to start, I guess, an update on recompletion opportunities in Montana and how that's going?
Yes, for sure. I'll expand it a little bit because I think it's more of an asset-based question. On Montana specifically, we have not done much recomplete work on the Montana asset that we acquired in January of '22 just because it's been a really good asset for us. It's been a high run time. We have a great team up there in Cut Bank, Montana that is running it, so it's essentially been a cash flow generation machine for us right now. I think on the true recompletion side, we have participated on a non-operating basis in North Dakota with mixed but fairly decent results regarding small working interest projects. As I mentioned earlier, I think our most near-term recompletion opportunities, at least what we are focusing on, is on our newly acquired East Texas assets going back into the Rodessa formation and in our South Texas assets, in which we have a very high working interest, with some as high as 50%. We are collaborating with our partner, and we believe there is Austin Chalk recompletion activity on many of our holdings down there. Therefore, we expect to see activity in these areas for us in 2023. As I've mentioned, we're still evaluating and formulating our 2023 budget, but we do see notable upside prospects over a significant portion of our asset base concerning recompletion opportunities. Our attention will primarily be on Texas, both in East Texas and our South Texas acreage.
That's really helpful. And I know it has been mentioned before; it's been talked about but just any other color on the M&A funnel, maybe some broader trends you're seeing? Anything would be helpful there.
Yes. I think I will reiterate what I already mentioned and perhaps provide additional insight into how we operate. We have a very strong business development team here and evaluation process. We are very active in the market on all sides of the deals, both small and large. I see a bigger gap between the larger scale of deals and the smaller scale of deals. The evaluation criteria seem to diverge significantly when the scale is that wide. We have observed that the valuation methodologies vary, as well as how companies and entities are assessing them. This is perhaps due to the large players perceiving enhanced value in near-term drilling compared to smaller companies pursuing the simpler asset cash flow multiples. This trend of attributing value to proven drilling locations is likely to catch the attention of the investing community, as the conversation around inventory becomes more prominent. I believe you'll increasingly see these deals emerge with recognized value attached to those drilling locations.
Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. And now I would like to turn the conference to Ryan Smith, CEO, for closing comments.
Thank you, everybody. I appreciate your time this morning and for your continued interest in U.S. Energy. I look forward to speaking again next quarter. Thank you.
Thank you. The conference of U.S. Energy Corp. has now concluded. Thank you for your participation. You may disconnect your lines.