Earnings Call Transcript - EPM Q2 2021

Operator, Operator

Good day, ladies and gentlemen, and welcome to the Evolution Petroleum Second Quarter Fiscal 2021 Earnings Release Conference Call. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Ryan Stash. Sir, the floor is yours.

Ryan Stash, CFO

Thank you. Good afternoon, everyone, and welcome to Evolution Petroleum's earnings call for our second quarter of fiscal year 2021. Today, we'll be discussing operating and financial results for the quarter. Joining us for the call are Jason Brown, President and Chief Executive Officer; and myself, Ryan Stash, Chief Financial Officer of Evolution Petroleum. If you wish to listen to a replay of today's call, it will be available shortly by going to the company's website or via recorded replay until March 6, 2021.

Jason Brown, CEO

Thank you, Ryan. Good morning, everyone, and thanks for joining us today on Evolution's second quarter fiscal 2021 earnings call. We appreciate your continued interest in and support of our company. I'd like to start by welcoming our new CFO, Ryan Stash, to his first earnings call with Evolution. I would also like to thank him and particularly, David Joe and the rest of the team for their diligent work in making this such a seamless transition. With the company's focus on growing through acquisition opportunities, Ryan brings a nice skilled set of investment banking experience to that effort. We have been encouraged by the recent increase in commodity prices. However, the COVID-19 pandemic is not yet in the rearview mirror and continues to disrupt all of us in many ways, which keeps volatility in the price of crude. The delicate balance of supply and demand continues to be uncertain as evidenced by the futures market. While we cannot predict the duration of such volatility, we are well positioned to weather these times as we've done this past year. We have continued to focus on managing costs and maintaining our balance sheet to protect us and ensure the long-term sustainability that our investors are accustomed to. Although we had recently completed our full credit line determination of $23 million in a three-year extension, you may have seen in our last Q that we were somewhat limited in our ability to draw on it due to some covenants related to trailing commodity prices. Ryan wasted no time in adding value to the company by negotiating our sixth amendment with our lender, giving us full access to our credit facility. This, along with our $19 million of cash on hand will primarily serve to support our continued acquisition strategy, which I'll discuss in more detail later on the call.

Ryan Stash, CFO

Thanks, Jason. I'll now share some more details regarding our financial results for the second quarter ended December 31, 2020. Please refer to our press release filed yesterday afternoon for additional information and details for the full fiscal second quarter 2021 and look out for our Form 10-Q to be filed likely later today. Now I'll hit some of the financial highlights for the second quarter. As Jason mentioned, we paid our 29 consecutive quarterly dividends on common shares and increased the next dividend payment by 20% from $0.025 to $0.03 per share. Revenues, as Jason mentioned, increased by 3.1% over the prior quarter to $5.8 million. We generated cash flow in excess of the quarterly dividend before the effects of our hedge payments and ended the quarter with $19 million in cash and no debt. We also amended our credit agreement to incorporate a more flexible current ratio covenant that gives us access to the full borrowing base. In December, the last of our hedges rolled off, which had been adversely impacting our recent results. As Jason mentioned, also, these hedges served their purpose and protected our balance sheet, but we are at 1,797 BOE per day due to decrease in production in the Delhi field related to the shut-in of the CO2 line, as we've discussed, and a lack of performance capital. As Jason discussed, with the resumption of the CO2 line and increased conformance work, we hope to see production numbers improve gradually over the coming quarters. We are, however, encouraged to see continuing price improvement on the realized prices for NGLs. Realized NGL prices were up 36% this quarter for an average price of $12.36 per BOE. Lease operating expenses increased 25% to $3 million in the second quarter compared to $2.4 million in the prior quarter. This increase is entirely driven by the resumption of the CO2 purchases at Delhi. All of their lease operating costs remained unchanged at $2.4 million. We would, however, expect to see some increases to lease operating expenses at Delhi in the coming quarters, now that the CO2 purchases and conformance workovers have resumed. Due to the depressed oil price environment, we experienced in March through May of 2020, our ceiling test for the book value of our properties was adversely affected. Therefore, we recorded a $15.2 million noncash impairment during the quarter as a result of the capitalized cost of oil and gas properties exceeding the full cost valuation ceiling. Further prescribed accounting rules of the full cost method of accounting, quarterly ceiling tests are performed and calculated using the trailing 12 months first day of month average prices. The ceiling test impairment was primarily driven by a decrease in this 12-month trailing average price for crude oil used in our ceiling test from $43.63 per barrel in September 30, 2020, to $39.54 per barrel at December 31, 2020.

Jason Brown, CEO

Thanks, Ryan. As I mentioned before, we continue to invest our time and attention into developing a collaborative working relationship with both of our operators, and they're starting to see fruits from that effort. We just had our annual working interest owners meetings with both operators and are encouraged by their plans for 2021.

John White, Analyst

Yes. Congratulations to Ryan for joining the team. It's a great move. Also, congratulations on the dividend increase; you’re staying true to your heritage and management style by raising the dividend cautiously. In this environment, that’s a positive approach. Could you provide any additional comments? I joined the call a bit late, but how do you view the progression of CO2 injection volumes for the rest of the calendar year?

Jason Brown, CEO

Sure, it's a great question, John. Thank you for the write-up you did for us as well. I'm always impressed with how well you, Jeff, and other analysts understand our situation. So we appreciate the coverage. CO2 has been a consistent topic with Denbury. They've encountered some issues at Jackson Dome, where they have three main facilities. Everything has been adjusted over the past few months so that different fields can share CO2. We're aiming for 85 and ideally 95 to 100, but currently, we're limited to around 75. I believe we'll maintain that 75 level throughout spring and summer. Their repairs are expected to be completed before summer, but with the warmer temperatures in summer, CO2 visibility can be an issue, making it a less suitable time to increase CO2 injections. We anticipate that availability could improve in late September or October as temperatures cool down. Most of next winter, we expect to see CO2 levels between 100 and 110 Mcf per day, although we have a capacity for around 125, which may not be fully utilized. This plan should provide sufficient makeup gas throughout late 2021 and into 2022. I expect reservoir pressures will continue to rise and contribute to this makeup. We’ve also noticed a softening in the production decline. However, it will likely take at least a year to return reservoir pressures to where they were last February. This doesn’t imply that production will decrease; rather, we expect it to increase as we've already seen some improvements. Does that make sense?

John White, Analyst

Yes. Indeed, that's a very, very nice detail.

Jeff Grampp, Analyst

It's Jeff Grampp with Northland. Just kind of curious to get an updated number from you guys. And it sounds like from the release and I think in your comments that there's still a little bit of either curtailed or shut-in production on either maybe both assets depending on how you want to characterize that. Is there any way to quantify or kind of get a handle on what's kind of left, if you will, in terms of kind of incremental production that could be added, given kind of the rally in prices and a return to normalized operations?

Jason Brown, CEO

Yes, that's a good question. Let's start with Hamilton Dome, which is a bit easier to discuss. We're excited that they're bringing online 11 wells, four of which will start in January and seven in February. While it’s speculative, our estimates suggest that the output from these wells could reach around 100 to 110 gross, translating to about 5% to 6% increase. Currently, we're producing approximately 1,900 barrels a day there, which should help us surpass the 2,000 mark. Before the decline, we were in the range of 2,350, so we haven’t fully recovered yet, but this will certainly get us closer. Additionally, we’ve noticed the differentials tightening during this period, which is positive, sitting around $12 off of WTI. Typically, this tends to widen at this time of year, but it's been a nice benefit amidst everything else. Regarding Hamilton Dome, I also want to mention that there have been recent regulatory changes affecting BLM and BIA land concerning permits and drilling. Since Hamilton Dome is on BLM land, I want to clarify that this does not impact our current operations, and we aren’t conducting any leasing or new drilling there. Moving on to Delhi, we're genuinely pleased to have several conformance projects approved, with three set to begin soon. There has been a positive shift in our technical team's collaboration with theirs, leading to constructive discussions about selecting new conformance projects. We spent 1.5 hours this morning discussing two additional projects that have a strong likelihood of being approved, making a total of five projects that we’re optimistic about. Previously, we didn’t have any conformance projects in 2020 or the latter half of 2019, with the last one completed just before I joined in July 2019. Each of these conformance projects has the potential to increase production, which we look forward to. As for the existing production at Delhi, it has decreased due to a lack of pressure support. Currently, we’re at about 4,400 barrels a day in February 2022, down from 5,600 barrels a day last year when the CO2 line went offline. We will need to address this shortfall, and I anticipate that it may take at least a year to 1.5 years to return to previous levels, potentially needing conformance projects to help with this recovery. While we don’t provide explicit guidance, we hope that production can gradually improve and that the conformance initiatives will contribute positively as well.

Jeff Grampp, Analyst

Yes, that's really helpful. And definitely appreciate the federal commentary at Hamilton Dome. That's helpful. Switching over on the acquisition side. Can you maybe just give us maybe a little peeling that onion back a little bit more is bid-ask narrowing, I guess that's kind of my default assumption given what pricing has done, that maybe helps kind of narrow things for buyers and sellers. But conversely, our potential sellers may be feeling a little bit more confident, and maybe there could have been some distress that maybe some folks are getting bailed out. Just kind of curious, those kind of playing dynamics and what you're seeing.

Ryan Stash, CFO

Yes, I'll start and then Jason can add his thoughts. Jeff, since the beginning of the year, we have noticed an increase in the volume of marketed deals that we believe align well with our interests. It's encouraging to see this rise in confidence among sellers. Currently, we are experiencing this trend. Regarding the bid-ask spread, we have observed a few deals that you are aware of as well. The market is starting to ease up. I believe the bid-ask spread is narrowing, and as participants gain confidence in the future market trends, we will see buyers and sellers reach an agreement more easily. We've witnessed some sellers, like Earthstone and Warberg, opting for stock as a way to benefit from potential upsides. This trend is likely to persist. Additionally, Northern released some information recently about a warrant related to this. This indicates that participants are becoming more willing to accept stock in this market, anticipating an improvement in sentiment and pricing. Jason?

Jason Brown, CEO

We have analyzed the process, and the bid-ask issue has been a persistent challenge for our industry. Overall, we are definitely seeing some improvement. Many participants who have been delaying decisions are becoming more proactive. There seems to be a glimmer of hope, and we are noticing increased motivation to seize opportunities despite ongoing volatility. The forward curve indicates uncertainty about the post-COVID landscape and the economy. We believe the $50 flat range is a solid buying range, and current prices are close to that. We made a significant effort last fall and were nearly there regarding pricing, but faced complications with various wells and liabilities, and the contract conditions were challenging. As a public company, we must act prudently. Several factors beyond price are at play. Over the last six months, we pursued several deals, with our Board gaining confidence in management's assessments. We are beginning to find a rhythm in understanding our targets and are collectively motivated to grow the company, which is encouraging. Building this rapport takes time. I feel very confident right now. Internally, we are aligning our motivations at an appropriate time with promising deals emerging. As mentioned, we are open to trading shares, and there is a consensus among our Board and management regarding our cash position, manageable debt levels, and commitment to growth.

Erik Volfing, Analyst

This is Eric with Grand Slam. Thanks for taking my question. Congrats on a solid quarter there. So you talked pretty well there about the M&A opportunities, which is really what my question was about. Could you maybe talk a little bit more about at what stage the board gets involved? Is it sort of after you've done preliminary work? Or are they involved quite early? Or are they actually sometimes helping you source? What's their role?

Jason Brown, CEO

Yes, there are definitely pathways for deal flow. Generally, we review everything that comes in. It's important to maintain relationships with all the investment banks and major firms like RBC and Jefferies, as well as the smaller firms that have emerged and are performing well. We evaluate all incoming opportunities quickly using established screening tools to filter them. For the past six months, we've been holding an investment committee meeting weekly, which is uncommon. We set up the committee about a year ago, indicating the Board's commitment to this process. This has accelerated our engagement with potential deals, as the Board is now aware of them earlier than usual. Typically, we'd want to progress further in the evaluation before investing significant technical resources. However, I've been proactive and we've conducted a lot of technical work over the holidays, including digitizing logs and collaborating with petrophysicists and core labs. I'm pleased with the teamwork and the solid geological and petrophysical analyses being performed to better understand these reservoirs. It's important to put in the effort to close deals, especially since many sellers are hesitant to sell when prices and valuations are low. Nonetheless, we need to ensure that we aren't compromising on thorough engineering or technical assessments. We concentrate on gathering the necessary financial data that Ryan is analyzing to determine its corporate impact and how we would structure capital to achieve the desired returns that would support our dividend. All of this is based on sound technical and geological foundations. So, that summarizes our process, and over the past six months, the Board has been actively involved, receiving weekly updates on our progress.

John White, Analyst

When you talked about I was going to ask about the conformance projects. But in response to your last bit of commentary with as long as I've known Bob and stretching on the engineering is the last thing I'm going to worry about.

John Bayer, Analyst

John Bayer with Sun Wealth Advisors. Jason, Ryan, and I'm sure David is listening. I didn't get a chance on the last call to wish him good luck and congratulations on the retirement.

Jason Brown, CEO

I'm sure he hears you. You heard my comment in the share. He just went over and above what he needed to do to help, and he's still a dear friend of the organization. So very, very helpful in Ryan, getting them up to speed. It was great.

John Bayer, Analyst

Yes. I hope I can get down to Houston here for some time. And certainly, try to get a hold of him and gather. So anyway, do want to echo previous callers, congrats on the quarter and the dividend increase, of course, and several of my questions have been answered as far as the CO2 purchases and so forth. But a couple of other questions. Going around to the M&A. You previously indicated looking at some more gas-centric acquisition possibilities. Is that still in the mix? Or is it sort of whatever's best that comes along, we're going to grab it? Does that make sense?

Jason Brown, CEO

Our gas interests are quite focused. I appreciate several aspects of gas, such as its long life, low lifting cost, and generally stable performance. This long life aligns well with our objectives. However, gas is highly sensitive to midstream marketing and transportation, which means we are fully engaged in that sector. We're evaluating gas projects, including one I reviewed this morning, which needs to be near the Carthage pipeline heading to Sabine Pass. We're also considering opportunities in the Barnett area of East Texas. As we move further into Oklahoma, transportation becomes a significant challenge for establishing a sustainable market like LNG. I've noted some current deflation in that sector, but the long-term objective remains focused on gas. In the Eagle Ford and West Texas regions, the influx of associated gas is likely to impact pricing due to the competition from oil producers extracting gas as a byproduct. So while we have an interest in gas, it must meet specific criteria.

John Bayer, Analyst

Sure. Got it. And then in the past, you mentioned you get a bit of a premium for your Louisiana suite, is that still holding up in that regard?

Jason Brown, CEO

A really good question, John. No, it's not. It is. In fact, it's a couple of bucks, $1.60 to $2 over. I think we probably anticipate for the next year, at least through '21, probably the first half of '22 is probably going to hang somewhere in the $1.60 to $2 above WTI is what LLS would trade at. That being said, our transport are all-in is about $3.30 to $3.40 off of that price. So right now, we would be about $1.50 to $2 under WTI net back. So just as a point of reference, we generally have been, I think, last year's reserve report was $1.65 over WTI. So that would mean that LLS was, what, $5 over WTI. So our net back $3.40 would still have us $1.65 above WTI. So that's been quite a bit of a hit, not only oil price but also the differential. So that you're asking the right question to kind of see what that translates to revenue for us. I think I would anticipate probably our marketing consultants, we work with a company called ARM, pretty well-known here in Houston to kind of look at marketing forecasts. I mean, it's probably going to be in that for us, $1.50 realized all-in, after our transport and gathering and everything, $1.50 to $2 under. What do you say, Ryan? Somewhere in there?

Ryan Stash, CFO

Yes, that's correct. It obviously depends on various factors for LLS, as Jason mentioned. What we pay is relatively fixed based on transportation costs, but we are affected by how LLS fluctuates in comparison to WTI. If that improves, we will see better pricing in relation to WTI.

John Bayer, Analyst

Okay. And then one last quick question. Unfortunately, one of the headwinds that you all face and the industry faces, of course, is ESG. And I'm just wondering, given that these fields are older and so forth. Do you have any issues with or addressing anything in regards to like methane escape and so forth, where that could potentially be an issue down the road as far as higher CapEx that might not be really in the picture right now?

Jason Brown, CEO

That's a really good question. Our industry is facing some challenges as public opinion seems to be shifting, regardless of the practicality of those views. Our assets are in a favorable position. Starting with Hamilton Dome, we aren't producing any gas there, so there are no VOCs being released. Environmentally, we have a solid relationship with the BLM, and Merritt operates efficiently. Therefore, I'm not worried about needing to invest heavily to enhance our environmental initiatives. In Delhi, the situation is even better; 30% of the CO2 we purchase comes from industrial sources, which equates to removing 750,000 cars from the road annually—quite significant. Denbury is exploring carbon capture due to their CO2 infrastructure, and we benefit from our partnership with them in Delhi. This topic was discussed at the Board, and management, including Ryan and I, plans to explore additional ways to enhance our ESG policies and efforts. Overall, we are in good shape compared to other oil companies. Regarding your question, I don't anticipate any capital expenditure will be necessary to improve our ESG standings. Ryan, do you agree?

Ryan Stash, CFO

Yes. No, I absolutely agree. I mean it's definitely a focus at the Board level and no doubt, in the investing community, as you know quite well, just our industry is under the spotlight right now, and ESG is kind of higher on our list to sort of address here in the near term.

John Bayer, Analyst

Maybe you ought to change your colors from blue to green and using up all that CO2. And would just suggest as well that maybe on the website or whatever that maybe bring some attention to the fact that you and Denbury are utilizing CO2 and taking it off the market, so to speak. And just a thought.

Jason Brown, CEO

We are currently reworking our website this month, and it will definitely include that. So yes.

Operator, Operator

There are no more questions in queue.

Jason Brown, CEO

All right. That was great. Thank you for your participation today. Please feel free to contact Ryan or me with any other questions. I look forward to providing you with an update on our next conference call. It should be in early May.

Ryan Stash, CFO

Thank you. Thanks, everyone.

Operator, Operator

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.