Earnings Call Transcript - EPM Q3 2021

Operator, Operator

Good afternoon, everyone, and welcome to the Evolution Petroleum Third Quarter Fiscal 2021 Earnings Release Event. It is now my pleasure to hand it over to your host, Ryan Stash. Please go ahead.

Ryan Stash, CFO

Thank you. Good afternoon, everyone, and welcome to Evolution Petroleum's earnings call for our third quarter fiscal year 2021. Today, we will discuss 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 for 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 August 11, 2021. And please note that any statements and information provided today are time-sensitive and may not be accurate at a later date. Our discussion today will contain forward-looking statements of management's beliefs and assumptions based on currently available information. These forward-looking statements are subject to risks and uncertainties that are listed and described in our filings with the SEC. Actual results may differ materially from those expected. Since detailed numbers are readily available to everyone in yesterday's news release, this call will primarily focus on key results of recent acquisition and how that affects Evolution, and our typical update on operations and plans for the remainder of fiscal 2021, including capital spending. I would now like to turn the call over to our President and Chief Executive Officer, Jason Brown.

Jason Brown, CEO

Thank you, Ryan. Good morning, everyone, and thanks for joining us today on Evolution's Third Quarter Fiscal 2021 Earnings Call. Thank you for your continued support and interest in our company. I'd like to start the call by thanking our team for their hard work in the past few months. In closing, our recent transaction in the Barnett Shale, we're extremely excited about this acquisition, what it does for our company and shareholders moving forward. The acquisition further diversifies our asset portfolio, which we feel reduces volatility risk. It also improves the sustainability in support of our dividend by significantly adding to our overall production and reserves. This acquisition represents a meaningful step in growing our business without requiring additional personnel or any material incremental G&A expenses. While the supply and demand imbalance remains and pricing is still volatile, we see many positives moving forward and believe that this is an important step in gaining both size and scale to create long-term value for our shareholders. Turning to Delhi and Hamilton Dome, we had an active quarter as we saw fieldwork pickup due to the uptick in commodity prices. Our operating partner, Denbury, has returned to conformance projects in Delhi after approximately 18 months of limited investments, redeploying CapEx spending after emergence from financial restructuring through bankruptcy last fall. Although total barrels decreased slightly during the quarter at Delhi, this was primarily due to the extreme weather that was experienced in the field in February. Purchased CO2 volumes were up and the operator we completed several wells. It will take a while to recover the reservoir pressure and production loss from the loss following the CO2 new purchase pipeline failure last year, but we are starting to trend in the right direction and are very pleased with the attention and capital support that Delhi is getting in 2021. In Hamilton Dome, we saw an increase in production, primarily from the reactivation of wells that were shut in last quarter. Differentials have been relatively stable and resulted in Ham Dome returning to profitability and contributing to our overall cash flows. We continue to see positive earnings this quarter and have had revenues of $7.6 million, a 32% increase from $5.8 million in Q2. I'm also very pleased to announce our 30th consecutive quarter issuing a cash dividend. In addition, we subsequently announced that we will increase our dividend by 67% to $0.05 per share for the fourth quarter. Our shareholders know how important it is that we return value to them, and we are thrilled to significantly raise the dividend even after having raised it last quarter. We continue to concentrate on cash flow and total shareholder return. We have historically provided an attractive cash return to shareholders. This quarter marked $71 million in cash dividends or $2.21 per share since the inception of the dividend program in December 2013. We are focused on delivering shareholder value and continue to look for acquisition opportunities that will provide cash flow support of our dividend. With that, I'll now turn the call back over to Ryan to run through some of the financial highlights, then I'll wrap up the call by speaking briefly about our strategy and outlook of the M&A landscape.

Ryan Stash, CFO

Thanks, Jason. I'll now share some more details regarding our financial results for the third quarter ended March 31, 2021. Please refer to our press release from yesterday afternoon for additional information and details for the full fiscal third quarter '21 and look out for our Form 10-Q to be filed soon. Highlights for the third quarter are as follows. As Jason had mentioned, we paid our 30th consecutive quarterly cash dividend for common shares on March 31, 2021, and declared a $0.05 per share dividend for our fourth fiscal quarter payable on June 30, 2021, which is a 67% increase from the prior quarter. Also, as we had previously announced yesterday, that we closed on substantially all of our acquisition of the non-operated oil and gas minerals and working interest in the Barnett shale for $18.2 million net of preliminary purchase price adjustments. I would add that this is just a preliminary purchase price, and we'll continue to adjust as additional cash flows are received as a result of the typical lag in revenues for non-operated properties. Total revenues increased 32% over the prior quarter to $7.6 million, and we generated cash flow in excess of the quarterly dividend and ended the quarter with $17 million in cash and no debt. I would also note that the $17 million in cash is net of a $2.3 million deposit we made last quarter for the Barnett acquisition. Finally, we completed the spring redetermination of the credit facility and increase of borrowing base to $30 million. Also, this number does not include any impacts for our Barnett acquisition. The increase in total revenues by 32% for the quarter to $7.6 million from $5.8 million in the prior quarter is primarily due to a 38% increase in oil prices, which averaged $53.52 per barrel. Net production was down 5% this quarter to 1,708 BOE per day, as Jason mentioned, primarily due to the severe winter storm experienced at Delhi in February 2021. However, if you adjust for the downtime we experienced at Delhi, average production would have been approximately 60 barrels per day higher for the quarter. Lease operating expenses increased 20% to $3.6 million in the second quarter compared to $3 million in the prior quarter. This increase is primarily due to an increase of $400,000 for purchased CO2, which represents a full quarter of CO2 purchases at Delhi, as purchases had just resumed in late October of 2020 after the pipeline repair. Also contributing to the increase in purchased CO2 cost is a higher realized oil prices. And keep in mind that the CO2 cost at Delhi is driven by the price of oil. The remaining increase in lease operating costs of $200,000 was primarily due to an increase in the amount of workover activity by our operators in the current quarter. General and administrative expenses remained flat at $1.8 million as increases in acquisition-related legal and tax expense in the current quarter were offset by decreases from certain one-time consulting and legal expenses associated with the company's CFO services this past quarter. To note, we incurred approximately $400,000 in one-time legal and tax expenses this quarter due to acquisition activity. We recorded an income tax benefit of $200,000 in the current quarter compared to a benefit of $3.2 million in the prior quarter, resulting in a 93% decrease of $3 million. This decrease is primarily attributable to the pretax loss of $15.9 million in the prior quarter due to the impairment that we took compared to a pretax income of $1 million in the current quarter. Net income for the current quarter was $1.2 million or $0.04 per diluted share compared to a net loss of $12.7 million or $0.38 per diluted share in the previous quarter. Again, this increase of $13.9 million is driven by the non-cash impairment that we recorded in the previous quarter. CapEx from maintenance and plugging activities was approximately $100,000 for this quarter. As we mentioned previously, conformance work has resumed at Delhi, and we expect this CapEx number to increase for the fourth quarter and full year 2022. We are currently estimating $250,000 to $500,000 for the fiscal fourth quarter and $1.25 to $2 million for fiscal year 2022. As Jason mentioned, the majority of volumes shut in at Hamilton Dome during the low price conditions last year had been returned to production, and future reactivations will be considered based on commodity pricing. There have been no updates to our reserves, and we continue discussions with Denbury and look forward to the development of Phase 5 at Delhi, which is still expected to begin in calendar year 2022 or 2023. Working capital decreased by $1.5 million from the prior quarter to $20.1 million. This decrease is primarily attributable to the $2.3 million deposit previously mentioned that we made for the acquisition of the Barnett Shale assets. This deposit was applied to the adjusted closing price of $18.2 million. And we ended the quarter with $17 million in cash after paying out $1 million in dividends and continue to maintain an undrawn credit facility. Now this concludes our review of financial results and operations for our fiscal third quarter ended March 31.

Jason Brown, CEO

Thanks, Ryan. I'd like to express how pleased I am with the development of our organization. All companies have had to figure out new ways to conduct their business this past year, but I'm very proud of the resilience of our crew and the culture that we have built with each other. Transactions are never easy. When you operate with a small team as we do, to keep our head down, it's even more critical that everyone be willing to wear multiple hats and pull together. This acquisition was a significant step for our company in its economic merits that our shareholders will benefit from for many years, but it was also a great vehicle to gel our team. We've had some personnel changes in the last year with the retirement of our CFO and the appointment of a new audit Chair, and I can't say enough about the quality of our people and how well they have come to work together. I believe that we have demonstrated that we have the infrastructure and ability to source, evaluate, and execute transactions, which is what our shareholders need us to be able to do to grow the company in long-term support of our dividend. The M&A landscape seems to have opened up a bit the past few months. Pricing, although always volatile and still existing in a supply-demand imbalance, seems to have stabilized enough to generate deal activity and tighten the bid-ask gap in a way that has made transactions possible in some cases. We are seeing a flurry of transactions, both marketed and privately negotiated. We're hopeful that we will be able to add to the successful Barnett Shale acquisition with additional properties over the coming months. We like the diversity of the commodity mix that we now have, but plan to continue to focus primarily on assets that bolster our cash flow in the short-term and long-term support of our dividend without specific bias towards any of the commodities. I will reiterate that we strategically look for additional low production decline, long-lived reserves to add to our assets that will continue to contribute to our dividend for many years to come. We remain in a great position, and I look forward to the future of Evolution Petroleum. With that, I think we're ready to take a few questions. Operator, please open the line for questions.

Operator, Operator

Your first question is coming from John White.

John White, Analyst

And got a lot of good news. Congratulations on the quarter. A lot of good news to talk about, increased dividend. I get the Barnett, jail close, and you got the borrowing base out of the way. So checked off a lot of boxes.

Ryan Stash, CFO

We've been discussing it for some time, and it was great to see everything come together recently. I'm very pleased with the outcome. Regarding the borrowing base, we will likely have it redetermined now that we've incorporated all the Tokyo gas, as that redetermination was previously pending, which will further extend the borrowing base. Overall, it was satisfying to accomplish this. Thank you for your comments, John.

John White, Analyst

And you mentioned CO2 at Delhi averaged 64.5 million cubic feet per day, and that was up substantially from the prior quarter. And you mentioned you expect that level of injection to continue through the end of your fiscal year. If my memory is working correctly, pre-pandemic wasn't the CO2 injection up in the 80 million cubic feet a day range?

Jason Brown, CEO

Yes, we averaged kind of in the 83 to 85 million a day. That's correct, John. They haven't been able to ramp up to full capacity yet with a series of work that have been done at their Jackson Dome facilities. So the big Jackson Dome facility supports CO2 for a number of Denbury's fields. And this seemed to be the year that a lot of things needed to be repaired. So they got the pipeline repaired, but then there are several things at Jackson Dome, of their three main facilities there, that have gone through essentially a turnaround. And so what has happened is other fields have had to share a little bit. So 71 is not where we want it to be unfortunately, the expected finish of all of that turnaround work, which is about this time, April, May, probably isn't going to allow us to get too much more until the end of the fiscal year. And fortunately, that's in the summertime when it gets a little bit warmer. And so we have some miscibility issues. What they've told us is that they plan to ramp-up CO2 as soon as the temperatures start to break in the fall, so probably October. And pretty much all next winter, they plan to ramp-up to about 100 to 110 to beef up reservoir support. Unfortunately, because of the timing of these other repairs and facilities this spring and then the miscibility issue this summer, where you just can't put away that much CO2 in warmer temperatures, we're going to have to probably wait. And so it's probably going to average somewhere in that 70 to 75 throughout the summer.

John White, Analyst

Well, that's excellent detail. And let me make sure I understand they're planning to get up in the 100 million, 110 range at Delhi in the fall?

Jason Brown, CEO

Yes. I think most of the winter next year, next spring. So they're planning to do some makeup CO2. It's just taken a while to get there. So yes, I think the capacity, the MAOP would safely operate about 125 million a day. I think that they probably will not push it that much and we'll probably top out somewhere in the 107 to 110. But certainly, we'll be making up some lost time there.

John White, Analyst

Again, I appreciate the detail there. On 2022 CapEx, you mentioned a range of $0.125 million to $2.0 million. And with the estimates I have, that provide a very nice amount, a very large amount of free cash flow.

Jason Brown, CEO

Yes, we agree with that. It's somewhat challenging to predict. In Tokyo gas and the Barnett Shale, we don't expect the current operator to invest much in capital expenditure. However, they are in the process of selling, and we see potential with a new operator coming in who will have a fresh perspective, mainly focusing on workovers and improvements, possibly even some refracs. We've invested a bit in that area, but nothing specific yet, and we're quite optimistic about the potential there. While I don't believe they will be setting up rigs, Denbury has resumed some conformance projects, and we are already seeing positive results from that. Additionally, there is some electrical submersible pump (ESP) work at Ham Dome to revive a couple of wells that have not been returned yet. I believe the projected number for next year is reasonable, around $1.50 to $2 million. You're correct that this will generate a substantial amount of cash flow.

John White, Analyst

That was my very next question was CapEx for the Barnett Shale. So you segued into that very nicely. The Barnett Shale had nothing to do with finance or operations. But with the location, it's very convenient. You can visit the properties and stay in Fort Worth.

Jason Brown, CEO

It's great to be in Texas. We enjoy operating here because it's friendly to oil and gas. This region has dealt with many regulatory issues long ago, which has been beneficial. We're focused on the long-term prospects, which feels similar to our evolution. Regarding cash flow in relation to capital expenditures, if we look at the past six years, the last year was a bit unusual, but consistently we've been allocating about 11% to 12% of our income towards CapEx. This is significantly lower compared to most of our peers because our focus is on excess cash flow. I expect we'll be in a similar range for 2022.

Operator, Operator

Your next question is coming from Richard Howard.

Unknown Analyst, Analyst

Jason, great quarter, great transaction. Have you thought about how you're going to talk about barrels of oil equivalent in the future, now that you're bringing in gas and gas liquids?

Jason Brown, CEO

Well, unfortunately, I guess we put out a deck that showed how we think about it in terms of value because everything comes back to what is this going to contribute to our cash flow to be able to pay the dividend. But the industry does the whole 6 to 1 because that's the British thermal unit breakdown. I guess we're still thinking about that. We're about to launch into a reworking of the investor deck and probably go out on the road to start telling our story pretty aggressively this summer. We think our current shareholders like it quite a bit, and we're pretty happy and have a good relationship with them, but we need to be able to expand out and get out there. So it's going to be an important thing. Do you have some thoughts on that, Rich?

Unknown Analyst, Analyst

Well, I think it's an issue because I personally like the way you described it in the transaction, but it is not the way the industry does. And you may be forced to go the other way. And that's the reason I bring it.

Jason Brown, CEO

Well, it's not an uncommon thing for us to have to invest quite a bit of time on education. We feel like we're a very different oil company to start with. We think that what oil companies are going to need to look like going in the future, the actual cash flow positive businesses that return money to shareholders. So that's part of our story. And I think educating new investors on the value-based, the way we look at it, is really what they want anyway. So I think we'll probably have to do both, and I spend quite a bit of time as we do building relationships with investors. Ryan, you got any thoughts on that?

Ryan Stash, CFO

Yes. No, I agree, Jason. I think as you mentioned, Rich, the challenge is kind of the industry vernacular when it comes to sort of reporting things on an equivalent basis. I mean, I think as we sort of talk to analysts and investors like yourself, we'll obviously be mindful of that and thinking through how to correctly portray the business, especially from a cost standpoint because, as you know, the LOE for gas assets is a lot lower on an equivalent basis than oil. So we just need to be mindful and make sure that everyone gets the kind of right spot as we talk about where we think the business is going.

Unknown Analyst, Analyst

Great. Okay. One other low question. So between the time of the effective transaction, January 1 and the closing, is about 128 days. And in that time, the properties generated about $4 million, is that correct?

Jason Brown, CEO

Well, I think it's probably going to be a little shy of that because we had to exclude a small amount of assets because of a dispute with a consent. If Tokyo Gas can get that fixed, we'd love to buy that as well. But I think you're thinking about it right. You saw about a 1.4 adjustment to the purchase price that we listed as preliminary. You'll have to remember that most non-op people get paid a couple of months in the rears. So of the four months between the effective date of one month and the closing date of May 7, I think we probably have accounted for a couple of those months. So we may not get to the $4 million, but certainly more than what we've recognized so far, if that makes sense.

Unknown Analyst, Analyst

And also given that lag, haven't prices significantly increased effectively?

Jason Brown, CEO

Right. So it would be a reasonable assumption without providing too much guidance that the March and April would be a little more than what we saw in January and February. So yes.

Operator, Operator

Your next question is coming from Erik Volfing.

Erik Volfing, Analyst

Congratulations on completing the acquisition and increasing the dividend. That's fantastic news. I was wondering if you could provide a bit more detail on what aspects of the acquisition didn't close.

Jason Brown, CEO

Sure. There were four or five fields involved, spread out over nine counties. One significant field was Alliance, which had some parts that were just working interest. What propelled us forward were some royalties and working interest in the Alliance field. Some of those working interests were tied to a lease that the leaseholder, Tokyo Gas, disputed, believing it was a preferred issue and thinking it required consent. As a result, we decided to stay out of that dispute. The PSA includes provisions to handle such situations, so we managed the PSA by excluding those assets and completed the closure on everything else. I want to highlight that TG Americas and Tokyo Gas have been great partners throughout this process, which can be challenging, and we appreciate working with them. If they can resolve their issues, we would gladly consider acquiring the rest. The bulk of the production is dry gas, and there are no liquids involved, so our liquid reserves and production were unaffected. In fact, the net revenue interest percentage was slightly higher because the remaining interests in Alliance were primarily royalties, which don’t incur expenses. Therefore, we are comfortable with what we left out and have adjusted the process accordingly.

Operator, Operator

Our next question is coming from John Bair.

John Bair, Analyst

I have a couple of questions. It seems that CO2 costs are rising, not only in your operations but also across the industry. Have you considered or is there a possibility of getting involved in a carbon capture program that could help lower your overall costs or even provide a source for CO2? I realize this might still be in the early stages. Additionally, are any of the operators in these fields exploring the use of green chemistry for enhanced oil recovery or field maintenance?

Jason Brown, CEO

Well. It's definitely something we're considering. We're focusing on ESG and thinking about our future and its implications for our company. About 30% of what Denbury injects underground comes from the industry, so we are already participating in that aspect. However, as a non-operated position, we have limited control over sourcing CO2 directly rather than purchasing it from the industry. Denbury is actively engaged in that area. We have also strengthened our partnership with Denbury, and we're looking forward to collaborating with their new South regional VP, Kate Ryan, as she explores the entire region. However, there aren’t many actions we can take until we potentially move into an operated position.

John Bair, Analyst

Okay. But the operators aren't really discussing or addressing that?

Jason Brown, CEO

No, I think they are. I think it's a big commitment for them. And I think you'll see Denbury get into what they call blue oil in a very big way because, I guess, blue oil is a greener oil or something of the carbon capture, I think is going to be a big thing for us. We haven't figured out a way to monetize that yet.

John Bair, Analyst

Yes. That's what I said it kind of perhaps early in the game right now in that regard. But certainly, everybody know that this announcement or suggestion by Exxon recently about putting together a huge program. So given that in your comments, you're saying that Ham Dome is back to profitability, is there any consideration of maybe additional wells or any workovers there that might continue to improve overall production rates?

Jason Brown, CEO

Yes, potentially. I doubt on new drilling, but workovers, for sure. Those guys are really smart, and they've worked during this downtime of COVID and really focused on maximizing the field with the lowest amount of cost. So there's going to be some costs that are captured, I think, in a more permanent way there. They've returned everything that just makes sense to turn back on. There are some wells that haven't been returned, but they need an ESP replacement. And so we need to sort of justify the workover. So it's those workovers that we'll see over the next year, but no massive plans up there. We are looking at a couple of other options. When we got into Ham Dome, there were some larger pipeline scheduled to be up there, Magellan and Tallgrass, we're putting in quite a bit more capacity. Some of that's changed a little bit and been delayed from the last year. So we're looking at some options to get better pricing. but so far, the WCS has really kind of stabilized and tightened the differentials, and we're definitely enjoying that. We expect that to continue lease through the summer. So that's been a pretty nice netback at this point.

John Bair, Analyst

Okay. One last quick question on the Barnett. In your press release, you mentioned that the acreage had some potential for new locations and so forth. Any discussion, I mean, you said that not really expecting much increased CapEx in the near term, but is there any potential fresh locations that could potentially improve the overall production rates?

Jason Brown, CEO

There certainly is potential. We have a few hundred locations identified, but I would estimate that less than 10% are economically viable or appealing. They are economically feasible, but attractive in the sense that someone would go out and set up a rig to drill them, especially if gas prices are around $3.15 or higher, like $3.50. It really depends on one’s outlook on gas prices. I believe there is significant long-term potential, though we are not relying on it or accounting for it, and we certainly didn’t pay for it. However, it is all held by production without any continuous drilling obligations, which creates future value for us. The only qualifier is that if a new operator enters the scene, we expect Black Bear to finalize a deal. As mentioned earlier, I think most of the capital expenditures will not go toward drilling new wells, but rather there's plenty of work available to boost production, which we are quite optimistic about. These workover projects tend to yield high returns quickly and typically perform very well.

Operator, Operator

Your next question is coming from Richard Howard.

Unknown Analyst, Analyst

Jason, one more question. You reminded me that Hamilton Dome is a Western Canada select producer. And I think the last I saw, those prices were over $50 a barrel, which I think is actually better than when you made the transaction. Have I got that wrong or am I close?

Jason Brown, CEO

No, you've got that exactly right. That's why I said it's tightened a little bit, and we're pretty happy with it. Yes, we've been netting back about 52, I think in April, it was 50, 51.75, something like that, net back to us. So with $30 lifting costs, that's a pretty good margin. Like I said, Ham Dome it's kind of an incomplete last year. Those boys are smart, and they kept us from losing money up there, but this last year just hadn't made a lot. But that thing still pays 12%, 15% of our dividend ten years from now. Our shareholders are going to be really happy with that field. But yes, you got that right, Rich.

Unknown Analyst, Analyst

Do you expect that we will accumulate another $15 million to $20 million in cash before we proceed with the next transaction? What are your thoughts on that?

Jason Brown, CEO

We certainly hope not. We want to utilize it effectively and are currently exploring several opportunities. As I mentioned, there seems to be some stability in the market right now, allowing for transactions, even though it’s not the case for everything. We're putting in considerable effort to take advantage of favorable situations. It's challenging, and we intend to be cautious with our decisions. Ryan, do you have any thoughts on this?

Ryan Stash, CFO

Yes, Rich. We still have an undrawn credit facility. We drew a little bit for working capital purposes, but we had enough cash to complete the Tokyo Gas acquisition. We expect this acquisition, along with our core business generating significant free cash flow in the upcoming months, will bolster our financial position. With an undrawn borrowing base, we believe we maintain good liquidity and the capacity to pursue another deal. As Jason mentioned, it will need to be the right opportunity, but we still feel we have room for further action at this point.

Operator, Operator

There are no further questions in the queue at this time. I will now turn the floor back to Jason Brown for closing statements.

Jason Brown, CEO

Well, thank you, everyone, for your participation today. Please feel free to contact us with any other questions. I look forward to providing you with an update of our next conference call in September. Thank you.