Ring Energy, Inc. Q3 FY2020 Earnings Call

Greetings and welcome to today’s Ring Energy, Inc. 2020 Third Quarter Financial and Operating Highlights Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn this conference over to your host, Mr. Paul McKinney, Chief Executive Officer and Chairman of the Board of Directors of Ring Energy Inc. Please go ahead.

Thank you, Laura. And good morning, everyone. Thank you for taking the time to join us today and for your interest in Ring Energy. We plan to review with you our financial and operational results for the three and nine month period ending September 30, 2020, and to provide additional insight into our strategy and activities. Before we begin, I would like to introduce the Ring employees that will be participating in the call today. Randy Broaddrick, our CFO, will be reviewing the financials and Danny Wilson, our Executive Vice President and Chief Operating Officer, will be reviewing with you the operations. Now before turning this over to Randy and Danny, I would like to make a few points about our third quarter. First, we had a very good one; our adjusted EBITDA increased almost 45% over the prior quarter and our free cash flow increased almost 46%. We reduced our bank debt by $15 million and exited the quarter with almost $18 million in cash on the balance sheet and a little over $32 million in liquidity. We were able to accomplish this by returning our wells to production, significantly increasing our oil and gas production over the prior quarter, and by substantially reducing our LOE, G&A, and capital spending. The gains we realized on our derivatives contributed as well. Looking beyond this quarter, we see challenges ahead, and I will be back to discuss some of these challenges and what we plan to do to meet these challenges once Randy and Danny review the details of our third quarter. So that being said, I will turn this over to Randy Broaddrick, our CFO, to review the financial details of our third quarter results. Randy?

Thank you, Paul. Before we begin, I would like to make reference to the forward-looking statements which may be made during this call. These statements are within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. For a complete explanation, I would refer you to our release issued Monday, November 9. If you do not have a copy of the release, one will be posted on the company website at www.ringenergy.com. For the three months ended September 30, 2020, we had revenues of $31.5 million, a net loss of $2 million and a loss per diluted share of $0.03. This net loss included a pretax unrealized loss on hedges of $6.2 million and approximately $600,000 in stock-based compensation expense. Without these items, after the effect of income taxes, our net income would have been approximately $3.4 million or a gain of $0.05 per share. For the nine months ended September 30, 2020, we had revenues of $81.7 million, a net loss of $93.2 million and a loss per diluted share of $1.37. This net loss included a pretax unrealized gain on hedges of $14.1 million, ceiling test impairment of $147.9 million, and $2.6 million in stock-based compensation expense. Without these items, after the effect of income taxes, our net income would have been approximately $14.2 million or a gain of $0.21 per share. The unrealized gain or loss on derivatives—on hedges is recorded because the value of the derivatives changed as a result of changes in oil price. The ceiling test impairment is due to the reduction in the value of our reserves as a result of a decrease in oil prices. During the three months ended September 30, 2020, we had $15.6 million in net cash flow and $4.3 million in capital expenditures, resulting in post CapEx positive cash flow of approximately $11.3 million. During the nine months ended September 30, 2020, our net cash flow was $49.2 million, with $22.2 million in capital expenditures, leading to post CapEx positive cash flow of approximately $27 million. For the three-month period, we had oil sales of 781,626 barrels and gas sales of 581,123 MCF for a total of 878,480 BOE. Our received prices were $38.80 per barrel of oil and $1.96 per MCF of gas for an average of $35.82 per BOE. For the nine-month period, oil sales were 266,980 barrels and gas sales were 1,764,165 MCF for a total of 2,361,008 BOE. Our received prices were $38.40 per barrel of oil and $1.30 per MCF of gas for an average of $34.59 per BOE. The differential between our oil price received and WTI averaged approximately $2 per barrel. Before I turn the call over to Danny, I would like to highlight a few additional items. With the third quarter of 2020, we have now recorded four consecutive quarters of positive post-CapEx cash flow. We intend to use cash flows to continue to reduce our debt under a credit facility. Regarding our credit facility, during our spring re-determination, our borrowing base was reduced to $375 million. As of September 30, 2020, we had reduced the outstanding balance drawn on our credit facility to $360 million. We are in the process of providing the bank group with all the information for our fall re-determination. As noted in our 10-Q, we requested and received an extension on the scheduled borrowing base redetermination to allow us to properly reflect recent cost reduction and operational efficiencies in the information provided to the bank. As such, we cannot reliably predict what the outcome of the fall redetermination will be at this time. In addition to reducing our outstanding debt under the credit facility, we have also reduced our accounts payable. Our accounts payable balance at year-end was $54.6 million, which has now been reduced to $24.8 million at the end of the third quarter. We also had cash on hand at September 30, of $17.9 million. Lastly, subsequent to September 30, 2020, the company completed a public offering and concurrently completed a registered direct offering of common shares, pre-funded warrants, and common warrants. In total, the company issued 13,075,800 shares, 16,728,500 pre-funded warrants, and 29,804,300 common warrants. Gross proceeds received at closing were approximately $20.8 million, with net proceeds anticipated to be approximately $19.1 million. With that, I will turn it over to Danny.

All right. Thank you, Randy. As was mentioned in the operations update in October, our focus for the third quarter was on returning well production after having been shut down for a significant amount of time in Q2. Our field personnel did an excellent job of bringing our fields back online, resulting in greater than a 70% increase in production from Q2. Third quarter production increased to approximately 848,000 net BOE versus 495,000 in Q2, and third quarter daily production was up to 90,220 net BOE versus Q2 daily production of 5,440 net BOE. Due to the continued low commodity prices in Q3, we had no operated drilling activity. We did continue with our ESP to rod conversion program, completing eight conversions during the quarter, six of these were Northwest shelf wells and two were on the Central Basin platform. Today, we have converted 46% of our wells on the Central Basin platform and 58% on the Northwest shelf for a combined 51% across those areas. We continue to see significant savings from the program, as future well work costs for the converted wells have reduced from $150,000 to $200,000 per job down to $20,000 to $40,000 per job, depending on the work performed, which is a 70% to 90% reduction. In addition, we will see lower future LOE costs from reduced electrical usage and the elimination of rental fees for the ESP. Evidence of this can be seen in our lower Q3 LOE of $10.11 per BOE, which is down from $14.03 per BOE in the same quarter a year ago. This is a 28% reduction. Another benefit of the conversion program is a greatly reduced failure rate. We've cut our failure rate measured in failures per month by over 0.5 since late 2018. This results in longer run times, which leads to greater production. This lower failure rate is a major factor in allowing us to maintain our production at higher than expected levels even with no drilling activity. In our second quarter call, we announced expected production levels for Q3 to be between 8,900 and 9,000 BOE per day, and instead we were able to come in at over 9,200. As for Q4, we expect production levels to once again be in the 8,900 to 9,000 BOE per day range. We continue to perform our workovers within budget, and through the end of Q3, we've spent approximately $22 million on CapEx. At this time, we anticipate that we will finish the year within our announced CapEx budget of $25 million to $27 million. And with that, I'm going to turn it back over to Paul.

Thank you, Danny. And thank you, Randy. At this point in the call, I want to spend some time addressing some of our challenges. I believe you would agree with me that we just experienced a very solid quarter. We significantly increased our production by restoring the majority of our wells back online and made considerable progress reducing our cost structure. Our numbers reflect the benefit of all that. When compared to the second quarter, yes, we did well. But the challenges faced in this industry and the challenges facing this company are still with us. First, we find ourselves in this pandemic and due to the economic downturn that is keeping energy prices at historically low levels. As we stated in our release, we believe these conditions may continue longer than any of us would like, and so we are planning our business assuming prices remain pretty much as they are today. The second issue is our high debt level and relative size of our liquidity. Since joining Ring, I have been asked what we plan to do to pay down debt or perhaps double our efforts. What are the various alternatives the company is considering to pay down debt? To help answer those questions, first, let's discuss Ring’s strength. One advantage Ring enjoys is our low decline, long life conventional production base, characteristic of wells in the Central Basin platform and the Northwest shelf. We do not experience high production declines like many of the shale producers, which forces them to invest capital to maintain their production and cash flow. The capital we need to maintain our production levels is relatively low in comparison. Another benefit of our production base provides an inventory of what I call blocking and tackling type of investment opportunities, such as ESP to rod pump conversions that Randy just discussed, and light to medium-sized workovers, such as pump change-outs, cleanout jobs, small acid jobs, recompletions, and compressor installations. These investments have exceptionally high rates of return, usually paying out in a matter of weeks or months and create significant liquidity. The third advantage of our asset base is the inventory of high rate of return drilling opportunities with very low breakeven costs. Referring to the Wellington section of our next Investor presentation, we generate internal rates of return between 65% and 98% at $40 per BOE. This inventory of highly economic growth opportunities allows us the option to spend capital to not only maintain and even grow our production, but to increase our liquidity at similar oil prices. When coupled with our long life, shallow decline production base and the high rate of return blocking and tackling projects, Ring has the inventory of organic opportunities to meet the challenges of the current environment and the flexibility to consider investment opportunities to not only survive these challenging times, but to be poised to grow when the market improves. Having said that, I believe it is important that you understand more about the principles by which we will make our future investment decisions. And part of what you need to understand is how these principles change depending on our circumstances as a company and what the environment is for the industry. When market conditions are like they are today, with relatively low commodity prices and high levels of debt, we will allocate our capital to projects that improve our liquidity and only to those projects that do so. So what does that mean? We will evaluate our investment opportunities not only at prevailing prices to determine the economic merits of a project, but we will also evaluate them using the most recent bank price deck to determine the amount of liquidity we are likely to generate with the investment. We believe this is an important test during times like we're in today. However, when market conditions return to historical norms and Ring Energy has lowered debt levels, we will still prioritize projects that enhance our liquidity, but because the overwhelming majority of those will meet that test, we will then have the option to consider other priorities, such as production growth and ensuring we capture medium and long-term opportunities to sustain and grow the company. Now that we've talked about the principles that will guide our investment decisions, let's talk more specifically about our near-term vision for what we are going to do. As I have said in the past, I believe we can buy barrels of production in the marketplace cheaper than we can drill for them. The market is ripe for consolidation. There are simply too many companies operating too few barrels of production and too few wells, and it appears there isn't a tremendous amount of competition to consolidate assets in areas in which we operate. This leads us to believe that we are the logical consolidator on the platform and second shelf. We also believe we are currently in a window of opportunity that may only be around for as long as hydrocarbon prices remain low. We want to take advantage of the current conditions and acquire what we can. To be clear, Ring Energy is focusing our efforts on consolidating existing assets that we believe are similar or accretive to our existing long life, shallow decline assets and would make great additions to our portfolio. The ideal assets will share many of the same characteristics we discussed earlier and ideally be in areas where we have existing operations. This is not to say that we will not consider acquisition opportunities in other areas or basins. However, it does mean that we are currently focused on acquiring assets in and around our existing operations to take advantage of economies of scale and synergies. Regarding drilling, we are currently allocating capital to the projects that deliver the highest amount of liquidity per dollar spent. We have a reasonable inventory of the blocking and tackling type projects that we discussed earlier. We plan to exhaust those opportunities before picking up a drilling rig. The next thing we will investigate before making a decision to pick up a drilling rig is our liquidity needs going forward, including our upcoming Spring 2021 re-determination. We will forecast cash flow, liquidity, and debt levels versus various investment opportunities, including drilling new wells. My preference is to wait to drill until prices return to pre-pandemic levels. However, if we need to create more liquidity by picking up a drilling rig, it may be the smart thing to do. We will be completing these evaluations necessary to make those decisions while we await the results of our upcoming borrowing base redetermination, due in December. Once the uncertainty of our borrowing base is resolved, we will be able to share our future plans with greater certainty. As mentioned earlier, we requested a one-month extension from the bank group in October once we realized the potential improvement to our borrowing base if we complete a number of our blocking and tackling projects. We needed enough time to finish the projects and provide enough actual production and operating cost information to give the reserve estimators what they need to determine the value contribution. These projects piled up during the height of the pandemic-induced price crash, where Ring, like many other companies, put a freeze on capital spending and expensive repair projects until oil prices began to stabilize. Ring picked up a workover rig before I arrived to begin this work. However, we decided to accelerate the work program by picking up several more workover rigs, hoping that the results would improve the borrowing base outcome. We’ll know the full effects of that program on our borrowing base outcome soon. To give you another update, as Randy said, we have already provided most of the information the bank needs and that they will rely upon to complete their valuation. We will continue to provide new information on our completed projects until the deadline when they will no longer accept data. At that point, it will be in their hands, and we will be waiting for the outcome, which we anticipate should be finalized sometime in early December. Regarding the Delaware asset sale that did not close, the first question many ask is what happened? The right answer is the pandemic. The timing of the low oil prices, the effects of these low oil prices and volatility had on our operation—not just the Delaware assets, but all of Ring’s assets—and the corresponding reductions in value made it challenging for the purchaser to secure the financing they needed to close. With a request for a sixth extension and knowing that we had a deadline approaching for our borrowing base redetermination, we decided to draw a line in the sand, so to speak. The termination process for the purchase and sale agreement has been initiated, and we are completing a full internal review of the assets before making the decision as to whether we will resume negotiations with the existing purchaser, run another sales process, or keep and develop the assets for the benefit of our shareholders. Regarding the impact this may have on our upcoming borrowing base redetermination, we don't really know right now; however, we believe that retaining these assets will increase the borrowing base and be relatively neutral concerning our liquidity compared to if we had sold the asset. I would also like to discuss the stock offerings we completed late last month. As Randy said, we raised approximately $21 million with estimated net proceeds of $19 million, which further increases our liquidity. However, this was a highly dilutive event. We’ve received considerable questions about it, such as why we did it, whether we had to do it, and what we are planning to do with the proceeds. The answers to these questions are straightforward. The answer to the second question is simple: we did not have to do it. The answer to the third question is similar to what we discussed earlier, and our eventual use of the proceeds will depend on the investment opportunities we have on hand, but our preference is to use the proceeds and liquidity to acquire assets that meet the criteria we discussed earlier and structure potential acquisitions to further improve our liquidity. Regarding why we did it, a couple of factors encouraged us to raise the funds. First, the idea of potentially raising equity was discussed before I arrived at Ring. I wanted the opportunity to see if we could acquire producing properties through a transaction that would increase our liquidity using our stock. Once I came on board, I immediately began engaging with organizations holding oil and gas assets that I believed would make great additions to our portfolio. During these conversations, I kept hearing the same message: before they would be willing to consider our stock as part of a potential transaction, we needed to fix our balance sheet. We found ourselves in a catch-22 situation. We wanted to use our stock as currency in potential transactions to create additional liquidity, but for parties to consider our stock, we had to increase our liquidity beforehand. It became apparent that we needed to consider raising equity. Another factor to consider is the risks and challenges faced by an organization when the cost of the investment opportunities required to build liquidity are substantial compared to available liquidity. A company needs enough liquidity to withstand the risk associated with their investment program. While we felt relatively confident that we would end up with adequate liquidity after the borrowing base is redetermined, the concern was the level of risk if the available liquidity was lower than preferred. Finally, we had scheduled a planning call to discuss the details of a potential equity raise. During this pre-planned call, our stock experienced a spike in activity. The question was raised whether we would consider a bought deal. Having previously evaluated all the discussed issues and seizing the rare opportunity to complete a bought deal at a premium to the market, we felt it was the right decision. We still believe it was the right thing to do. The challenge ahead is whether we can secure accretive acquisitions that will ultimately overcome the dilution experienced in the equity raise, and as mentioned earlier, we are focused on achieving that. With those subjects covered, I’d like to take a moment to congratulate our new board members: Tom Mitchell, John Crum, and Richard Harris. Welcome to our Board. I look forward to working with each of you to create shareholder value and grow this company. Before I turn this over to our moderator for questions, I’d like to share a few words about Tim Rochford. In the past, I have had the opportunity to work with or meet some legendary figures in our industry. Tim Rochford ranks among the absolute best—a true oilman who has created considerable wealth for his investors and shareholders while doing what he loves. He is a man of integrity, with a strong work ethic and commitment to creating shareholder value. Tim has a rare character; he can look in the mirror and say, 'It is time to pass the baton.' Tim, thank you for the opportunity to fill your shoes and take this company to the next level. I am truly grateful for the opportunity that you and the Board have entrusted to me. And to the shareholders who invested in Ring because of Tim's leadership and track record, please know that I will do my best to earn your investment and trust, just as Tim did. With that being said, I’d like to turn it over to our moderator, Laura, for questions.

Our first question comes from Neal Dingmann with Truist Securities. You may proceed with your question.

Morning, all. Paul, thanks for the details. My first question would be, how do you and your team now evaluate the idea of bringing the rig back versus doing a deal? Is it just simply return? Maybe give me your mindset when you're considering those two options.

It's a function of the merits of each of those investment opportunities. You know, when you drill a well, you achieve production levels that you forecast from the well. But when you acquire assets, especially in today's environment, you're not just getting the daily barrels of production that come along with that asset; you're also acquiring other elements that aren't being valued in our current market. This is partly why I've said I prefer buying barrels in today's environment over drilling for them, due to the additional benefits that accompany acquisitions. We are very effective operators in the areas we cover, so if given the opportunity to acquire more assets there, it strengthens Ring Energy for the future.

Great. Could you discuss baseline production and how you see what you can do to maintain that? Or is it the nature of your assets that enables holding levels?

Your question directly relates to my comment about our low decline, long life production. The San Andres formation is characteristically known for long life and shallow declines after initial production. What I am observing in our production base—especially since we've returned all of our wells back online—is that they exhibit shallow declines. When there is a shallow decline, you have fewer barrels to replace to achieve growth. The capital needed to maintain that production tends to be less because fewer barrels need to be replaced. This is one of the significant advantages of our organization, and we will always be search for ways to upgrade our opportunities and properties.

Just to back up what Paul said, if you look at Q1, where we drilled four wells and brought those on, we averaged production during that quarter of about 10,899 net BOE per day. Considering our current levels, we've only seen a 15% drop-off over the year, which I believe is quite extraordinary compared to various shale operators and the production decline they face.

I would agree. Thanks, Danny. Thanks, Paul.

Our next question comes from the line of Jeff Grampp with Northland Capital Markets. You may proceed with your question.

Good morning, guys. I was wondering, Paul or Danny, what do you think a new well might cost today? Feel free to break it down by the shelf and the platform.

We're looking at about $2.2 million on the Northwest shelf. Honestly, I think we can get it down to $2 million or a little less on the Central Basin platform. We continuously evaluate this and communicate with our vendors. There's also a fair chance we can lower those costs further, depending on the market when everyone else returns to work. The vendors are eager right now, so getting it done in that range between $2 million to $2.2 million seems feasible.

Thanks. Does that change your previous view that a $50 realized price was the inflection point? With your focus on liquidity, does it make sense to think of drilling only if liquidity is defensible?

At this point, I wouldn't strictly rely on $50 as a go-no-go decision. I can foresee us possibly picking up a drilling rig at lower prices, given current conditions. Within any drilling program, you have really good wells and others that are moderately good, meaning there's a range of outcomes. Some locations are in areas where we anticipate superior economics compared to what was stated in our investor presentation. Thus, I think it's inappropriate to link our decision to a specific price; it’s more about particular circumstances in the company and our liquidity needs moving forward.

Great. That's helpful. One last clarification on the borrowing base: Was the Delaware basin included in the current borrowing base, or would retaining the asset during the fall redetermination be additive to the collateral base?

The Delaware assets were included in the spring redetermination that took place earlier this year. So yes, these assets will remain as part of the same data set.

Got it. Thanks for your time, guys.

Our next question comes from the line of Noel Parks with Coker & Palmer. You may proceed with your question.

Good morning.

Good morning, Noel.

Did you comment on the rod pump replacement program? Is there a capital plan for that for the rest of the fourth quarter and the first quarter? What's the inventory of remaining replacements you might have?

Yes, we have additional work planned. The rod pump conversion operates differently than many processes; we typically wait for the ESPs to fail before we initiate a rod conversion for maximum runtime. We have also established a reliable failure rate, and I think we're looking at six to eight conversions per quarter as a normal rate for us. On the Northwest shelf, we've already converted about 58% of the wells, indicating we're progressing well. The timing of rolling out these conversions hinges on when we see production drop to levels conducive for rod pumping. Currently, it appears we'll hit those points within the one-year mark, which aligns with our economics in the investor presentation. On the Central Basin platform, we've completed 46% of the wells, aggregating to a total of about 51%. We might have about another 30% to 35% conversions upcoming. Of course, as we drill further, our inventory will increase. Right now, we're estimating that around 35% of the well count remains.

Great, thanks. You mentioned adding additional workover rigs. Can you give us the day rates for those?

They typically run about $125 an hour. To make it easier, if they operate for about eight to ten hours a day, you're looking at $1,250. With a few additional costs included, it comes closer to $1,500 with everything factored in.

What were those costs a year or two ago? Just provide a sense of how much they might have come down?

Back then, they were probably running closer to $200 to $225 an hour.

Oh, wow. That's a significant percentage decrease.

Absolutely, it’s a significant saving.

In exploring different financing alternatives, did you consider terming out your debt as part of a high yield offering to reduce dependence on the credit line?

There were a variety of options we contemplated. When looking back at the sequence of events, this opportunity arose quickly, and we decided it was best to take advantage of it.

Our next question comes from the line of Andrew Bond with Alliance Global Partners. You may proceed with your question.

Good morning, Paul, everyone. Assuming the current price environment persists into next year, what might our maintenance CapEx budget and development plan look like to hold production flat around 9,000 BOE per day? Or might you foresee some modest production decline as you indicated you might hold off on picking up a rig and focus more on lower-hanging opportunities if the current price environment persists?

That's a tough question to answer right now. Yes, it will depend on our liquidity and how we are positioned going forward. We haven't thoroughly discussed our ongoing efforts to reduce costs, which not only includes lease operating expenses in the field but also our G&A. Our team is committed to reducing costs and remaining cost-conscious. We are willing to accept a slight production decline next year. Not significantly, and we believe the nature of our assets will differ from the decline seen by shale producers. During tough times, our preference is to maintain liquidity. Therefore, we are open to spending capital to maintain production, possibly requiring us to pick up a rig. However, we will exhaust our higher-return opportunities before we pick up a drilling rig.

Understood! That’s great insight. Thank you! Congratulations on ongoing free cash flow generation, and we look forward to following your story.

Thank you, Andrew.

Our next question comes from Dun McIntosh with Johnson Rice & Company. You may proceed with your question.

Good morning, Paul.

Good morning.

Could we discuss the opportunities you're seeing to manage production through M&A, whether those are smaller deals or possibly larger corporate transactions? Are you noticing any activity among private equity operators perhaps looking to liquidate?

There's a lot I could cover here, and there's no substitute for cash. Everyone wants cash. However, at this end of the market spectrum, not many people are eager to sell their assets, as they would not achieve the valuations they believe they could obtain under better price conditions. Over the last couple of years, we've seen numerous asset sales that failed to close. Many assets are held by private equity firms or have faced bankruptcy, leading to banks equitizing them. Conversely, larger firms focused elsewhere hold assets that they are not currently investing in. Given all these potential opportunities, we believe starting small is the best approach, building momentum as we acquire properties, and then seeking larger deals. For as long as the price environment remains as it is now, our plan is to steadily capture any available deals and grow the company. Regarding our stock and interest in equity interests, organizations differ; some are receptive to it, while others are strictly cash-focused. This is the reality we are currently dealing with. There also exist other entities in the industry that are looking to invest capital, each with different return requirements. We’re exploring all avenues and opportunities available to us, structuring deals that can attract both capital and assets to grow Ring purposefully. We believe we need to scale up; as it stands, our market cap is too small. My goal is to reach around $2 billion in market cap, but we have a long journey ahead. However, we are optimistic about the opportunities across different groups available to us. The challenge remains structuring deals to bring all parties together to finalize agreements and repeating this success. Did that answer your question, Dun?

Absolutely. Thank you, Paul.

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would like to turn the call back over to Mr. Paul McKinney for closing remarks.

Thank you, Laura. Thank you to everyone participating in this call. We're excited about what the future holds for Ring Energy and our investors, and we are encouraged by your support. This is the end of our conference call. Thanks again.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Have a great rest of your evening.