Ring Energy, Inc. Q3 FY2021 Earnings Call

Good day, and welcome to the Ring Energy Third Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Al Petrie of Investor Relations. Please go ahead, sir.

Thank you, Chuck, and good morning, everyone. We appreciate your interest in Ring Energy. We'll begin our call with comments from Paul McKinney, our Chairman and CEO, who will provide an overview of key matters for the third quarter. We will then turn the call over to Travis Thomas, Ring's Chief Financial Officer, who will review our detailed financial results. Paul will then return to discuss our future plans and outlook before we open the call for questions. Also joining us on the call today and available for the Q&A session are, Alex Dyes, Executive Vice President of Engineering and Corporate Strategy; Marinos Baghdati, Executive Vice President of Operations; and Steve Brooks, Executive VP of Land, Legal Human Resources and Marketing. During the Q&A session, we ask you to limit your questions to one and a follow-up. You are welcome to reenter the queue later with additional questions. I would also note that we posted a Q3 2021 earnings presentation to our website this morning. During the course of this conference call, the company will be making forward-looking statements within the meaning of Federal Securities Laws. Investors are cautioned that forward-looking statements are not guarantees of future performance and those actual results or developments may differ materially from those projected in the forward-looking statements and the Company can give no assurance that such forward-looking statements will prove to be correct. Ring Energy disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, you should not place undue reliance on forward-looking statements. These and other risks are described in yesterday's press release and in our filings with the SEC. These documents can be found in the Investors section of our website at www.ringenergy.com. Should one or more of these risks materialize or should underlying assumptions prove incorrect, actual results may differ materially. This conference call also includes references to certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable measure under GAAP are contained in our earnings announcement released yesterday. Finally, as a reminder, this conference is being recorded. I would now like to turn the call over to Paul McKinney, our Chairman and CEO.

Thank you, Al. We appreciate everyone joining us today. As you know, our top priority coming into 2021 was to strengthen our balance sheet through debt reduction. Our strategy has been to capitalize on the organic opportunities within our portfolio to maintain our production and liquidity and focus on generating strong cash flows to further pay down debt. We are pleased with our third quarter results, as we once again generated free cash flow and strengthened our financial position by paying down debt, which in turn increased our liquidity. Looking at our results in more detail, we generated adjusted EBITDA of $19.7 million and $2.6 million of free cash flow during the third quarter, while paying down $5.5 million of bank debt. We ended the third quarter with approximately $56 million of liquidity, a 9% increase from the end of the second quarter. During the third quarter of 2021, we sold 758,387 barrels of oil equivalent or 8,243 barrels of oil equivalent per day, which was 4% lower than this year's second quarter sales of 792,551 barrels of oil equivalent or 8,709 barrels of oil equivalent per day. Impacting third quarter sales volumes were certain events, including new well completion activities of the company and an offset operator that temporarily reduced the production from a number of our higher producing wells. I am happy to report that the production from these wells has since recovered to normal levels. Additionally, the company continued to experience lower than anticipated natural gas sales due to certain third-party processing facilities capacity constraints, in both the Central Basin Platform and the Northwest Shelf areas. In the Northwest Shelf, the plant restrictions also reduced oil sales due to higher pressures. Finally, many of the CTRs completed during the third quarter resulted in longer than anticipated downtime while the horizontal sections of the wells were being cleaned out. We performed 10 CTRs, including seven in the Northwest Shelf and three in the Central Basin Platform. Year-to-date through September 30, we have performed a total of 24 CTRs, including 18 in Northwest Shelf and six in the Central Basin Platform. Offsetting the impact of lower sales volumes was higher third quarter prices for both crude oil and natural gas that contributed to an overall 3% increase in revenues over the second quarter. A key highlight of this year's third quarter was the continued success of our 2021 drilling programs. As shared in the past, we have aimed in 2021 to invest in only our highest rate of return drilling opportunities. Our programs have been designed to not only mitigate our production declines but to maximize cash flow as well. During the third quarter, the production from our Phase III drilling program contributed very little to third quarter production volumes, but should allow us to capitalize on the currently strong commodity prices during the fourth quarter. Perhaps more importantly, though, and assuming these strong commodity prices continue, the production from our Phase III and Phase IV drilling programs should significantly increase revenue and earnings early next year, as the majority of our lower-priced hedges roll off. With respect to what we accomplished during the third quarter, we utilized two rigs to successfully execute our Phase III drilling program of four wells, including two 1-mile lateral wells in Northwest Shelf and two 1.5-mile lateral wells in the Central Basin platform with all four wells at 100% working interest. Consistent with the success of our Phase I and Phase II programs in the first half of this year, all of the Phase III wells were drilled and completed on schedule and within budget. As I indicated earlier, the wells were placed online late in the third quarter between September 9 and September 18. So the production from these wells had a very minor impact on our third quarter sales volumes. However, we have been very pleased with the production results from these wells to date, since they are meeting or exceeding our pre-drill expectations. Success of our 2021 drilling programs and the continued improvement in crude oil prices encouraged us to commence our Phase IV drilling program of two wells, including one 1-mile lateral in the Northwest Shelf area with approximately a 75% working interest and a 1.5-mile lateral well in the Central Basin platform with 100% working interest. The Northwest Shelf 1-mile lateral was placed on production at the end of October and is currently exceeding expectations. The Central Basin platform 1.5-mile lateral well was successfully drilled in October and is waiting completion and is expected to be placed on production before year-end. While the production from these wells will not have a big impact on our 2021 production, it should provide a nice increase as we enter 2022. With that, I will turn the call over to Travis Thomas to discuss our financials in more detail. I will then come back and make a few closing comments.

Thanks, Paul. For the third quarter of 2021, we generated revenue of $49.4 million and net income of $14.2 million, or $0.12 per diluted share. Excluding the estimated after-tax impact of pre-tax items, including an $8.2 million non-cash unrealized gain on hedges and approximately $800,000 for share-based compensation expense, our adjusted net income was $6.8 million or $0.07 per share. During the third quarter of 2021, we had approximately $16.3 million in cash flow from operations and $13.7 million in capital expenditures. The combined result was positive free cash flow of $2.6 million. For the three months ended September 30, 2021, we had oil sales of 659,247 barrels and natural gas sales of 594,841 Mcf for a total of 758,387 BOE. Our third quarter of 2021 realized pricing was $69.61 per barrel of oil and $5.86 per Mcf of natural gas, for an average of $65.11 per BOE. The differential between our average oil price received in the NYMEX WTI was a negative $1.05 per barrel for the third quarter of 2021 versus our second quarter average differential of negative $0.99 per barrel. Our average natural gas differential from Henry Hub was a positive $1.43 per Mcf for the third quarter versus a second quarter positive difference of $1.07 per Mcf. For more detailed discussions of our financials and other income statement line items, please refer to our earnings release and 10-Q that was filed with the SEC yesterday. Of course, I will be happy to answer any questions you may have during today's Q&A session. As Paul discussed, during the third quarter, we were pleased to report another period in which we generated free cash flow, further paid down debt and increased our liquidity position. We will continue to use much of our free cash flow to reduce our debt position with the level of free cash flow and cadence of debt pay-down primarily driven by the timing of capital spending and market conditions. As of September 30, 2021, we had $295 million drawn on our revolving line of credit and liquidity of $56.2 million, including $2 million in cash and $54.2 million available on the revolver, which included a reduction of $800,000 for letters of credit. We paid down our revolver by $5.5 million in the third quarter and a total of $18 million in the first nine months of 2021. Turning to our outlook for the remainder of the year, we expect fourth quarter sales of 8,800 to 9,200 Boes per day, including 7,500 to 7,900 barrels of oil per day. Mentioned in the release, our estimated company net production in October averaged over 9,000 Boe per day. With the addition of two Phase IV wells coming online in the fourth quarter, we are positioning ourselves to capitalize on what we expect to be continued strong oil price environment in 2022. Keep in mind that we have been essentially fully hedged at lower prices for most of 2021. However, based on our current contracts in place starting January 1, 2022, our hedge volumes will drop to 3,129 barrels per day. We anticipate an average lifting cost for the fourth quarter of 2021 of $10.50 to $11.50 per Boe. Lifting costs include lease operating expenses and gathering transportation and processing costs. Turning to our fourth quarter 2021 capital investment program. We expect total capital spending between $11 million to $15 million, with all expenditures funded by cash on hand and cash from operations. In addition to company directed drilling completion activities for the two well Phase IV program, our capital spending outlook includes targeted well re-activations, workovers, infrastructure upgrades, and continuing our successful CTR program in the Northwest Shelf and Central Basin Platform areas. Also included is anticipated spending for lease costs, contractual drilling obligations and non-operated drilling completion and capital workovers. In the updated investor presentation, we will provide a breakout of capital spending. Our third and fourth quarter 2021 capital program was designed to place us in a stronger position as we enter 2022. Regarding our future hedging activities, we believe it is important to protect our future cash flows, capital spending programs, and ability to pay down debt. However, we also want to participate in what we believe will be a rising price environment to the fullest extent possible. We look forward to sharing the details as we execute our opportunistic hedging strategy. So with that, I will turn it back to Paul.

Thank you, Travis. In 2021, we executed on a number of initiatives that put in place new processes designed to improve how we evaluate the technical, operational, financial, and administrative aspects of our business. We hope that you are as pleased as we are with the progress we have made and look forward to further improvements in 2022 and beyond. A clear example of our success has been our targeted drilling program for 2021, and our ongoing efforts to drive increased operational efficiencies in our pursuit of reducing costs and meaningfully strengthening our financial and market position. We are doing this by remaining squarely focused on generating free cash flow and improving our debt-to-EBITDA metrics. We can do this through continued debt reduction, as well as growing our EBITDA. Another key focus for our company is a pursuit of strategic acquisitions, and we are active in the marketplace screening opportunities that we believe could make long-term sense for our stockholders. As we have discussed in the past, any potential acquisition using equity must bring in sufficient production, revenue, and cash flow to improve our leverage ratio, and the transaction metrics will need to be accretive to our existing stockholders. As you recall, we launched a sales process during the second quarter of 2021 to sell our Delaware assets. I had hoped by now, we would have been able to share with you the terms of the sale of those assets, but that sales process is still underway. We continue to be in discussions with several interested parties and will provide further updates as definitive information is known. Before I wrap up this call and turn it over for questions, I'd like to share what we are doing with respect to ESG. We are putting the final touches on our initial sustainability report, which we look forward to publishing before year-end. With respect to 2022, we are actively working on our capital budget for next year. And although our Board of Directors has not approved these plans, we intend to maintain a single rig working for most of the year. The opportunities we have in the Northwest Shelf and Central Basin Platform should lead to meaningful production growth, allowing us to take advantage of the stronger commodity prices, increased revenue, earnings, and improve our balance sheet. In closing, we believe these are very exciting times for Ring. The steps we have taken over the last 12 months position us very well for 2022, and we look forward to sharing our drilling plans for the next year in the coming months. We appreciate the continued support from our stockholders and look forward to keeping everyone apprised of our ongoing progress. And with that, I will turn it back over to Chuck for questions.

Thank you. We will now begin the question-and-answer session. And the first question will come from Jeffrey Campbell with Alliance Global Partners. Please go ahead.

Good morning.

Hey, good morning, Jeff.

The press release indicated that there was upside based upon positive results from your two Phase II – Phase III, excuse me, Central Basin Platform wells. And these were the first new wells that were drilled in the area in two years. Can you qualify the elements contributing to this upside? I think some color here would be interesting.

I'm going to turn that over to Marinos Baghdati to answer that question. But I got to tell you we are very pleased with the results of all four of our wells. They're all doing very well. So Marinos, do you want to answer the question specifically about the Central Basin Platform?

Sure. We have not drilled a well there since 2019, as you mentioned Jeff. And with these two wells and the results we're seeing, we've made a few changes to the completion practices, a few tweaks to the completion of the wells. And based on the results and current oil pricing, we're encouraged that we'll be able to continue drilling in the CBP area in the coming years.

I think it does. I mean I'll just add that when we first evaluated what had been done in the past, we quickly came to realize that a lot of the drilling in the Central Basin Platform is very geologically based. And so we put a lot of time into evaluating the geology of the locations that we picked. And then at the same time we did a complete review of all the completion technology like Marinos stated. And we decided to make some tweaks and the results of that have been very positive. And so what you're going to find going into next year is that we have a handful of wells we're going to continue drilling down there, applying what we've learned this year and hopefully continuing to improve the results. But right now we're very happy with the results and they're very, very strong economically.

This is Alex. I'd like to add one more thing. The other thing that's contributing to the success of the CBP well so far is we've gone back and geosteered all the wells prior and we're really focused on the landing zone. So it's another key contributor to our success so far in the CBP. So we're very optimistic about what the future holds there.

Okay. That was very helpful. It sounds like when we kind of pull all that together it's better targeting better drilling better completion. You noted that two rigs were released after the Phase III program. Was there one rig involved in Phase IV? Has it been released? And if so when do you anticipate resumption of drilling?

Yes. We actually drilled each of the wells with a different rig. Both rigs have been released. And that was due to several issues. But I think it was a top drive issue, wasn't it? We were originally going to do it with one rig but we decided to pick up another rig because of the challenges we had with the top drive on the first well drilled.

Okay. Do you have any idea when you will resume drilling? I assume you are not actively drilling at the moment.

Correct Jeff. We finished drilling the CBP well on October 17th. That's when we released the rig. And we have actually two rigs that we're evaluating now for our 2022 program. And if we decide to drill any more wells towards the end of this year we'll be able to pick that rig up — one of those two rigs up. They're available. And we feel comfortable with the rig situation as it stands today.

One of the things that is impacting our plans, just to let you know this is a little bit more color than perhaps you asked for but sourcing all the materials to drill our wells is an issue. We're seeing supply chain issues affect our drilling program. And so before we pick up a rig we're trying to ensure that we will not have delays associated with those type of problems. And so we're securing everything we can prior to picking up the rig. And once we get it going we hope to keep it going for the rest of the year or most of the rest of the year.

Yeah. That was very helpful. I appreciate that extra insight. I'll get back in the queue. Thanks.

Thank you, Jeff.

The next question will come from Neal Dingmann with Truist Securities. Please go ahead.

Good morning Paul and Marinos. Paul, my question is when you look at your efficiency on both the rig side and the completion side, I know you don't have full guidance for next year. However, is it fair to say that the plan might still be to focus on a maintenance capital program? I'm curious about your approach to free cash flow and debt reduction. Do you think the best strategy moving forward is to maintain a capital life activity program like others, or is there a possibility to increase activity given the returns from your wells? I'm not asking for specific guidance for next year, but more about your overall plan if you can share.

No, Neal, that's a really good question. This brings us back to discussions we've had in previous calls. I have mentioned that we will continue with this strategy. As we improve our leverage metrics, we will gradually shift the allocation of our capital more towards growth. Looking ahead, especially at the beginning of next year, most of our lower price hedges will roll off. We are positioning ourselves with the capital spending in the latter part of this year to increase our production, allowing us to boost revenue and cash flow next year. With our metrics improving due to that additional EBITDA, we will allocate more funds towards growth. Next year won’t see an abrupt change; rather, it will be a gradual shift where we will slowly start to increase our focus on growth.

Got you. Regarding your thoughts, I know you've already mostly hedged for next year. Some people have adjusted their hedges a bit to take advantage of the upside. I'm not sure if you can share any insights on that or your views on point hedging further out.

Well like Travis mentioned in his portion of the call we're going to have a little over 3,100 barrels a day of lower-priced hedges that we'll carry into next year. Right now, it's our belief that our shareholders are investing those because they really do believe in the upside in energy prices. And so, we are going to try to structure our defensive position so that we can take full advantage of the prices as we go forward into next year. And so our hedging strategy right now is clearly focused. We will always have a hedging strategy that puts in the protections necessary so we can continue to pay down debt, so we can protect our capital program, but we're going to structure it such that we can take full advantage of the prices as they continue to remain strong.

Okay. Thanks Paul.

Yeah. Thank you, Neal.

The next question will come from Noel Parks with Tuohy Brothers. Please go ahead.

Hi. Good morning.

Good morning, Noel.

I apologize if you've already addressed this, but could you please discuss the G&A trend for the quarter? Is it up sequentially? I believe it has been for the last couple of quarters, and I also know that our overall re-trend has dipped over the past three quarters. Can you elaborate on that? Thank you.

Yes, I will. When I joined the company, we had a relatively small staff, and we have been working hard to keep our general and administrative costs low. However, we have started to expand our engineering, land, operations, and financial teams to the right levels needed to manage the business. Recently, we have added a few more employees, which will lead to a slight increase in G&A. Regarding lease operating expenses, we are implementing multiple initiatives. The advantages of our cost reduction program don't happen all at once, but we are seeing good progress in lowering our LOE despite rising costs due to supply chain challenges and inflation. I was surprised to see how inflation rates vary outside the oilfield, and our field experiences indicate significant price increases, especially for steel. These price hikes impact cementing and other services we use to repair and maintain our wells, leading to higher operating costs. However, we believe there are still initiatives that can help us reduce expenses further. Those savings might be offset by rising costs, but it's too early to determine the extent of that impact due to the current inflation and supply chain challenges.

Great. Thanks for the explanation. And one thing to just talk on the M&A front. I was curious to hear about maybe what the potential buyers of the Delaware Basin are taking. I'm just wondering if sort of like the prior process if their access to financing was among the things sort of slowing that process down. And then if you could expand that out probably just maybe talk on the seller side of M&A in the region. So what is the psychology these days bid-ask spread is that the issue? We were seeing higher, but somewhat more stable trading range of increased prices for instance?

We continue to see strong interest in the Delaware Basin. The properties would likely have sold faster if we had deeper pricing. However, the main challenge we're facing is that potential buyers seem to be struggling to secure the financing needed to close the deal. Last year, we faced similar issues and we don't want to repeat that. We've invested time in working with these potential buyers to better understand their financing situations, but it appears they are encountering difficulties. Smaller transactions seem to be more challenging for banks compared to larger deals. We're still in discussions, but we want to avoid the issues we experienced last year. There's often a gap in expectations between buyers and sellers, but we are seeing transactions occur. In deals where we participated but weren't successful, we realized we were in the right price range. Our primary challenge has been our balance sheet, and we remain committed to improving it through acquisitions that enhance our leverage ratio. We would need to leverage equity to achieve this. I’ve made a commitment to shareholders that any transaction will be beneficial to them in terms of cash flow and production per share. If we had the necessary cash, we could have likely been more successful this year. Many often seek a disproportionate equity share, but I’m focused on the strategy that aligns with shareholder interests. I will not forget my promise that any deal must be accretive. We have the ability to pay down debt and strengthen our balance sheet with our current assets, and while I would like to accelerate that process, I will not compromise our strategy to do so.

Great. Thanks for that.

The next question will come from John White with Roth Capital. Please go ahead.

Good morning, everybody.

Good morning, John.

Yes. Paul thanks for that detailed commentary on the Delaware asset sale. You were very frank, and I appreciate it. Switching to the topic of you making an acquisition I think everybody is aware there's probably more private companies in the Horizontal San Andres than there are public companies. So I would guess that gives you a lot of targets to work on. And I'm wondering, are you looking at opportunities outside of the Horizontal San Andres Play in other parts of the Permian Basin?

Yes, we are. We do like the San Andres Horizontal Oil Play and we're also looking at opportunities to acquire more interest in that play. But as you know that play also extends down into the Central Basin Platform where we've drilled a couple of wells already this year and are very successful. But we really like the Central Basin Platform area, in the southern part of the Northwest Shelf primarily because we operate there. We've got a really strong operating team and I'd love to be able to spread the cost of that team, over more wells and more barrels of production just to capture those synergies. But we have also seen some other opportunities outside of that area that are very appealing. And so, my primary pursuit is finding opportunity to generate the returns that I know that are competitive and comparable to the ones that I have in-house. I just don't want to dilute my existing portfolio of properties by buying properties that have super high operating costs or don't have the same type of economics, because I want to allocate capital to them. And so I'm trying to keep a really good and attractive portfolio of high margin, low decline and profitable assets. We like where we are. We're going to continue to focus there. But there are other assets that are just slightly outside of that Central Basin Platform and the southern shelf that are appealing as well. I can't promise you one way or another, but we are focusing primarily in the Permian Basin. We haven't really evaluated anything outside of the Permian Basin right now, but there are some opportunities even outside of there. But I think we're going to continue to focus on the Permian Basin just simply because we know it, we're working there, we're very effective and cost-effective there. Does that answer your question, John?

Yes. Thank you for that. And appreciate the detail and good luck on the fourth quarter drilling efforts.

Thank you.

Our next question will come from Jeffrey Campbell with Alliance Global Partners. Please proceed.

Hi. Thanks for taking my additional questions. I got two more. My first one is does your fourth quarter 2021 guidance anticipate contingent struggles with the third party processing to recover nameplate capacity and what's your full view on this issue going into 2022.

Yeah. I'm going to partially answer that, but I'm going to turn it over to Marinos as well. Yeah, we struggle with what's going on primarily in the Central Basin platform. The operator of those facilities continues to tell us that they're going to have things up and running. We'll be up and running for a few days or maybe five days or a week and then all of a sudden we're down again. And so we're really struggling with. And I don't think we're the only operator. I think most of the operators out there in the Central Basin Platform that sell our gas for this particular gathering system have struggled with the same issues. And so I'm tired of making promises as to when that's going to come online. And we began this year in the original guidance, we had we assumed that after the winter storm that all of that would be restored. And it turned out that a lot of that equipment was older, rotating equipment that was challenging to repair and is proven to still be that way to this day. Marinos, is there any more color you want to add to that?

No sir. Well, actually yes, there's a couple of things. We are working discussing with other parties alternatives for taking our gas in certain areas. And in addition to that we are making efforts we've been installing compressors in certain areas that have allowed us to increase our gas sales quite a bit, and we're going to continue to do that to kind of mitigate the problem while we navigate through this.

Okay, that was helpful. Let me repeat one part of it again. Is the expectation of ongoing challenges already reflected in the guidance you provided for the fourth quarter?

Yes, they are.

Okay, great. Thank you. And my last question was, do you have any particular expectations regarding your ongoing next bank redetermination?

We are in the final stages of that process and are happy with the results so far. I prefer not to make any comments until the banks finalize their decisions. Currently, the outlook is very positive. If you recall from the spring redetermination, the banks did not require any additional hedging, and it seems we are heading in that direction again. Therefore, liquidity remains strong, and we expect it will at least remain steady.

I'd like to add one thing. This is Alex Dyes. On the RBL, the price decks have come out and they are higher than the spring.

That's right.

We're working with our banks to fully finish the redetermination and it should be out hopefully in the next month or so.

Yeah.

Yeah. I think that was helpful. And again congratulations on the quarter.

Hey, thank you very much. We're really excited about the quarter. I know the production was lower than we had anticipated. But if you look at how we position this company for next year, we're looking at a really strong first quarter as we springboard out of the fourth quarter of this year.

As there are no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Paul McKinney Chairman and CEO for any closing remarks. Please go ahead.

Yeah, thank you everybody for joining us today. I'd like to remind you that we have a special Stockholders Meeting coming up next week. And so, we look forward to everybody voting. So with that, I'll end this meeting and thank you again for your interest and support in Ring Energy.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.