Ring Energy, Inc. Q3 FY2022 Earnings Call

Good morning, and welcome to the Ring Energy's Third Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Al Petrie with Investor Relations. Please go ahead.

Thank you, Operator, and good morning, everyone. We'll begin our call with comments from Paul McKinney, our Chairman of the Board and CEO, who will provide an overview of key matters for the quarter. We will then turn the call over to Travis Thomas, Ring's Chief Financial Officer, who will review our 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 VP of Engineering and Corporate Strategy; Marinos Baghdati, Executive VP of Operations; and Steve Brooks, Executive VP of Land, Legal, Human Resources and Marketing. I'd also note that, we have posted a Q3 2022 earnings corporate presentation to our website. 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 intentions or obligations 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 Securities and Exchange Commission. These documents can be found in the Investors section of our website. Should one or more of these risks materialize or should underlying assumptions prove incorrect, actual results may vary materially. This conference call can also include 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 release issued yesterday. Finally, as a reminder, this conference call is being recorded. I'd like to now turn the call over to Paul McKinney, our Chairman and CEO.

Thanks, Al. Welcome everyone, and thank you for your interest in Ring Energy. We appreciate you joining us today to discuss our recent results and outlook for the rest of the year. The third quarter marks a transformational period for our company and our shareholders as we announced and completed the acquisition of Stronghold Energy's assets. As you know, these operations are focused on the development of 37,000 net acres in the Permian Basin’s Central Basin platform where we also conduct operations. As a reminder, we closed the acquisition on August 31, so the third quarter only reflected one month of Stronghold operations. This bodes well for the fourth quarter during which we will record three full months of results with the Stronghold assets, which should set us up for a strong finish to the year. We were extremely pleased with our third quarter results, which is a direct reflection of our ability to execute on our value-focused proven strategy. In addition to the acquisition of the Stronghold assets, our third quarter benefited from the continued strong performance of our legacy drilling, completion, recompletion and capital workover programs, as well as our ongoing focus on operating cost control. While pricing did pull back some from the levels experienced during the second quarter, overall, they were still strong and we continued to benefit. The combined result was record quarterly production, revenue, net income, and adjusted EBITDA. We also posted another quarter of free cash generation, our 12th consecutive quarter, and were pleased to pay down $17 million of debt since we closed the acquisition on August 31. Our posted sales volumes for the quarter were 13,278 barrels of oil equivalent per day, which was 42% higher than the second quarter. As I said earlier, primarily driving the increase was the addition of one month of sales volumes from the Stronghold assets as well as a continued success of our 2022 drilling completion, recompletion and capital workover programs. With respect to the fourth quarter, we stand by our previously released guidance and expect sales volumes to be between 18,000 and 19,000 barrels of oil equivalent per day due to the three full months of production from the Stronghold assets. Looking specifically at our drilling program, during the third quarter we drilled eight horizontal wells, including five in the Northwest shelf and three in the Central Basin platform, thereby bringing the total number of horizontal wells drilled during the first nine months of the year to 23. During the third quarter, we completed nine horizontal wells, including four wells that were drilled in the second quarter and five wells drilled in the third quarter, bringing the total number of horizontal wells completed and placed on production year to date to 20. We are very pleased with the results from our Northwest shelf and Central Basin platform horizontal wells, and attribute our success to remaining focused on the geology, selecting the best landing zones and improving our completion methods. We also believe that remaining focused on these technologies will bode well in our future drilling and completion activities in the newly acquired Stronghold properties. With respect to the other activity completed during the third quarter, we recompleted three wells on the Stronghold acquisition acreage and converted six horizontal wells with ESPs to rod pumps, something we call CTRs. Five of the CTRs were in the Northwest shelf and one was on our legacy CBP acreage. As many of you know, our CTR program has been a significant contributor to reducing our total cost of operations. At this point, we have converted the majority of our inventory of CTR candidates and moving forward, we'll be performing fewer CTRs. With respect to capital spending, excluding our investment for the Stronghold transaction, we spent $40.3 million during the third quarter compared to $41.8 million during the second quarter. We continue to efficiently execute on our drilling and completion program that is designed to drive additional efficiencies and increase production rates. For the fourth quarter, we expect to spend $42 million to $46 million, which includes a drilling of four horizontal wells on our legacy acreage and 4 to 5 vertical wells on our Stronghold acreage. We expect to complete and place on production seven horizontal wells and two to three vertical wells. The combined results of our efforts to date have been free cash flow generation that was used to reduce our debt and further strengthen our balance sheet. We ended the third quarter with a leverage ratio of 1.4x, which was 33% lower than the 2.1x at the end of the second quarter, and 60% lower than the 3.5x leverage ratio we had at the beginning of the year, exceeding expectations we set for ourselves. As you know, the borrowing base of our credit facility was increased more than 70% to $600 million due to the acquisition and continued strength of our legacy business. And after paying down $17 million in debt, we ended the quarter with more than $165 million of liquidity, which places us in a strong position as we finish the year and make plans for 2023. So with that, I will turn it over to Travis to discuss our financial results in more detail. Travis?

Thanks Paul, and good morning, everyone. We appreciate your participation on today's call and interest in Ring Energy. As in the past, my comments today will primarily focus on our financial position and sequential quarterly results. For detailed discussion concerning comparisons to last year's third quarter, please see our press release and 10-Q filed yesterday with the SEC. As Paul discussed, our third quarter results were positively impacted by the Stronghold acquisition which closed on August 31st, as well as the continued strong performance of our targeted 2022 development campaign and ongoing efforts to drive further operational efficiencies in the business. With that backdrop, during the third quarter of 2022, we sold 933,000 barrels of oil, 953,000 Mcf natural gas, and 130,000 barrels of NGLs for a total of 1.2 million BOE. This is compared to sales of 729,000 barrels of oil and 723,000 Mcf of natural gas for a total of 850,000 BOEs for the second quarter of 2022. As a result of the Stronghold transaction, beginning July 1st, 2022, we began reporting revenues on a 3 stream basis, separately reporting crude oil, natural gas, and NGL sales. For periods prior to July 1st, 2022, sales and reserve volumes, prices and revenues for NGLs were included in natural gas. Third quarter realized pricing was $92.64 per barrel of crude oil, $4.89 per Mcf of natural gas and $25.68 per barrel of NGLs, or $77.28 per BOE. During the second quarter, we had realized pricing of $109.24 per barrel and $7.29 per Mcf or $99.95 per BOE. Our third quarter average oil price differential from NYMEX WTI was a positive $2.28 per barrel versus a positive $0.81 per barrel for the second quarter of 2022. This difference is mostly attributed to the Argus WTI, WTS, which averaged a positive $0.96 in the third quarter compared to a negative $0.46 in the second, and the Argus CMA role, which averaged $2.90 per barrel in the third quarter and $2.60 per barrel in the second quarter. Our average natural gas differential from Henry Hub for the third quarter was a negative $3.15 per Mcf, compared to a negative differential of $0.23 per Mcf for the second quarter. Our realized NGL averaged 29% of WTI. Contributing to the difference was the two stream to three stream conversion as well as the gathering, transportation and processing or GTP costs netted from the revenue starting in May of 2022. The combined result was record quarterly revenues of $94.4 million that were 11% higher than the second quarter revenues of $85 million. Looking at the more significant expense line items on the income statement, LOE was $13 million or $10.67 per BOE compared to $8.3 million or $9.77 per BOE for the second quarter. Higher production on our legacy assets combined with the additional production from the acquired assets primarily contributed to the increase in overall LOE. Higher labor cost and industry-wide inflationary pressures also contributed to the increase and resulted in higher LOE per BOE. We did not record any GTP costs in the third quarter. As we discussed in our second quarter earnings call, due to a contractual change effective May 1st, we no longer maintain ownership and control of natural gas through processing. GTP costs are now reflected as a reduction to the natural gas sales price and not as an expense line item. As such, for modeling purposes, the gas price deduct should be used in lieu of the GTP expense. Production taxes were $4.6 million versus $4.2 million in the second quarter, with the tax rate remaining steady at a little less than 5%. DD&A was $14.3 million compared to $10.7 million for the second quarter. On a BOE basis, DD&A decreased from $12.65 in the second quarter to $11.73 for the third quarter. Cash G&A, which excludes share-based compensation, was $5.9 million versus $3.9 million for the second quarter of 2022, with $4.79 and $4.63, respectively, on a per BOE basis. Included in the third quarter G&A was $1.1 million of transaction cost. Interest expense was $7 million versus $3.3 million for the second quarter with the increase substantially due to a higher average daily balance in long-term debt associated with the additional borrowings on our new revolving credit facility at the closing of the Stronghold transaction on August 31, 2022. Also contributing to the increase were higher interest rates and the write-off of the unamortized deferred financing costs related to the exiting lenders. During the third quarter, we posted net income of $75.1 million or $0.49 per diluted share. Excluding the after-tax impact of pre-tax items, including $47.7 million for non-cash unrealized gain on hedges and $1.5 million for share-based compensation expense and $1.1 million of transaction cost for the Stronghold acquisition, our third quarter adjusted net income was $32.5 million or $0.28 per share. This is compared to the second quarter 2022 net income of $41.9 million or $0.32 per diluted share. Excluding the estimated after-tax impact of pretax items, including $12.2 million for non-cash unrealized gain on hedges and $1.9 million for share-based compensation expense, our second quarter adjusted net income was $31.3 million or $0.29 per share. As of September 30, we had $435 million drawn on our revolving credit facility. As Paul discussed, the borrowing base on our credit facility was increased more than 70% to $600 million upon the closing of the transaction. We owe a special thank you to our banks, especially the underwriters who made this increase possible. As a result, we ended the quarter with $165.1 million in liquidity, including $900,000 in cash and $164.2 million available in the revolver, which reflects a reduction of $800,000 for letters of credit. We are pleased to pay down the facility by an additional $17 million subsequent to the closing of the transaction on August 31, and we look forward to further debt reduction moving forward based on the timing of our capital spending and overall market conditions. Looking at our share count, during the third quarter we had a total of 3 million of our common warrants exercised at a price of $0.80 per warrant. Accordingly, our third quarter results reflect the issuance of 3 million shares of common and a receipt of 2.4 million in cash. There are currently approximately 20 million common warrants that remain unexercised. In addition, as part of the consideration for the Stronghold acquisition, we issued approximately 21.3 million shares of common stock and 153,176 shares of convertible preferred stock to the owners of the Stronghold assets. This is the primary driver of the variance in our average basic and diluted shares outstanding count for the third quarter. The convertible preferred stock was converted into approximately 42.5 million shares of common stock following the approval of the conversion by a stockholder vote on October 27. As a result, we currently have approximately 174.4 million common shares outstanding. Turning to the outlook. For the fourth quarter of 2022, we continue to expect sales volumes of 18,000 to 19,000 BOEs per day with the midpoint of our guidance representing a 39% increase from the third quarter. This reflects a full quarter of production from the acquired Stronghold assets and the benefit of the continuous drilling program we initiated in late January. As Paul discussed, we anticipate fourth quarter capital expenditures of $42 million to $46 million, which is approximately 15% lower than our prior estimate. Our spending outlook includes completing and placing online the remaining three wells drilled in the third quarter. Drilling and completing eight to nine wells, including four horizontal wells, including two in the Northwest shelf and two in the Central Basin Platform North and four to five vertical wells in CBP South. We also expect to recomplete 8 to 12 wells in the central basin platform south. For the fourth quarter LOE, we are targeting a range of $10.25 to $11.40 per BOE. In terms of the 2023 calendar year, we are reiterating our outlook of a plan to maintain or slightly grow 2023 full-year average sales volumes compared to the anticipated fourth quarter ‘22 sales volumes. Capital expenditures of $150 million to $175 million that include a balanced capital efficient combination of drilling horizontal wells on legacy assets and vertical wells on the recently acquired CBP South assets, as well as performing recompletions and CTRs. I would note that all projects and estimates are based on assumed WTI oil prices of $75 to $90 per barrel in Henry Hub natural gas prices of $5 to $6 per Mcf. If prices were to pull back materially, we have the flexibility to reduce capital spending as necessary. As we discussed on our last call, in late June, we began to add to our hedge position to secure strong pricing levels in support of our acquisition of Stronghold CBP assets, and we continued to opportunistically add more hedges throughout the third quarter. Our expanded RBL requires us to hedge 50% of our PDP production on a rolling 24 month basis. We're also looking forward to the roll-off of the remaining low-price hedges we put on during COVID. I will now turn it back to Paul for his closing comments before we answer questions.

Thank you, Travis. As I said at the beginning of the call, the third quarter represents the beginning of a truly transformational period for our company and our shareholders. As we are now in a much stronger financial position with the flexibility to react to changes in the marketplace and take advantage of opportunities that may appear. During 2023, we plan to target our capital spending program on maintaining or slightly growing our production and use our excess cash from operations to reduce debt, because we believe our absolute debt levels justify our continuing focus in this regard. If we enjoy sustained higher oil and natural gas prices than what we are experiencing today, the company will have the flexibility to pursue the available opportunities that maximize long-term shareholder value, whether that be accelerating debt reduction, expanding our development program to organically grow production, further pursue targeted acquisitions or return capital to the shareholders. In closing, I want to thank our workforce for their tireless efforts and dedication. As important though, I also want to thank our shareholders for their continued support as we further position Ring for long-term success and value creation. With that, I will turn the call back to the operator, and we look forward to answering your questions.

Today will be from Jeffrey Campbell from Alliance Global Partners.

Congratulations on the strong quarter. Paul, I first wanted to ask about the new drilling production data on Slide 18 with the Stronghold new drilling data. Looks like the expectation is somewhat more positive for new drilling in target area one versus target area two. I was wondering if you could compare these two areas based on their relative size using whatever measurement you want to? And can you indicate whether target area one will be drilled preferentially over target area two in 2023?

Yes, I'm going to give a first stab at that, but then I'll turn it over to some of my guys to give more color. We've got several things that we'll be juggling, and we've talked about this in the past. When we made allocation decisions on our legacy acreage, we moved the rig and allowed our production to maximize the utility of the existing infrastructure. We would drill until we filled, for example, the saltwater disposal systems in the Northwest Shelf and then we'd move down to the Central Basin Platform drill wells until we fill that up. And by that time, we'd go back up and the wells would decline, and that's where we had more rooms where we could drill again in the North. The same thing will happen in our southern acreage as well. We have a couple of areas that have very strong economics with respect to the new wells that we plan to drill. We have infrastructure limitations, whether it be saltwater disposal or electricity. You'll find that we will be moving our rigs back and forth basically to minimize the non-performing capital. Like, we don't want to drill so much that it forces us to drill additional saltwater disposal wells, for example. That's just kind of how the program will go forward. It's all a function of maximizing the value of the existing infrastructure that we have. But again, we will be targeting the highest rates of returns. The next well drilled will always be at the top of the next best things list, if you want to call it that. That's my take on it. I would love to turn this over to Marinos and have him explain a little bit more.

Paul, you hit it perfectly. Yes, it's all about the infrastructure in target area one versus two in the southern assets. We have a couple of bottlenecks that we are working through right now. Once we get those resolved, we will be able to pivot at a moment's notice so that we don't have to spend the non-performing capital like Paul mentioned.

That was really excellent color. I appreciate that. We have had a period of very supportive commodity prices for some time, yet the shallow Delaware Basin assets remain unsold. I was just wondering if the completion improvements that you have had in your horizontal programs or maybe lessons that you will learn or still be learned in the Stronghold completions might make it worth giving the Delaware Basin assets another look at some point.

That's a good question as well. This isn't the first time we have heard similar type questions. We do have undeveloped opportunities out there in the Delaware Basin, and they are economic at today's prices. When you look at it from my perspective, my responsibility is to allocate capital where I can get the best returns for my shareholders. Right now, those investment opportunities in the Delaware Basin just don't stack up against any of the opportunities that I have in the Northwest Shelf, either in our northern or southern areas of the Central Basin Platform. It's challenging for me to allocate capital there. We've mentioned in the past that this is truly a non-core area for us, much shallower production, much lower cost, the returns are still economic, but they just don't stack up. That's really in a nutshell. We just can't find ourselves allocating capital to something where we have a better place to invest.

Is there anything further left to do to try to affect the sale of the assets since they don't compete in your portfolio?

Yes, actually there are. We continue to work with parties that have expressed interest, and we believe they will be successful. However, whether we are successful with these ongoing discussions and expressions of interest drives up, we might find ourselves somewhat in auction. There is no telling what we'll do. Again, it is not an area of focus for us because we have our sights set elsewhere.

Jeff, this is Alex. I just wanted to echo Paul's comments here on the Delaware. Yes, we could apply some of the lessons learned from our CBP and Northwest Shelf assets to that asset, but one big thing that distinguishes that asset is it is shallower and located in a place where you're competing with a bigger guy, the bigger players. So, just competing for that equipment and services there versus our assets in the CBP and Northwest Shelf, those economics just keep proving to be superior. This is another reason why we still just focus on our assets.

Could you guys talk about the refrac opportunities and where you said in infrastructure?

I'll take that one. There's multiple areas on the vertical assets and some of them have some electrical constraints that we're navigating through. Our partners there which provides the electricity are going through some changes to the transmission lines and the substations. They anticipate these bottlenecks to be resolved by the middle of 2023. So that'll open up things that we can do. We're also looking at freshwater supply on one of our areas, the target area one that has better production results. Once we get these resolved, it will allow us to be more active in that area compared to the other area. Basically, what we've provided for guidance is given the information that we have right now. If we update, we can improve on what we've provided so far. Also, Alex has something to add.

Yeah, Neal, I'd like to add one more thing. We have a variety of investment types. We have drilling both in Northwest Shelf and CBP, both horizontal and vertical. These recompletions, to Marinos's point, there's certain things the ops team is working through, but you're going to see that in our program, allowing us to sprinkle a few of these projects every month, depending on where that is. We've added a new slide on page 18 providing insight into that performance and investment type.

Returning to your question, Neil, regarding refracs, there is an opportunity for refracs out here. But we have infrastructure limitations, particularly fresh water limitations associated with having the water to frac. We will be testing and trying some ideas out there this year. As those ideas generate results, we'll have more to discuss as we go into 2023, which we find exciting.

Paul, can you talk about the rates or the performance of the recompletions that you performed on the Stronghold assets in the quarter? And also, as you talk about allocating capital amongst the highest return assets, can you provide a little detail or ranking of where the Northwest Shelf and the new Stronghold assets rank in your rate return stack?

Yes, very good question, and we get it quite often. Historically, if you go back and look at our operations on the legacy assets, the Northwest Shelf provided lower breakeven cost and higher rates of return. We decided to try some new ideas in our legacy acreage and the results have been positive. We have one or two wells that we drilled last year that rank with the Northwest Shelf wells. The rates of return and low breakeven costs are very similar between the two areas. The rates of return in the southern part acquired through Stronghold are also very competitive. The added benefit in the South is quicker revenue generation due to how production goes into the tanks. All areas are very competitive, and you can find opportunities in the South that rival those in the Northwest Shelf.

Jeff, let me take that first part of that question about the recompletes since we took over operations on September 1st for the Stronghold acquisition. Slide 18 shows you the historical recompletion well performance of the recent fleets that Stronghold managed before us. Those wells are shown in gray. The blue represents the average of all recompletes done in 2022, which includes those three wells.

Good morning. Just a couple of things. Just as you are a few months in with the Stronghold asset, I wonder if you could just talk a bit about the maintenance status of legacy few wells. And also plant management, permitting things, like that, was it all pretty tight or have you had some cleanup to sort of align it with your own standards and practices?

That's a good question. The assets have been very well taken care of. I'd be proud for a Railroad Commissioner to come out to the locations that Stronghold managed. They did a great job, very conscientious with their locations. There are typically some surprises you encounter with any acquisition. Fortunately, the surprises we've faced so far are typical for an acquisition. We are not completely done integrating records, but everything has gone very smoothly. We'll finish integrating these assets this quarter and by mid-quarter before the holidays, they'll align with our existing management standards. We are very happy with the progress.

Okay, great. And could you talk about the rig cost environment, maybe using sort of worst-case assumptions of water handling being on the more expensive side, materials being on the more expensive side? Where roughly are we talking about for a breakeven for the assets?

That's a complex question. When we look at our existing operations, the breakeven costs are basically our margins. We have very high margins on both the southern properties and all of our legacy acreage. Our breakeven costs are among the lowest in the industry. This comes from our investment strategy of pursuing conventional assets while also developing unconventional resources. We enjoy a diverse portfolio that includes both low-cost drilling opportunities and recompletions, all of which have competitive rates of return. Therefore, this diversity helps create a stable and predictable return for our capital investments. I believe I have answered your question. Is there anything else?

If I can jump in and talk about the services. I didn’t mean to alarm anyone on the electricity or water. We're not facing challenges that others face with our assets. We feel we can resolve these problems, but until we do, we're not banking on it. Our plans are based on available resources right now.

Well, I guess just for perspective, I remember realized oil in the thirties, and call that WTI upper thirties was actually economic doable to move ahead. So I'm thinking with inflation and everything, if we're looking at a $45 WTI, does that still work for all the properties, some of the properties?

You're bringing up very good points. Historically, we needed approximately $45 to maintain activity during COVID, even with breakeven costs at $25. This organization has many costs to bear beyond drilling costs. Given today’s environment and inflation, would we operate at $45? We probably can, but if pressed, I'd estimate $50 would be a more comfortable level now. At $50, we could maintain activity and cover a range of our costs. While we're in a higher cost environment than during COVID, I still believe Ring enjoys a favorable position compared to many in this industry.

Ladies and gentlemen, at this time I'm showing no further questions, so I'd like to turn the conference back over to Paul McKinney for any closing remarks.

Yes. Thank you, Chad. Again, I'd like to thank all of you that joined us today for your time and interest and all of our investors for your trust and investment. We are truly excited about what the rest of this year and 2023 will bring. We believe that 2023 will bring an exciting year for Ring and our stockholders. We look forward to the next time we get to talk about them. In the meantime, everybody take care. Thank you again for your interest in Ring.

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