Riley Exploration Permian, Inc. Q3 FY2022 Earnings Call

Hello and thank you for standing by. My name is Regina and I will be your conference operator today. At this time, I would like to welcome everyone to the Riley Exploration Permian Incorporated Fiscal Third Quarter 2022 Earnings Release and Conference Call. I would now like to turn the conference over to Philip Riley, Chief Financial Officer and Executive Vice President of Strategy. Please go ahead.

Thank you, and good morning, everyone. Welcome to our third quarter 2022 conference call. The company recently changed its fiscal year from September 30 to December 31. Today, we will be covering results for the 3 and 9-month periods ending September 30. We will report the 2022 results in March of 2023. Yesterday, the company published four items that can be found on our website and under the investors section: an earnings release, a 10-Q, and two presentations. One presentation provides an update for third quarter results. The goal here was to provide simple and transparent drivers of performance to be used in conjunction with our other public filings. We may reference a few slides from this on the call today. The second presentation provides an overview of the company’s story with minor updates from previously released versions. Participating on the call today are Bobby Riley, Chairman and CEO; Kevin Riley, President; and myself, Philip Riley, CFO and EVP of Strategy. Today’s conference call contains certain projections and other forward-looking statements within the meaning of the federal securities laws. The statements are subject to risks and uncertainties that may cause actual results to differ materially from those expressed or implied in these statements. We will also reference certain non-GAAP measures. The reconciliations to appropriate GAAP measures can be found in our earnings release for presentations issued yesterday. I’ll now turn the call over to Bobby.

Thank you, Philip. And thank you again to everyone for joining us on today’s call. Yesterday, after the close of the market, we announced the results of our third quarter. This is the first quarter for Riley reporting since we completed our change in fiscal year end from September 30 to December 31. Our rationale behind the change was simply to align better with other EMPs for reporting and analytical comparisons for both investors and analysts. Riley delivered very strong financial and operating results in the third quarter, again being driven by continued organic growth. To highlight a few items for the third quarter, we averaged production of 9,413 barrels per day, which exceeded our high end of guidance and represents an increase of 36% year-over-year compared to the third quarter of 2021 and an increase of 13% quarter-over-quarter compared to the second quarter of 2022. We began full scale water injection on our EOR pilot during the third quarter and commenced CO2 injection on November 1. We generated $51 million of adjusted EBITDAX and $55 million of operating cash flow, representing an increase of 14% and 25% respectively over the prior quarter. We paid dividends of $0.31 per share during the third quarter and have since announced and paid an increased dividend of $0.34 per share during the fourth quarter, representing a 10% increase upon declaration. Riley's strong financial position provides us with the flexibility needed to navigate through both product price volatility and periods of economic uncertainty. This also allows us to patiently seek attractive opportunities to enhance the per share value of the company. I will now turn the call over to Kevin to discuss operational results.

Thank you, Bobby, and good morning to everyone. As Bobby mentioned, we had a great quarter as a result of our low decline production base, in addition to the outperformance of a number of development wells recently brought online. Riley Permian’s average daily oil sales of 9,413 barrels per day for the quarter represents a 13% quarter-over-quarter growth or 36% year-over-year growth compared to the third quarter of 2021. The company averaged total equivalent sales of 12,717 barrels of oil equivalent per day for the same period, which is a 25% quarter-over-quarter increase, or 33% year-over-year growth compared to the third quarter of 2021. The natural gas and NGL volumes increased quarter-over-quarter at a higher rate than oil volumes due to the additions in plant processing capacity by our midstream counterparty. The company also continued its efforts on its development activity during the 3 and 9 months ended September 30, 2022. We brought online 7 gross 4.2 net and 14 gross 10.8 net horizontal wells respectively. Regarding the EOR pilot project in Yoakum County, Texas, as Bobby had previously mentioned, we began full scale water injection in August, and I have since commenced CO2 injection on November 1. Early indications as a result of the water injection appear to have slowed and/or arrested production decline for the three horizontal producers within the EOR pilot. We anticipate a production response from the CO2 injection within 6 to 9 months, so sometime near late spring or the summer of 2023. During the quarter, our average completed lateral length on operated horizontal wells turned to sales was approximately 7,800 feet, representing a 10% increase in average completed lateral length per well, quarter-over-quarter, with drilling and completion costs remaining relatively flat compared to the previous quarter. For similar well designs, our lease operating expenses were $8.8 million, or $7.53 per BOE for the 3 months ended September 30. This came in at the midpoint of guidance but was a 9% increase quarter-over-quarter while being lower than our production growth, both on an oil and oil equivalent basis. I’ll now turn the call back over to Philip Riley to review our financial results.

Thank you, Kevin. Total revenue was $88 million for the third quarter 2022, consistent with the level in the second quarter, driven by higher production volumes but offset by lower pricing. Third quarter 2022 derivative settlement losses were approximately $9 million, which were 34% lower than settlement losses in the second quarter. Combining those two, revenue net of settled hedges was 13% higher quarter-over-quarter. These factors in turn drove a 16% quarter-over-quarter increase in cash flow from operations before changes in working capital from $44 million to $50 million, which you can see visually in the chart on Slide 4 of our third quarter results presentation. If you look at the 9-month period year-to-date, our cash flow from operations before working capital increased 94% year-over-year, from $64 million to $124 million. About 40% of the increase has been due to production volume growth, with the balance due to net price realized, net of hedge settlements. The company was approximately 50% hedged during 2022 with legacy hedges bought during 2020 and 2021. For the next year, we’re about 20% hedged at lower prices. Now I’ll offer some comments on capital allocation referencing Slide 5 in that same presentation. First, we’ve been able to grow volumes materially more than last year while reinvesting a lower amount of cash flow. This is driven by a few factors, including some really strong production from new development wells and a materially improved operating cash flow. The slower reinvestment rate, in turn, has allowed us to reallocate more to dividends and the balance sheet with a third of cash flow from operations before working capital year-to-date, versus 19% last year. Total dividends paid for the 9-month period were up 25% versus last year, and we’ve paid down debt by 25% year-to-date. While investment is up year-over-year, operating cash flow is still outpacing the CapEx increases for a net benefit. This leads to higher free cash flow for the year, about $41 million year-to-date. We acknowledge our company may be producing less free cash flow than some other companies on a relative basis, but this is mostly a function of the higher reinvestment for growth, as many other companies are choosing zero growth, which of course requires significantly less reinvestment. Looking ahead to next year, while we won’t be giving detailed 2023 guidance today, we believe that we can generate low double digit oil production growth with a lower reinvestment rate than 2022. This could be driven by a combination of the tailwind of very strong 2022 growth, improved net price realizations as a result of further hedge roll-off, and lower AOR. I’ll caveat this is conditioned upon roughly $70 or better oil prices, with only modest increases from here on DNC costs and absent additional new venture spending. Final quick comment on the credit facility: we recently completed a regular semiannual borrowing base redetermination and elected to increase the base by $25 million to $225 million total. While we’re largely undrawn, we believe that increased liquidity in a volatile market is beneficial despite the small incremental undrawn fees. Thank you. And I’ll turn it back to Kevin now.

Thank you, Philip. I’ll now give guidance for the company’s activity for the fourth quarter. We forecast accrual basis capital expenditures of between $34 million and $41 million, which excludes amounts for corporate and land acquisitions or other opportunistic investments. We forecast fourth quarter of 2022 oil production to average between 9,400 and 9,900 barrels per day, and total equivalent production to average between 12,600 and 13,200 barrels of oil equivalent per day based on estimates of available gas processing capacity. We anticipate fourth quarter LOE of approximately $9 million to $10.5 million in cash G&A expenses of approximately $4.7 million to $5.2 million. The company additionally anticipates cash income taxes of approximately $3 million to $5 million to be paid during the fourth quarter. I’ll now turn the call over to Bobby for closing remarks.

Thank you, Kevin. And again, thank you to everyone for joining us today for our third quarter call. We remain focused on a disciplined model of low leverage, moderate production growth, and return of capital through dividends to our shareholders. Thank you again for your support. Operator, you may now open it up for questions.

Our first question will come from Neal Dingmann of Truist Securities. Please go ahead.

Good morning, all. Thanks for the time. My first question is on capital allocation specifically. Could you all speak to how you are thinking about per share growth going forward? I’m focused on whether Riley would consider boosting production more next year, which could be achieved by increasing share volumes or even buying back shares to boost share growth, or will the focus remain more on maintenance capital and shareholder return? You obviously seem to have opportunities to do both, and I’m just wondering how you are looking at that.

Yes, Neil, this is Philip, I can take that. We certainly look at per share metrics. We haven’t finalized a budget for next year, but we do plan to grow. The question is how much. We believe our level of growth differentiates us, as very few EMPs are growing at our pace. Based on the midpoint oil production guidance that Kevin just gave for the fourth quarter, frankly, we can hold that flat next year for each of the quarters, and that would imply 10% year-over-year growth. We could grow more; there are crosscurrents for oil price. We’re watching the economic indicators trying to understand how impactful a U.S. and global recession could be and what impact that may have on oil price. On the positive side, we see the lower reinvestment levels by many of the multinationals and even U.S. EMPs. I made comments on the lower reinvestment rate earlier; we can grow while still having a lower reinvestment rate. That would correspond with more capital available for discretionary allocations such as shareholder return. A few more notes on that: we plan to continue paying dividends and anticipate raising that once annually, most likely in the fourth quarter, absent a transformational event. We prefer the steadier pattern versus a variable methodology used by some companies. There’s potential for continued debt paydown, though, admittedly, at certain low levels. We could decide to keep it flat. We are also considering other investments outside of traditional D&C, such as carbon capture activities. There’s potential for shareholder buybacks, but they'd have to be approved by the Board. It’s a topic we have discussed. We’re trying to balance multiple objectives, increasing the float on the one hand while managing private equity overhang and offsetting annual increases due to customary stock-based compensation. Ultimately, those all factor into that per share metric growth that you are talking about, and it's important to us and the Board.

Looking at all of that. And then secondly, just maybe on development activity, I know there has been more focus recently on co-development and other large development strategies. I am just wondering if you could discuss your approach going forward to maximize efficiencies, especially since you are operating a smaller program. It seems you are still achieving good efficiency.

Development strategies have pretty much remained the same, Neal, since we started. We have a nice foothold for holding through development. We are operating through cash flow, trying to maximize efficiencies and utilization of existing infrastructure while holding the field and creating an HBP asset. I don’t anticipate drilling too many parent-child wells or co-development in that sense in the coming year. We continue to look at every opportunity and optimize what we are doing to be efficient. You can see that even through our growth, with the completed lateral quarter-to-quarter seeing a 10% increase. That helps drive costs down as you gain more reservoir for the same well; effectively draining more rock. We’re looking at every option as we continue. Nothing is set in stone, but we’re trying to be as efficient as possible in this volatile landscape.

On infrastructure, if anything, it seems your situation has improved. Are there any constraints that prevent that development strategy? Meaning, do you foresee any infrastructure build-out necessary?

We continue to build small pieces within our infrastructure. We initially invested heavily in infrastructure to establish what we consider to be our foundation when we started in 2015. However, as we branch out and hold more acreage, we’re laying down small lines for water gathering, oil, gas, or power distribution. We are exploring opportunistic ways to increase efficiency and strive for self-sufficiency in some areas. We’re excited about discussing more in the upcoming quarter.

I look forward to it. Thanks, guys.

Good morning. Thank you, operator. Very nice results. Congratulations to you and your team. The significant increase in production guidance for the fourth quarter—is that primarily due to the increased CapEx in the third quarter and the increase in CapEx guidance for the fourth quarter, or does your drilling slightly longer laterals play a part in it, or have you found a better section of the reservoir? Can you talk about that?

Yes. I think overall, if you look at the last several quarters and year-to-date, our PDP has outperformed our expectations and what was forecasted by our third-party reservoir engineers. Along with the development wells that we brought on exceeding expectations, it’s a combination of both; wells coming online faster than previously anticipated, but from a timing perspective, we’re generally completing wells as planned. Last quarter, we were right on track and expect the same moving forward this current quarter.

Thank you. And your gas processing—are the main upgrades to that facility finished, or are there more expansions and upgrades to come?

That phase of the expansion upgrade is complete and operational. We have since, along with other producers in the area, agreed to an additional expansion, which is expected to be 14 to 16 months out to bring on additional capacity for future growth. For now, what we have and what we are operationally looking to achieve, I believe we have sufficient capacity for our continued growth.

Good morning.

Good morning.

Good morning.

Just a couple of things. Any thoughts on costs? Have you sensed whether we have hit the peak of service cost inflation? Has it leveled off at all as you are modeling for next year? How much are you looking at?

From what we’ve seen, that has come in quarter-over-quarter and year-to-date. Looking back, we have appeared to hit the peak and flattened out a bit quarter-over-quarter. Our per unit costs are generally about the same for similar types of wells. We’ve also proactively done some bulk buying and procurement for next year to help lower costs or arrest further inflation. Based on what I have seen, I would say yes, we have peaked; but it remains to be determined.

Great. Thanks. I am just wondering if there is anything significant going on with exploring other horizons besides the San Andres in your vicinity, either working or looking at, or are your competitors doing so?

This is Bobby. We always continue to explore. We have a strong exploration team led by qualified geoscientists. We are looking for areas to expand around San Andres. We have also drilled a few wells in South Texas and the Eagle Ford, Austin Chalk area. It’s still early in appraisal, so nothing really to announce here, but we are encouraged by what we see in that area. There are great opportunities for us there.

Good morning. In the fourth quarter guidance discussion, it seems gas processing capacity is a limiting factor. Can you provide some insight, in light of the expansion 1.5 years or so out, regarding your current capacity?

So, in the last quarter, we reported two-thirds of the quarter was operational with the capacity finished in July. There are still guesses and estimates about how everything will line up in the facility. Therefore, we have included some cushion in our expectations. Gas and NGL volumes in sales are a small percentage of our revenue. Though they influence our per BOE metrics. We’re trying to speak in some sense on an absolute basis with ROE or G&A figures, as per BOE numbers are driven by processing capacity. We appreciate your patience as we navigate through another quarter or two and continue to optimize our gas and NGL sales.

Okay. The Eagle Ford is a known basin, your company seems similar to others with small interest in diversified basins. There are large packages available, some of which could be split into smaller pieces. Could that be of potential interest to you?

Most of our production is organic, and we have not relied on acquiring existing PDP. We focus on developing our area and organic leasing opportunities specific to our targets. We have experience in the Eagle Ford from the 2009-2010 period. I don’t see us biting off one of those acquisitions at this point. We’re focused on the quality of rock that we want to target. Overall, our rate of return is better on organic development than on acquisitions.

Hi. Thank you, guys. Great quarter. I did have a question regarding the earnings releases and the mention of earnings per share? I know it’s maybe not the most accurate measure of your performance, but it is a metric that investors look for. I’m not invested in companies that don’t release earnings per share. Is that something you could incorporate into your reports moving forward?

Yes, happy to, Rick. We understand. We’ve tried to find a balance of citing more traditional metrics like that. However, there are factors influencing net income, such as our unrealized hedge gains and losses. We had a nice net income this quarter, partially due to that $34 million mark-to-market gain that you’ll find in our 10-Q. That drives a higher net income and hence earnings per share. With prices where they are now, that could flip to a loss. It complicates a focus on net income and earnings per share, but we appreciate your feedback and will take it into consideration.

We have no further questions at this time. Ladies and gentlemen, that will conclude today’s call. Thank you all for joining. You may now disconnect.