Vitesse Energy, Inc. Q2 FY2023 Earnings Call

Greetings. Welcome to Vitesse Energy Second Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to Ben Messier, Director of Investor Relations. Thank you. You may begin.

Good morning, and thank you for joining. Today, we will be discussing our financial and operating results for the second quarter of 2023, which we released yesterday after market close. You can access our earnings release and presentation on our Investor Relations website, and our Form 10-Q was filed with the SEC yesterday. I'm joined here this morning with Vitesse's Chairman and CEO, Bob Gerrity; our President, Brian Cree; and CFO, Dave Macosko. Our agenda for today's call is as follows. Bob will provide opening remarks for the quarter. After Bob, Brian will give you an update on operations, and then Dave will review our Q2 2023 financial results. After the conclusion of our prepared remarks, the executive team will be available to answer questions. Before we begin, let's cover our safe harbor language. Please be advised that our remarks today, including the answers to your questions, may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks and uncertainties, some of which are beyond our control that could cause actual results to be materially different from the expectations contemplated by these forward-looking statements. Those risks include, among others, matters that we have described in our earnings release and periodic filings. We disclaim any obligation to update these forward-looking statements, except as may be required by applicable securities laws. During our conference call, we may discuss certain non-GAAP financial measures, including adjusted net income, adjusted EBITDA, and free cash flow. Reconciliations of these measures to the closest GAAP measures can be found in the earnings release that we issued yesterday. Now I will turn the call over to our Chairman and CEO, Bob Gerrity.

Thanks, Ben, and welcome, everyone, to our second quarter Q call. It's going to sound an awful lot like our first quarter Q call, which is what we intend to do. We are a dividend-first, return of capital company. To that, we paid a $0.50 dividend, and our Board has approved a second $0.50 dividend. So as a dividend-first company, a lot of our ability to pay that dividend and protect it depends on our deal flow. And our deal flow in the second quarter was excellent. We have very high economic hurdles, and we were able to source a lot of capital deals in that second quarter, and we're very thankful for that. Remember, there is about a year plus or minus lag between CapEx and production. So first and foremost, we are underwriters. And our underwriting depends on the quality of our data. So I want to give a special shout out to our data scientists who have created and maintained our database, which we call BLuminous. Amanda Bailey and Adam Woodson have done a great job in creating that database, which is democratized across our entire organization. And what that means is that land, accounting, engineering, finance, and even management accesses our data continuously. We want to know exactly what's happening in the field. We're in over 6,000 wells, and we call those wells the kids in the class. So our ability to accurately underwrite our capital expenditures depends on that data. Thank you for joining the call. I'm now going to turn the call over to our President, Brian Cree.

Thanks, Bob, and good morning, everyone. I'll be providing a very brief update on our operations. I'm going to start off with our development pipeline. As of June 30, 2023, we had 8.5 net wells that we're drilling, completing, or that had been completed but not yet producing, and another 11 net wells that have been permitted for development by our operators. Capital spending through the first half of 2023 is on pace to beat the upper end of our yearly CapEx guidance as we spent $43.3 million on development CapEx and acquisitions. As Bob mentioned, we are encouraged by the amount of well proposals and near-term drilling acquisitions that have met or exceeded our hurdle rates so far this year. While average AFE costs increased less than 10% last year and during the first quarter of '23, the average AFE cost decreased in Q2 2023, which is a good trend for us. With the rig count remaining modest in the Williston, we have not experienced the same cost inflation as other basins. That's it. I'm going to turn this over to our CFO, Dave Macosko, to review our financial highlights for the quarter.

Thanks, Brian. Good morning to everyone on the call. I'll give a quick summary of our financial performance for the second quarter of 2023. Overall, our second quarter was much more typical than what we expect the company to look like going forward since our results weren't burdened with the one-time spin-related charges that we saw in income tax expense, stock comp expense, and G&A expense, which we took in Q1. Our net income for the second quarter was $9.6 million, and adjusted net income was $11.4 million. Our adjusted EBITDA was $34.8 million, which is down from $40.1 million in Q1 due to lower commodity prices, primarily related to natural gas and NGLs. We generated second-quarter cash flow from operations of $39 million and free cash flow of $16.1 million. We define free cash flow as cash flow from operations adjusted for working capital changes, less cash spent on drilling and completion CapEx. This free cash flow was used to pay our quarterly dividend, reduce the balance drawn on our revolving credit facility by $4 million, and facilitate $3.1 million of attractive near-term drilling acquisitions. We ended the quarter with $41 million outstanding on our credit facility, while elected commitments remained at $170 million, with a borrowing base of $245 million. Our second-quarter production was up 16% from the second quarter of 2022, totaling 11,359 barrels of oil equivalent per day, with oil representing 67% of our production and 94% of total revenue. Our year-to-date production was 11,441 BOE per day, again, 67% oil. Total revenue, including the effects of our realized hedges, was $53.2 million for the quarter. Lease operating expense in the second quarter increased a modest 3% compared to the first quarter of 2023 on a per BOE basis, which reflects quarterly variability related to workover activity. General and administrative expense for the second quarter of 2023 totaled $4.5 million or $4.32 per BOE, a decrease of 59% on a per-unit basis compared to the first quarter of 2023. This decrease was primarily due to lower one-time costs related to the test spin-off from Jefferies Financial Group, as I mentioned earlier. On the hedging front, we layered in additional oil swaps through Q1 2024 to take advantage of the increased oil price that occurred in April. With respect to our guidance, we are reaffirming our previously issued 2023 annual guidance. With that, I'll turn the call over to the operator for Q&A.

Our first question is from Chris Baker with Evercore ISI.

My first question is for Bob. Just on the ops update provided with the release. A good uptick in net activity wells, 8.5 in the second quarter, and I think some good out of detail just on the 3.5 net AFEs. I was hoping you may be able to help us just tie these figures back to this year's CapEx guide. And then perhaps, Bob, as you kind of referenced earlier, any read-throughs for how we should think about 2024 production growth, just given the lag impact from that spend?

Yes, Chris, great questions. You can't imagine how much time our finance team sits in this room and models. So your takeaway that we've had good activity in the second quarter is correct. We've seen a lot of deals that clearly hit our hurdle or above. So we don't know at this point, Chris, if that's going to continue in the third quarter. Early indications are good. But again, we're non-ops, and we don't hit a budget; we hit an economic hurdle. So we can't really give you additional insight about 2024, but we can certainly say that your conclusions about activity levels are right on the mark.

No, fair enough. I guess the other question I had was just about the diversified operator exposure. You mentioned earlier about service cost deflation, but I was curious about what you are seeing in terms of leading-edge deflation on true services, just beyond what most have discussed regarding visible consumable components coming down like steel, etc.

Chris, we didn't see a significant bump last year. However, we are seeing a decrease in costs throughout the whole complex, including steel spreads and drilling costs. So I can't say it's a large trend, but things are trending positively. I think that over time, we're strong believers that capital will become more efficient, and we will achieve similar production results with less money. Thus, we see the trends going in the right direction. I believe part of that is due to technology improvements in fracs while part of it is just increased efficiency. The infrastructure of the Bakken is pretty well built out. So no huge deflation trend, but again, things appear to be improving.

That's great. And if I could just ask one more question. Can you share your latest thoughts on larger-scale acquisitions? It seems that the smaller-scale deals are progressing positively, which is encouraging. However, if you have any updates regarding the larger-scale acquisitions, that would be appreciated.

Yes, it's fair, Chris. We bid on a number of larger transactions, ranging from $100 million to $300 million in the second quarter. We were not close. So we look at everything. Take a look at our balance sheet, and you can see the capacity that we have to make a good-sized, accretive acquisition. So we're looking. We'd love to do it. However, we haven't successfully won any yet, Chris, but we're trying.

Our next question is from Lloyd Byrne with Jefferies.

Just a couple of questions. I guess, on the back of Chris' question. Can you speak to the capital efficiency you're seeing in the Bakken? And just not deflation, but maybe a cost per foot basis, whether that's improving with technology. And then I have a quick second question.

Yes, I'm going to have... Yes, you bet, Lloyd. Great question. It's good to talk to you as well. We have seen more 3-mile laterals and more refracs. We think that that is the future of the field. There was a noticeable increase in the second quarter compared to the trend. But Brian Cree will elaborate on this.

Yes, Lloyd. So as Bob mentioned, we've seen an increase in both 3-mile laterals and refracs between what we saw in the first quarter and what we saw in the second quarter. That trend has continued from what we started to see at the latter part of 2022. Capital efficiency is what we believe will drive future results. We've been executing since 2014, and advancements in technology, especially in fracs and refracs, have significantly transformed our asset over time. We expect this technological evolution to continue enhancing our capital efficiency.

Yes. Just to reiterate that refracs have extraordinary economic advantages, while the 3-mile laterals are relatively new, and we don’t have enough data yet to conclude that they will significantly impact results. Thank you for your question, Lloyd. Do you have a follow-up?

Great. Yes. Maybe someone could just comment on your deferred taxes and how you see that progressing going forward. I know a lot of it was tied to the spin, but just kind of where you are.

I'm going to ask Dave Macosko to respond to that, Lloyd.

Yes, so we took the big charge in the first quarter due to the change in corporate structure. Going forward, we will be looking at a tax rate somewhere between 17% to 20% of our current net income as we progress.

Our next question is from Donovan Schafer with Northland Capital Markets.

So...

Donovan, I need to interrupt you. Congratulations. Donovan is the father of young Sebastian, whose nickname is Sabi. So it...

It's Sabi. Thank you very much. I'm going to have to do bottle service shortly after cleaning and feeding. Congratulations on the quarter. I want to start with a compound question. The first part is, you seem to be trending above the high end of your guidance on capital expenditures. In many cases, like building a factory, exceeding guidance on capital expenditures is often perceived negatively. However, it appears that in this situation, it's not due to inflation but rather reflects the opportunities you're seeing for more initiatives. Should I view this positively? Is that a fair assessment, Brian?

This is Bob. I'll start, and then I'll let Brian provide insights. Look, we have built our machine to convert undeveloped acreage and drilling opportunities into cash. Ultimately, we return that cash to our equity owners, of whom management is a large part. We get compensated through dividends. So the factory analogy is quite apt. The widgets we purchase must be very economic. So when you see our CapEx going up, it's due to opportunities to make our factory efficient. So your conclusion that an increase in CapEx is favorable is correct. We are at the upper end of our range, but just to clarify, we are not changing our guidance; deal flow is good.

This is somewhat related. I think Chris asked about your thoughts on 2024 growth. Being a non-op, you can present the CapEx, and sometimes I think of it as laying chips on the table. However, you don't have control over the exact timing of when things will close. While I understand it's challenging to predict a specific number for 2024 growth, given that you are spending at a higher CapEx level and assuming that oil prices stabilize around $80, plus or minus $5, when would it be appropriate for us to inquire further about growth considering the pace of your investments? Even if it's unreasonable to ask about growth quarter-to-quarter, after several quarters, when should we consider that?

That's a fair question, and I'll have Brian elaborate. Everything we do in the morning hinges on protecting the dividend. So CapEx must be economic. Brian, would you like to expand?

Yes. To address your first point, you correctly concluded that CapEx is beneficial. To your question about timing and growth, CapEx can be lumpy. If we see another good CapEx quarter by the end of Q3, we will begin assessing what that might mean for 2024. Let's get through Q3 and observe trends in CapEx for Q4, and then we will likely comment on production for 2024.

That's very helpful. Okay. The last aspect I wanted to touch on is centered around your focus on protecting the dividend. In the context of going public and the spinout from Jefferies, it was reassuring that you had roughly 50% of oil production hedged through 2024. I believe the hedge position was solid, ensuring the dividend was secure through the end of '24. Do you plan to keep hedging at about 50% if opportunities arise? If you are able to lock in a hedge for '25 and '26 that secures that dividend, will you pursue that?

So Donovan, this is Brian. Great question. Hedging is paramount to us for dividend protection. We're a dividend-paying, capital return company. Right now, our hedging for 2024 isn't quite at 50%. It's stronger for 2023 than for 2024. This is mainly due to market backwardation. We continuously assess our hedging strategy, and as we approach 2025 and 2026, we intend to continue locking in hedges at favorable prices. Our current hedges are at approximately $78 for the remainder of 2023 and above $76 for 2024, demonstrating our strategy for protecting the dividend.

Okay, that makes sense. Thank you for the insight. I'll follow up offline with any additional questions.

Great. Congratulations again, Donovan. We're genuinely pleased for you.

Our next question is from Michael Schwartz with Jefferies.

I had one question on the 3-mile laterals I wanted to ask. Of the 97 gross AFE you got, how many have 3-mile laterals? And which operators are adopting this approach? Additionally, what is your average lateral length for your production in the Bakken? When do you anticipate the impact of these 3-mile laterals to be adopted more broadly in the basin?

So Michael, this is Brian. I'll provide some quick numbers on that. During the second quarter, the number of 3-mile AFEs we received was more than double what we saw in the first quarter. Again, these figures can be unpredictable. Currently, operators like Kraken, Cord, and even Continental are increasingly pursuing 3-mile laterals. Thus, we've seen this increase, though we still see more 2-mile laterals than 3-mile laterals.

Thanks, Michael.

We have reached the end of our question-and-answer session. I would like to turn the conference back over to Bob for closing remarks.

I want to thank everybody for being on the call, and we look forward to talking again in 3 months. If you have any questions, please contact Ben. Thank you, everyone.

Thank you. This will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.