Evolution Petroleum Corporation (EPM) Q3 2012 Earnings Report, Transcript and Summary

Good day and welcome to the Evolution Petroleum Corporation third quarter fiscal 2012 earnings conference call. All participants will be in listen-only mode. (Operator Instructions) After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Sterling McDonald. Please go ahead.

Thank you operator and good morning. Thank you for listening to Evolution Petroleum’s conference call to discuss results for the third quarter of fiscal 2012 which ended on March 31st. My name is Sterling McDonald, I am CFO of Evolution Petroleum and with me today is Robert Herlin, our CEO and Daryl Mazzanti our VP of Operations. Before we begin, let us cover the basics. If you would like to be on the company's email distribution list to receive future news releases, please see the contact information on our news release. If you wish to listen to a replay of today's call, it will be available shortly by going to the company's website at www.evolutionpetroleum.com or via recorded telephone replay until May 14, 2012. Necessary information can be found in the earnings release. Please note that any statements and information provided today are time sensitive and may not be accurate at a later day. Our discussion today may contain certain forward-looking statements that are based on management’s beliefs and assumptions that are based on currently available information. We can give no assurance that such forward-looking statements will prove to be correct as they are subject to risks and uncertainties that are listed and described in our filings with the SEC. Actual results may differ materially from those expected. Our discussion also may include discussions of probable, possible or potential reserves or recovery. Such unproven estimates are more speculative than proven reserves. Now we will briefly review results of the third fiscal quarter and I will turn it over to Bob Herlin, our CEO. Bob?

Thanks Sterling and thanks to everyone for participating this morning. We earlier announced our quarterly results by a news release and with those detailed numbers are readily available to everyone, I will confined my remarks to some key results, operations and projects. Sterling will similarly review key financial results and I will follow with a few observations about our overall strategy and then we will take the questions. In short, we had a record operating quarter with earnings to common stock of about $1.3 million or $0.04 per diluted common share on revenue of $4.8 million, production of 619 BOE a day. These results are all improvement on a prior quarter and the year ago quarter and are achieved slight lower product prices compared to the quarter ended December 31st. About 96% of our revenues are from oil and natural gas liquid sales and that’s compared to 77% of our volumes. Now earnings were impacted by some unusual lease operating expense items in the Lopez and Giddings Field and I’ll cover that later in my remarks. Starting with Delhi, gross production for the recent quarter increased some 9.5% over the prior quarter and they ran about 5,474 gross barrels per day, about 405 barrels a day net. I do like to point out that this is still less than half the projected peak rate as projected in the field and that peak rate won’t be reached into sometime late 2017, so production should increase in (inaudible). Production during the quarter was primarily result of CapEx in 2009 and ‘10. It did reflect just an initial limited response to the expanded 2011 capital expenditures. Our Delhi crude oil sold for about $113 during the quarter and that’s about 10% premium over WTI and about $2 a barrel less than the previous…

Thanks Bob and good morning, again. As you can imagine, we’re pleased to report record recurring results. There is a minor defect in our press release, which we’ll correct. We mentioned in the second paragraph, record earnings. Its record recurring earnings when we take into account that we had a large gain on sale in 2006 for (inaudible) Delhi. But our record recurring earnings in Q3 ‘12 were on record product volumes and revenues. Earnings increases were restrained due to the lower unit margins we experienced. In the sequential comparison to the prior quarter, lower unit margins were a result of two things; lower realized prices on all products across-the-board; and secondly, higher LOE due to operational issues Bob discussed regarding the optimization of water disposal method at Lopez and the remedial workovers at getting to the increased production now. Going forward, bear in mind that our margins at Delhi are currently 100%, with our royalty interest dropping straight through to the bottom line. Unlike Delhi, production from our other project carries lease operating expense with them. So those projects tend to dilute margins, depending on the relative production changes between Delhi and our other fields. Of course, further dilution of margins will likely (inaudible). Barring a spike in oil prices, when our reversionary working interest at Delhi kicks in, it will also carry LOE charges. Regardless, increased volumes at the back end will carry additional contributions to profitability at the bottom line, assuming any positive margin. On the finance side, we continue to make incremental improvements to our liquidity and available funding sources as we continue to guard against additional capital and/or commodity market dislocations that maybe lurking. During the current quarter we added another financing vehicle to our arsenal in the form of a revolving line of credit.…

(Operator Instructions) Our first question comes from Joel Musante of C.K. Cooper & Company. Joel Musante - C.K. Cooper & Company: Just got a few questions for you, in the Mississippi Lime, what's your plan for moving forward there. Is it mainly just going forward with development or are you going to go through some kind of a derisking process solved by retaining leases and then after that infill drilling.

Well obviously like most people what we re trying to do is both derisk and capture leases through unitization as quickly as you can. Obviously none of us want to have to exercise lease options if we can avoid it and so each unit is roughly starts off at 640 acres and so we will be targeting to drilling of one well per section. And then that allows us to go back later in infill field with the addition of two to three locations that we think we are going to be able to put in there eventually. We do plan on drilling long laterals here of 4500 to 4800 foot length and hopefully have as many as four wells per section. But we intend to, this is going to be a major growth vehicle for us going forward but without any immediate long-term obligations again tied into our overall strategy of the company. But right now what we are doing is we've got all this immediate cash flow that's coming in from Delhi and is all taxable income and so we are saying okay we can let it sit here as cash, pay tax on it or we can put it into a low-risk high return oil project that has the ability to take advantage of the current IDCs that are available to the oil and gas industry and get more wells drilled, add more oil production at current additional value. So we think that’s all highly accretive to shareholders. We do anticipate to growing it overtime. Joel Musante - C.K. Cooper & Company: When do you think you will be able to start your – spud your first well there?

Well, the first well is going to be spud this month and that first well is a saltwater disposal well which you have to have before you can start producing well. But we have a second rig that's going to be moving in early June we believe to date and that will be for our first producing well. So we have initial three well program. One, the disposal well and two producers. Joel Musante - C.K. Cooper & Company: Alright. And when you permit the wells, you go through a process where you are talking about, may be doing some force but may be having the benefit of doing force pulling there. I mean, how long of a process is that?

Well that can vary. It depends on how much acreage you are starting off with. I think on our first well we essentially had the whole unit already leasing. So the unitization process is pretty minimal. But as you see wells that you want to drill coming down the pipe, you plan for that and you start the unitization process accordingly, so the drilling is not slowed down by the process of getting unitized. Joel Musante - C.K. Cooper & Company: Okay, alright, good. I just had a couple more on just some housing-keeping type stuff. In terms of your LOE going forward, what should you be using or looking at there?

Our LOE this last quarter was almost high and you know there is no bones about it. We are not happy with that. On the other hand should the reason for and those reasons we’ve believe or non-recurring. We spent a boatload of money in South Texas in terms of trying, doing multiple well workovers, doing various kind of acid treatment. We are trying everything in book to figure out how to get these injection wells to take more water. And this is not something that we can capitalize, we had to expense it. So that’s something that now that we think we’ve got that process resolved, we shouldn’t be seeing that kind of high expense level going forward. And then getting, we had a high expense because on one of our wells that had basically gone uneconomic and we didn’t even have any reserves on it to speak off last summer. But we actually went back and we took the yard, the mechanical pump lift and we took that off the well and we put it back on the gas lift. And then that actually put the well back in the economic production and actually if I put my (inaudible) you know nice reserves there. However since it was already on gas lift before and we replaced that with mechanical lift, we can’t go back and capitalize gas lift. So that had to be totally written off as LOE. That was the pretty hefty charge for us. Keep in mind that you know we’re still fairly small operations, so we didn’t take much of an operation like that to have an impact on our earnings. So we think that's fairly unusual. Then the last major impact, we disposed a lot of water in the Giddings Field from two of…

Well, we generally do not like to provide any guidance whatsoever primarily because the biggest source of our production comes from projects that we don’t operate. But it’s not unreasonable to think that Delhi will continue to increase, so that will be a source of increased production. Its something we can control or what I can say is that in South Texas, I think when we get these permits and which is hopefully soon that that will allow us to get those, two of those new producers online full rate and that could have a significant and meaningful impact, that's all oil that's actually selling at a premium price. We are just interested in grab the oil, but we get the premium, because it’s going to market that's designed for low gravity oil that's being hit with vast quantities of very high freight light volume from Eagle Ford. So anyway that could have a big impact and the other impact is going to be in our GARP wells. We’ll be showing full quarter result from both of our GARP presentations plus we’ll have a third one which we think we are going to get flown here pretty quick which should start contributing. So those are all going to have an impact on our results. We do not expect any contributions from our Mississippi Lime project until fiscal ’13, maybe we should see in this result the first quarter of fiscal ’13 which should be September 30th quarter; quarter of this year.

The next question comes from Kim Pacanovsky of MLV & Company. Please go ahead. Kim Pacanovsky - MLV & Company: I am just wondering since you have some positive results with GARP, have you changed how you are marketing the technology and have you increased reaching out to other operators?

We are still in the stage of demonstrating that it works on other people’s wells and not just that, but on wells as the typical target for the application. Our next goal, I should say will be to get our current customers to agree to put it on more wells, so that we can create more of a history in track record and its great having it on two wells, so what we really would like to have it as on 20, 30 or 40 wells. At the same time, we are going to be starting to approach other operators that are in other fields, I mean we think that the Bakken is a great opportunity for us. I think Eagle Ford is going to be a great opportunity and at some point not quite yet. So there are some other opportunities. We think it’s got great application out in the Permian Basin and so we are going to be talking and focus about that as well. But at the moment, its strictly still a commercialization process and once we have a portfolio of results then we have to decide, okay how is the, what's the best way of marketing this, is it as an operator, is it as a joint venture partner, is it through a service company partner or whatever and that's going to be an interesting conversation. Kim Pacanovsky - MLV & Company: And what’s the impediment to getting these; there are two different operators right that are using it now?

Correct. Kim Pacanovsky - MLV & Company: Okay. So what's the impediment to getting these operators to say okay to 20 or 30 wells. Is it the way the contract is written or I mean, I am looking at the numbers you just threw out and you would think you would have to, you would be an idiot to not finish off more wells. So why isn’t that happening yet?

See, I’ve had this conversation in break-outs and presentations over the last year or two, but oil and gas business is an interesting industry. It’s a combination of high-risk and – with high-risk work by very concerned people. If you think about it, out in the field where the work gets done, you’ve got these field folks. They’re the ones responsible for making this work and agreeing to have any technology done or changes to the well. They look at this as being something that if it works, they get no credit. If it doesn’t work, they get all the blame. And therefore, there’s no upside to them for having this. They really don’t want to involve this black box. And you have to just really thoroughly convince them that it’s going to work and that we’re going to make it easy for them before they agree to it. So that’s a hurdle that we’ve had to overcome. And we’ve overcome it to some degree; obviously, to the point that we’ve been able to install it. The more data that you have, the easier to sell it is. To a certain degree it’s a top-down approach, but you also have to come up from the bottom because if the bottom doesn’t support this, it will never work, no matter how much the top level people want it. So it’s an interesting market. It’s an interesting opportunity. And that’s why I said, it’s not real clear what is the best way to actually get this to market and we’re obviously not convinced that we are the best ones to do it. We’re open to any and all to best market this and profit from it and bringing it to the advantage of every one in the industry.

I’ll then infer to say too that of the two commercial projects that we have, one of them could bolt-on more wells. The other one is maybe more limited.

Right. Kim Pacanovsky - MLV & Company: Okay.

The second application may be kind of more of a one-off. It will give us hopefully the results that we’re looking for. But that particular party doesn’t have a lot to bolt-on in terms of other wells.

But the first party has substantial potential for expanding with this. Kim Pacanovsky - MLV & Company: Okay, terrific. And then just one other quick question, who is the operator in the Woodbine that you’ve farmed out to?

I don’t think we made that public, and I can’t remember if we have a limitation on that. So there – we’re just not real sure if we’re under any limitation on disclosing their name. So I’d rather not say just yet. We’ll try to – we’ll look at that contract and see if we can disclose it, but they are active in the area. Kim Pacanovsky - MLV & Company: Okay.

And there’s not that many – there’s only about half a dozen companies who are active there, so you can figure two of those half a dozen.

(Operator Instructions) Our next question comes from [John Collar], a shareholder. Please go ahead.

My first question has to do with Lopez. And I’m just wondering what sort of hallmarks you’re looking for before you decide that it’s repeatable, and whether or not you think you can find other significant opportunities you said in past? What are the determinants? Is it the reservoir? Just any information on that might be helpful.

Sure. I would say that we have met the hurdles of – the criteria for going forward with an expansion based on results that we have today. Our target was a well that would make at least 13 barrels a day on a consistent, stable basis, and that would decline at a very low level, a single-digit decline rate. And we think that we not only hit that but we think we’ve exceeded that. Now, in that criteria the second hurdle which we weren’t really anticipating, and that’s what we’ve been dealing for the last – oh shoot – six to nine months, and that is this reservoir that gives up fluids so readily isn’t real happy about taking the fluid back again. So we’ve been had to deal with that and we think we have the answer now as we’ve worked real hard on this last quarter. And I can tell you it’s very painful seeing those invoices for that operating expenses. But we think that we have the answer now. We’re applying it and it seems to be working up to a limited extent that we can apply it. And we still have to get some state permits which allow us to put it before force. But we don’t think that – we think that’s sort of a logistical issue than anything else. But as a result, I think we’re prepared at this point to renew our activities in terms of development drilling and so forth and start looking at rolling out to other areas. We have -- over the last year, we have identified other fields that have the right characteristics, and that's being the type of rock thickness, the level of the previous development, the amount of oil production when the field was abandoned, and so forth that we think that these opportunities are available. We've done some checks, leases are available, and I think there's an opportunity there for us now to roll this concept out and go forward. And as I said earlier, the opportunity is not in drilling another 20 or 30 wells in our Lopez field. It will be nice. But the real upside value is going elsewhere in areas that we already know about and target it and add 200 or 300 locations.

And then my last question, as you look to deploy the cash from Delhi, and you said in past presentations that you’re looking at a whole bunch of different opportunities, how do you scale up your organization from an engineering and financing, just human resources base to handle this? And do you think that there is, given the real boom time going on now in hydrocarbons, if you’re going to – you think you’ll have a problem scaling up?

I don't think that’s going to be a problem for us, primarily because for a number of reasons. Number one, our Mississippi Lime operation that actually is being operated by another company. And so our contribution is more of our intellectual property, so to speak; our experience in drilling horizontal wells. So we can advise them and so forth. But we’re not actually responsible for the day-to-day operations, which is a key issue. Second thing, as Sterling alluded to more directly and I somewhat indirectly. We are looking at selling off our Giddings operations which is where we operate. That’s where the bulk of operation activity is located. Obviously once that is spun off and that frees up a lot of capability and so that operational capability, we would more focus down in South Texas in installing our GARP well. So if you think about it, the hurdles to expanding our level of activity are actually pretty low. And then the last thing that helps us is that we have always since day one outsourced all of our property accounting and leasehold administration and so forth to a third party firm and so that takes a lot of that administrative burden off the table for us. So it’s actually pretty easy for us to scale up as we've talked about. Our intent is not to build the huge operation here. We've never wanted to do it and still don’t intend to. We are going to stay with the staff that we have. We are not going to add headcount and make all this happen.

Our next question comes from Robert Kecseg of Las Colinas Capital Management. Please go ahead.

I wanted to ask you question about your April presentation slides and on that slide that you show the 2P future cash flow growth. That was put together by your independent engineers. I just wasn’t sure, are those calendar years and so that is (inaudible).

Well, what I like to do is point you to the latest presentation which is.

I don’t think it is up – it is on website.

Right. And then of course but that will be after they finish the year end again, so it will change all these bar chart from June 2011 to June 2012?

So that will not be in our hands until August, late August. I think it is fair to say without getting too far out on a limb that our average pricing that we would have to use, we look 12 months back we don’t have May and June pricing right now which could be weaker, but the average pricing in the year so far is going to be a quite a bit higher than that, it was used at Delhi I think it was $94.80 or $94.69, somewhere in there.

Yeah that's right Sterling. I am looking at the slide, you got $94.81.

Yeah those fiscal years, those are 6 months offset from calendar years, so they are six months earlier than what a calendar year number is going to be. So the calendar year presentation is going to show higher numbers.

And then on the new idea in the Mississippi and are you pretty much exclusive to the one county as far as where this property is that or you are planning to expand leases?

In today's. Maybe not in another time or another place and another price deck.

Okay and also from what I gathered your partner hasn't really done any drilling to speak of themselves in the area, so you are really be going into this together as far as your actual drilling experience the rest of it has been?

That's not true; they have drilled with other partners on other projects. This will be the first time drilling with us. But they are active in the area.

(Operator Instructions) As there are no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Bob Herlin for any closing remarks.

Thanks to everyone for listening in. We think it was a great quarter and we are really looking forward to continuing growth in the revenues and earnings and I look forward to our next call with you. Thanks.

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