Evolution Petroleum Corporation (EPM) Q4 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the Evolution Petroleum Announces Fiscal 2012 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Sterling McDonald, Chief Financial Officer. Please go ahead, sir.

Good morning, and thank you for listening to Evolution Petroleum conference call to discuss results for fiscal '12, which ended June 30. I am Sterling McDonald, I'm the CFO of Evolution Petroleum. And with me today is Bob Herlin, our CEO; Daryl Mazzanti, our VP of Operations; and David Joe, our Comptroller. Before we begin, let us cover the basics. If you'd like to be on the company's e-mail 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 evolutionpetroleum.com or via recorded telephone replay until September 20, 2012. The 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 date. Our discussion today may contain 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 full fiscal quarter and full year, and I'll turn it over to Bob.

Thanks, Sterling, and thanks to everyone, for participating this morning. This last year has been another major transition year for the company, as production revenues, earnings and cash flow have begun dramatic growth. With the reversion of our work interest in Delhi projected to occur a little over a year from now, we are working diligently to ensure that our shareholders will reap the benefits of that step increase in cash flow. As for our financial results, we earlier, today, announced our numbers for the year and the quarter, then last week, we reported our operational results and reserves. And since those detailed numbers are readily available, I will confine my remarks to key results operations and projects. Sterling will similarly review key financial results and I'll follow with a few brief observations about our overall strategy, and then we'll take your questions. Our fourth quarter earnings, our common stock dipped somewhat to $0.03 per diluted share compared to $0.04 last quarter, but an improvement over the $0.02 per share a year ago. Our results for the quarter were impacted by several non-recurring items that Sterling will discuss in more detail. But the one material item from operations was the temporary reduction in volumes in the second half of the last quarter in our EOR project at the Delhi Field. This is the first summertime test of full-scale recycle operations in this plant And the hot, humid conditions, apparently exceeded the cooling capacity handling the significant volumes of product recycle gas exiting the compressors. Therefore, production in CO2 volumes had to be temporarily reduced somewhat until the summer temperatures abated. While unfortunate, we fully expect additional cooling capacity we added for next summer so we've already begun to see improvement since June. For the year, our earnings to come in…

Thanks, Bob. Well, we're excited to report that this is the first profitable year in our 9-year history absent asset sales. And its first year's $4.5 million in earnings was no slouch, as it represented a 9.5% return on year-end capital. Comparison is even more impressive and consider there's a 50%-plus return on the $8.5 million of total cash that's been paid into common equity since our inception 9 years ago. So I'd like to take a minute to look behind the earnings details especially with respect to the fourth quarter. As you may have noticed, we posted a strength in 6 straight profitable quarters, with each quarter's earnings having been progressively higher, except the recent sixth quarter, which was off $373,000 sequentially. Temporary production risks that Bob mentioned, that Delhi made up all of the $267,000 sequential quarterly decline in revenues during the fourth quarter, but when combined with lower LOE and other field expenses and even including higher depletion, pretax field income was basically flat for the year at $3.8 million, meaning that the fourth quarter's income variance wasn't due to field activity. Rather, it was due to a topping of year-end accruals. In this case, the standout items were incentive compensation and income tax provisions. As to incentive compensation has always been our practice to accrue the prior year's incentive payout over the first 3 quarters, then turning out any excess or deficiency in the fourth quarter. Obviously, when sequential payouts increase as they did this year due to performance above expectations, the fourth quarter receives an extra expense higher than the prior 3-quarter pace. Of course, the reverse happens when incentive compensation is falling, which means that staff is performing below expectations, which is not our goal. As to income taxes, there is always a year…

Thanks, Sterling. Some of this will probably familiar but would no debt, growing cash flow and lots of cash of hand, scope our size, we believe that we're well-positioned to grow Mississippi Lime project and to grow our business, as well as take advantage of other opportunities that could arise. I'd like to point out that these projects target only the redeployment of our Delhi cash flow over the next few years and they're also intended to fully and timely utilize drilling tax incentives that could offset our Delhi taxable income over the next 1 or 2 years. Our overall strategy has not changed, and that is that the growth of per-share value and transferring that created value to shareholders in the most tax-efficient manner. With that, we're ready to take questions. And so operator, can you please open the line?

[Operator Instructions] And our first question is from Jeffrey Connolly of Sidoti & Company.

You've been able to reduce lease operating costs in fiscal '12. Can you give us any type of guidance on the run rate for fiscal '13 for lease operating expense?

We generally tend not to give guidance of that type because, in general, for a company of our size, it's hard to project off of numbers that we don't control, and we don't control the operations at our Delhi project. And the wells that we do -- and we don't operate in the Mississippi Lime. And the wells that we do operate, there's just not that many of them. And just like we had this last year, we had about $1.5 million of projected LOE, so we blew that by an extra $200,000 or $300,000, because we did this collective work in South Texas. And so it's generally for our kind of company it isn't real helpful to try and provide guidance.

Well, let me add to that, too, that depending on -- we -- Bob mentioned the possible monetization of getting some -- certainly, we have a lot of our LOE is there. Delhi doesn't produce any LOE until we back in, but certainly, when we get toward the end of next year, we're going to have a big LOE come into our financial statement. That will be after the fiscal year, but I'm talking late calendar year. And on that same note that Bob mentioned, the LOE in South Texas can play a role, but most importantly, I mean, we hope to be producing in the Mississippian Lime area pretty soon and we expect to have LOEs associated with those operations.

And the number of wells we drill there is variable. I mean, it get -- it could be anywhere from 6 wells, it could be 8 or 10 wells. So can we have 45% of LOE? And so that could have a big impact, so whatever number I gave you is not going to be right number. I rather not keep trying.

And our next question is from John Fox of Fenimore Asset Management.

I have a few questions. First on Delhi. If I look at your slides in the investor presentation, you have that cash flow slide, which I know is on a calendar basis. But if I look at that slide and I'll take calendar '12, it's about $17 million of cash flow, and calendar '13 is about $22 million, or $23 million, $24 million, whatever cash flow. Should I think about averaging those 2 and thinking about that for fiscal 2013 in terms of cash flow from Delhi?

It kind of gets back to the last question, we're just not comfortable giving guidance for the stuff that we don't operate and can't control. But you can take what Delhi is now and it's reasonable to expect that, that is a rate that will make that or more -- somewhat more over the course of the year. And then whatever you think that light sweet price is going to be, since we have no OpEx with Delhi then that will gave you a fairly reasonable projection of the cash flow from Delhi. Obviously, you've got to net that out of tax, which is a 38% tax rate adjusted for whatever IDCs we generate through our drilling activity in Oklahoma.

But we also get a 15% statutory depletion rate for tax purposes on the first 1,000 barrels net to our interest.

Well, just very quickly, if I take 5,500 a day times 100 LS times 0.074, that's 15 million a year, and your CapEx this year, if I understand, is $10 million or so.

Yes. We're going to be generating positive cash flow in our base case economics. We're understanding our cash flow and that ignores all the working capital that we have on hand already so there's clearly a lot more bandwidth capacity to handle more activity.

Okay. And Bob, that CapEx number -- there is also somewhere in your 2 press releases an additional payment to the JV. Is that included in the $10 million or is that additional?

That would be on top of that, but it's not that much more.

Okay. And then what will it take to get the Mississippian Lime probables into a proved category?

Well, that's real straightforward. You have to a producing well with enough production history that the outside reservoir engineer and assign a decline curve to it and so you feel comfortable with those numbers. And then around each producing well, he will give you -- I better ask Daryl here. Daryl Mazzanti, our VP of Ops, but what do you think -- how many [ph] are we going to get of each PDP?

Each well should have on the productive trend, well, this is a little different than the [indiscernible] you should have 4 -- up to 4 puds.

So at least 4. Potentially 8 but at least 4. Keep in mind that what we're doing is we're drilling one horizontal well per section in order to tie up the full 640 acres, but each section we believe is going to end up with another 3 drilling locations in that section. But ideally, we'd like to get 8 puds out of each PDP, but I think more likely, that's going to be 4 offsets.

. Okay, terrific. And then, when the -- as the GARP is successful, where do we see that in your financials?

Right now, it's not a significant presence because we have it only installed in 2 commercial wells. We have it in couple of our own wells that we own 100% of. So it's not really a separate line item this year. We are hopeful that, that will change this coming year, that we will have the ability, I shouldn't say the ability -- or I shouldn't say -- ability that we'll have the revenues sufficient to allow us to show as a separate line item. Which makes sense since it is an oilfield service business. We really do need to start showing it separately when come to material, but I'm hopeful that this coming year, we'll be able to do that.

And your next question is from Joel Musante of C.K. Cooper & Company. Joel P. Musante - C. K. Cooper & Company, Inc., Research Division: Yes. I just have one question on the Mississippian Lime. The range of resources is one of your -- it was a nearby operator and they've had some pretty good results there. And I was just wondering, if your wells came in similar to those, what would it take for you to, let's say, accelerate the program? I mean, where do you stand in terms of your partner or in terms of your acreage, in terms of increasing activity levels?

Sure, Joel. Ranges leasehold position is just south of ours, south and southwest. They've had some excellent results, which is very encouraging to us. The fact is there is another operator that is just east and just south of us, they also have an excellent result, so we're feeling pretty good in general about the program. Obviously, we'll feel a whole lot better once our wells are producing, hopefully, at the same kind of rate. In our joint venture agreement, right now, we have for a limited point of time, the first year or. So we defer to them for operations and for proposing wells, and they have a certain range. They have to drilled x number of wells but no more than Y. If they don't do at least the lower number of wells, which is like 6, then we have the right and ability to propose and operate if necessary. After that 1-year period, then that limitation's off the board and we can proceed as quickly as we think appropriate. But we -- I have to say that both we and our partner are on the same page here. We're proceeding in a very thoughtful and careful manner. We're testing our acreage. We're trying to learn from what other people are doing. We're trying to let other people prove up acreage as much as possible while we use our own capital in the more judicious manner, and that seems to be working so far, lots of people drilling around us. In terms of expanding, we're always looking for opportunities to add to our position there. Obviously, we'll feel a whole lot more comfortable about doing that once we have our own wells down and working and producing. But we are looking to expand our presence. We really like…

Yes, I would have to, Joel, point you back to the statement that we have said from day 1, and that is that we are all about how can we increase the value per share and get that value into the hands of the shareholder. And that can mean all kinds of options, whether it mean sale of the company, whether it means growing the company rapidly, we're going to do whatever is it of the smartest thing for the shareholder, incents employees and staff to own 20% of the company. You can be assured that everyone here is focused very much on that key goal, how do we get the value up? So I want to tell you exactly what we're going to do because frankly, I don't think that's been set yet, but we're going to do what's in the best interest of shareholder, whoever that might be.

Your next question is from Jeffrey Connolly of Sidoti & Company.

Guys, a quick follow-up on the Mississippian Lime play. I've heard a couple of operators to south of us in Logan and Pane [ph] County talk about how there may be some Woodford -- a new Woodford play underneath there. Have you guys thought about that at all or heard anything about that?

We've heard about it, the Woodford oil play. That's something that we're keeping an eye on, but we don't want to get too terribly distracted from our initial focus, which is Mississippian Lime. The nice thing about -- if you guys could get Lime well, then you can always go back for the Woodford later. So we're aware of it, we're following it. It kind of follows into what I just said earlier. We're going to let other people prove that concept depth for us since time isn't going to hurt us on that one, we can actually capture that later.

I think it's fair to say too that your development costs are going to be deeper on the Woodford, and the Woodford is probably the source rock for the Mississippi Lime, and whereas in the Lime we are harvesting what would be more of a conventional resource. We're looking at fractures in a limestone that have migrated there over geologic time. Whereas, if you go into the shale, that is more load to give up its hydrocarbon to production. And it's likely is a more expensive proposition, but it's something that we're going to look at later.

[Operator Instructions] Our next question is from John Poehler [ph].

A quick question on the capital expenditure budget. If you look at $10 million, as you mentioned, it's below your cash flow and below your working capital. If you look at your opportunity set and if things goes as planned and given your human resources and whatnot, what potential do you think you have to expand that this year, this fiscal year, and then, maybe again, next fiscal year?

Sure. As I said before, we have actually considerable capacity to increase our capital expenditures and that is by design. We think there's some other opportunities out there and we want to preserve our ability to chase after those. And that in a couple of areas, but that's -- in growing our GARP business, we're working on some opportunities that can involve laying out considerable capital expenditures. It allows us to chase after additional Mississippian Lime leasehold and be able to put down money on that and commence drilling fairly rapidly. It allows us to accelerate drilling in Mississippian Lime during the spring of 2013 as appropriate. We just need -- we want to make sure we have the flexibility to meet all these opportunities as opposed to laying out a plan that could spend every penny of free cash flow, and then you're hamstrung, what do you do if something else happens you want to take advantage off. So the CapEx program that we laid out this one that we're pretty confident of that happening. So the other things that might come along, we just have the flexibility to meet those. Going into the following year, which would be fiscal '14, which would begin in July of 2013, that I would expect to be a much larger capital program for 2-- several reasons. One is that we're going to have a lot more cash flow coming into the company with that reversion occurring in sometime the latter half of next year. We will be generating substantial cash flow from Delhi. Now obviously, we're going to also be paying for our 24% share of any CapEx at Delhi but that will be the last phase, so that can easily be a $10 million or $12 million expenditure, our net to us there. Obviously, more than covered by cash flow. We will have a much more active drilling program most likely in Mississippian Lime, not only on the any joint venture but on any other acreage would pick up and then we fully expect our GARP business to be very active at that point in time. And therefore, we'll be putting in directing far more capital expenditures into that area. So I think that what we'll be doing in the next year will be what we're doing this year on steroids.

[Operator Instructions] I'm showing no further questions. I would like to turn the conference back over to management for any closing remarks.

Thank you, Laura. Thanks to everyone for participating. Feel free to give us a call. We're more than happy to talk to you to explain any more about what's in the release today. We're very excited about the company and prospects going forward, and think this is a natural progression of the company. Thanks, and hope we'll talk to you the next quarter. Bye.

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