Evolution Petroleum Corporation (EPM) Q1 2017 Earnings Report, Transcript and Summary

Welcome to the Evolution Petroleum Corporation First Quarter Fiscal 2017 Earnings Release Conference Call. [Operator Instructions] I would now like to turn the conference over to David Joe, Chief Financial Officer and Senior Vice President. Please go ahead.

Good morning and thank you for listening to Evolution Petroleum's conference call to discuss operating and financial results for our fiscal 2017 first quarter ended September 30, 2016. I'm David Joe, CFO for Evolution. And on the call with me today is Randy Keys, our President and CEO. If you wish to listen to a replay of today's call, it will be available shortly by going to the company’s website via recorded replay until November 15, 2016. Please note that any statements and information provided today are time-sensitive and may not be accurate at a later date. Our discussion today will contain forward-looking statements of management's beliefs and assumptions based on currently available information. These forward-looking statements are subject to risk and uncertainties that are listed and described in our filings with the SEC. Actual results may differ materially from those expected. Since detailed numbers are readily available to everyone in yesterday's news release, this call will focus key overall results, operations and an update on our reserves. I'm now going to turn the call over to Randy Keys, President and CEO.

Thank you, David. We had a very solid quarter, despite average WTI prices in the $45 range. We reported after tax net income of 1.8 million for the quarter on revenues of 7.6 million. And I’ll let that sink in for a minute. In a $45 oil price environment, we were able to drop 24% of revenues to the bottom line after all cost, cash and no cost, cash and non-cash, after DDNA expenses and after taxes. There are technology companies in Silicon Valley that are unable to generate that kind of net income margin. This was part of the decision to increase our common stock dividend. Our primary goal with the dividend is to provide a meaningful cash return to our shareholders, but to do so in a sustainable manner so that our shareholders can depend on the return overtime. This is not a simple task in an industry with volatile commodity pricing, a depleting asset base and continuing demands for capital investments to sustain production levels. We considered all of those factors in the context of our very strong financial position and quality asset base and concluded that we were confident with the 30% increase in the quarterly dividend rate from $0.05 to $0.65 per share. This equates to a new annual dividend rate of $0.26 per share. One or our key questions internally on sustainability was the breakeven oil price to fund the dividend from net operating cash flow. We determined based on the best current information that we have that the new dividend rate sustainable from cash flow with an oil price down into the low $30 per barrel. This is without considering the substantial working capital resources that we have available. While we would be able to continue the dividend for a short period with working capital, if we encountered an extreme period of negative short-term volatility as we did earlier this year. Our goal is to sustain the dividend from current cash flow in the long run. So that I did not find unduly negative or cautious with a more positive price scenario, we have much greater flexibility and confidence to continue and ultimately increase the dividend. At $50 or $60 oil prices we’ll be in a much better scenario with regard to the dividend rate. I would add that we originally planned to review the dividend in the first quarter of calendar 2017, after we’d seen the results of the NGL plant. But with the recent outperformance in the Delhi Field and with our excellent financial position, we decided to take this action now. We’ve also indicated that our board intends to review the dividend in 2017 based on the final results of the NGL plant and of course future developments in the oil markets. During the quarter, we also made a decision to redeem our $8 million issue of preferred stock. These shares were callable at par and going forward we’ll save 674,000 of annual dividends based on the 8.5% yield on these shares. This amounts to approximately $0.02 per common share on an annual basis. The redemption did cause a onetime non-cash deemed dividend of 1 million, to close the books on this transaction which reduced net income to common shareholders to $.06 million or approximately $0.02 per share. On a pro forma basis, if the preferred stocks had been retired prior to the current quarter, our earnings per share would have been $0.06 per share. More importantly, this redemption further streamlines and simplifies our balance sheet. We’re left with 33 million shares outstanding and virtually no dilutive securities or other complexities to our capital structure. On the operational front, virtually all of our news is positive except oil prices and even prices have improved in the past two quarters from the extremely low price levels seen earlier in the year. First, production was up another 5.8% quarter-over-quarter to 73,071 barrels of oil per day. We’ve seen steadily rising production since reversion of our working interest in November, 2014. At the time of reversion, production was around 5800 barrels per day. Over the succeeding two-year period since reversion, production has increased by more than 27% with relatively consistent growth quarter-over-quarter during that period. Most of the increases resulted from projects to increase sweep efficiency of the CO2 flood through selectively sending the CO2 to the best zones within the formation. And this has been - also been done with an eye to the most efficient and frugal use of our CO2 resources. Our purchased CO2 volumes, which are the main driver of our lifting costs, have averaged around 73 million cubic feet per day over most of the past year. This is down from around 90 million cubic feet in the comparable period in 2015. Last quarter we had the lowest rate of purchased CO2 since reversion at 59 million cubic feet per day, but the current quarter was more in line with our historical trends and expectations. These lower CO2 costs have been a key factor in our very competitive lifting costs, which have been in the $13 per barrel range over most of the past year. The exception was our most recent quarter when lifting costs dropped below $12 a barrel. Since our purchased CO2 costs are tied directly to the price of oil, this cost has dropped significantly with lower oil prices. So, despite the $45 WTI crude oil price levels we've seen in the past two quarters, with these competitive lifting costs we are still able to maintain a solid positive net field margin in the $30 per barrel range. I should mention for purposes of comparison to other companies that this lifting cost is an all-in production cost including severance taxes, because the Delhi field is a qualified tertiary recovery project in the state of Louisiana. As such we pay no severance taxes until all costs of the project have been recovered including an interest factor. So, while we are certainly not satisfied with the current price environment for crude oil, we have some offsetting benefits from lower CO2 costs and the expectation that this production tax holiday makes them through the next decade or beyond. On the oil price front, we are currently netting approximately $2.25 below WTI prices at the field. This takes into account our pipeline transportation and marketing costs and is partially offset by a small premium for our Light Louisiana Sweet crude oil pricing. The next major catalyst for near-term growth is the Delhi natural gas liquid or NGL plant. This project was authorized in February of 2015 over 18 months ago with a $100 million price tag, which is approximately $25 million net to us. Most of last year was spent designing and fabricating the major components and field production began in earnest earlier this - earlier in this calendar year. We completed construction in October of this month and we expect to begin startup and testing during November and that the plant will be online by the end of the year. We've incurred over 95% of the budgeted capital costs and we are pleased that the plan is expected to be completed largely within budget, which is quite an impressive accomplishment on a massive project of this size and scope. The NGL plant also includes a 25 megawatt GE LM2500 turbine to generate a majority of the combined power needs of the NGL plant and the existing recycle facility. Until we begin to run both plants and the turbine at full capacity, we will not know with confidence the amount of electricity generated and needed in the field. As in the slide, a 25 megawatt turbine could supply the power needs of a small city of about 20,000 people. A week and a half ago, I had the privilege of hosting a tour of the Delhi field facilities for a small group of business school students from the Freeman School of Business at Tulane University. These students participate in the Broken Road program, which is a credit course to give undergraduate business and MBA students’ real world experience in the field of finance. Small groups of these students perform in-depth research on about 40 smaller regional companies, which are under followed by the traditional analyst community. They meet with management and write a research report on their assigned company. And if they are lucky, they get to take a field trip to get a clear understanding of these companies’ operations. Evolution has participated in this program for at least the past eight years. And I can say with confidence that both I and the students were impressed with the scope and quality of the current field operation in the Delhi field and the new NGL plant. The NGL plant has been a massive undertaking and is now completed as a first-class project. Also on the operating front, we completed the previously announced modified Waterflood Project in Test Site 1, the area which was affected by the June 2013 fluid release. This project consisted of installing three high rate water injection wells on the eastern boundary of the area with three high rate water production wells with electric submersible pumps further to the west. These ESP pumps can move over a 1000 barrels of fluid per day and we have already seen a response from these wells with the best well producing a 10% oil count from the total fluid production. We have not yet seen full sustained production from all the wells, but we're encouraged by the results so far with this relatively low cost production enhancement project, which cost approximately $600,000 net to Evolution. Like many of our projects including the NGL plant, this project has operational benefits for the CO2 flood as a whole. But this small project is expected to pay out in less than a year and contribute significant value over time. We also recently approved 11 small AFPs for continuing conformance projects to open up new perforations in existing wells or to bring inactive wells back online or to squeeze up other perforations. Our continuing CO2 injections are not yielding a commensurate production benefit. We've done a handful of these projects during the year and we believe that these new projects are a strong indication of the solid economics that result from these relatively small production enhancement projects. With the completion of the NGL plant, we do not see any significant capital expenditures in the near-term. The timing of the project to develop Test Site 5 to the east, which has a preliminary estimate of $12 million net to Evolution, has not been decided at this time. Both we and the operator view this as an attractive project, but it remains to be seen if it is proposed in the 2017 or 2018 calendar development budget. We agree with the operator that this project should be initiated when oil prices are at a level, which will allow funding of this development from cash flow. We believe our financial strength with $20 million of net working capital, substantially all of which is cash, gives us the flexibility to take advantage of opportunities that may come up in this environment by maintaining or increasing our cash dividend to common shareholders. We also have no debt outstanding. Looking to the future, we are positive about the prospects for the company, including our ability to continue our growth plan, create long-term value, and return increasing amounts of cash to shareholders. I'm going to touch on a couple of other financial matters from the quarter before turning the call over for questions. We had a limited derivative program for the past quarter using callers with a $45 floor and a $55 ceiling, covering about 35% of our forecast production. WTI price has been much of the quarter at the lower end of the collar range, but we did not have any net settlements during the quarter. We don't expect to add hedges in the near-term as we do not have any significant financial commitments for debt or capital spending that we need to protect. Our internal guidelines permit hedging of up to 70% of our expected production on a short-term basis for up to 12 months in the future. But I don't expect we will be adding any hedges in the near future based on our current situation. Our G&A expenses of $1.2 million came in very much in line with expectations as our efforts to streamline the company and reduced discretionary costs have paid off. The key drivers for this are the settlement of our litigation, which dramatically reduced legal costs, and the separation of our artificial lift technology operations in late 2015. However, we have taken and continue to take many smaller initiatives to lower costs where possible, the most recent being the relocation of our office to lower cost course, which we completed in July. Our effective tax rate was a little below expectations at 33%. This calculation assumes that we will get some benefit from our $5 million of percentage depletion carryforwards, which lowers our effective rate. And at current prices, we continue to add approximately 2.5 million per year of additional percentage depletion, which will benefit future periods. In summary, the big news items for the quarter are the 30% increase in our common stock dividend, the retirement of our preferred stock, the completion and imminent startup of the NGL plant, and the continued positive performance of the Delhi field. And with that, operator, we are ready to take questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Brian Corales with Howard Weil. Please go ahead.

Good morning, guys.

Good morning, Brian.

Just a question on the NGL plant, congrats on getting that kind of on time and on budget. How should we think about the production volumes? I mean should we start to see a benefit in December or is that something that is a 2017 event?

Well, we expect to see some small volumes during the start of phase during December, but I look for and we hope to see full - a full month of production in January that's assuming that things go off as planned. So, I think we're - we're optimistic. Everything seems to be all systems go, but with any major project like this, you've always got some process of startup testing and working out the bugs and getting it up to full production. We do believe that it will start taking the full recycle CO2 strain that it’s designed for once - once it goes online.

All right. And then is there any way to quantify, I mean, some of these work over projects? It sounds like you approved the gross amount of $4 million or so. What kind of production uplift do you see from that?

Well, it's a complicated process. There is about 90 to 100 production wells in the field and they all fluctuate somewhat from month to month. So, we don't - we don't really have a target in terms of production. What we've seen is that some projects come on very strong and others are very modest. On a portfolio basis, we think we'll see a nice increase in production, several hundred barrels a day on a gross basis at least, but if it's not something, that’s easy to quantify well by well or project by project.

Got you. That makes sense. And then finally one more if I can. It seemed you had a nice increase in the dividend and I guess you're looking to reevaluate once the plant is up and running. How do you balance an increase in dividend versus share repurchases versus potentially bolting on another asset or so?

Well, one way to look at it is we're saving - the increase in our dividend is the penny and a half to $0.06. It was a couple of million dollars less the savings on the preferred where it's about a $1.3 million incremental cash outlay for the new dividend. So, it's not - it's not significant to our overall financial position or even cash flow. So, we can sustain this dividend. I think, fairly, fairly easily. We - we have a dividend - sorry a stock buyback program. We have not been active with that program recently. I think we will reevaluate that as we see the year unfolds. Some of that is price-dependent, value-dependent. And we are looking - we have been and we’ll continue to look for new opportunities. We have not found anything we felt was compelling to this point. But we are continuing to look at that. And so I think the way I would describe it is we've got a nice pool of capital resources, this $20 million of working capital after retirement of the preferred. We see that as funds for the right opportunity. And if we don't find the right opportunity, it's also funds for repurchase of stock.

All right, guys. Thank you.

Thank you, Brian.

The next question comes from Jeff Grampp with Northland Capital Markets. Please go ahead.

Good morning, guys.

Hey, Jeff.

Question, Randy, on the NGL plant, do you guys have a good idea or a better handle on what type of realizations we could be expecting once that's up and running or is it still a little bit up in the air?

It’s a little up in the air. At this point my view is we've - everything we've done to this point has been a theoretical calculation. We know what the CO2 recycle stream is. We know the percentage of hydrocarbons. We know the expected yield. But until the plant is up and running, we're still just making calculations. And so I prefer to wait until we see - we see the actual results. We see nothing that changes our view of the expected realizations at this point. The operator came out with their estimate. They were a little - a little cautious there. The upper part of their range was in line with where we were. They had a little lower bottom end of the range, but it's still - it's still within expectations, frankly, the original expectations that we - that we had when we first committed for the project.

Okay. That's fair. And then on the CO2 volumes that you guys reported for the quarter, I guess it looked to be a little bit higher sequentially, so just trying to get an idea, is that maybe a better run rate we should be thinking about going forward or does the - could things even maybe trend higher as you guys get the NGL plant online and start recovering from extra gas volumes out of the stream?

Yeah. First off, - to the first part of your question, we've been told that - we’re actually told of a couple months back that 60 million to 70 million a day was - was kind of the range - the target range that the operator was using. So, we - we - I would say that our current rate is representative maybe on the high end of the range, but probably for your purposes should be used as a run rate. On the second part of the question, we have gotten a little further clarification on the volume lost from the NGL plant and that is expected to be about 8 million cubic feet of gas volume per day. So, we may see an increase in purchased CO2 volumes based on the volumes that are being pulled out of the NGL plant, which is about 4.5 million a day of methane, plus the - the liquids - the volume of the liquids that’s in the stream. So, the plant - the plant produces about 150 - sorry, processes about 150 million cubic feet of recycle CO2 per day that's approximately 11% hydrocarbons on the inlet. It extracts the methane that's used in the - in the turbine to generate electricity. It extracts the liquids, which are sold at the field by truck. They'll be sent to processing plant over in east Texas. And so, we will see some volume loss. We also expect to see some benefit from the pure CO2 stream. So, that's another unknown that we really - we have some data on, but we can't fully quantify until the plant is up and running.

Okay. No, that's perfect color. I appreciate it, Randy, and I’ll let someone else step in.

The next question comes from Jim Collins of PG LLC. Please go ahead.

Good morning, Randy. Good morning, David. Congratulations on a great quarter. I just wanted to ask you to put on your predictive hat here. You mentioned that your collars, the 45 to 55 expired. So, where do you actually see WTI prices and obviously the LOS [ph] prices that you get going over the next six to twelve months and how you are positioned to react if that should happen?

Well your guess is as good as mine on most of this stuff but we are probably fundamentally a little more embarrassed than the industry has a whole, a little more cautious on prices the industry got very bullish over the past or two when prices broke about $50 you know with the apparent breakdown of the OPEC agreement that we've seen a pretty significant pullback. I guess we are really still waiting until the November meeting date to get final release or what will be the next decision point. So I would say we are cautious on prices but we are not sufficiently concerned about major shock to the downside that we would want to buy floors or put on additional colors. We still think there is some upside if OPEC can reach agreement so and like I said, our only real commitment at this point is the dividend and we feel between our relatively well protected downside on a cash flow basis plus some working capital we are in a position whether that without any real concerns unless it becomes extended and in fact we don’t see an extended long-term low price environment down in the 30s. It could certainly happen but we don’t really see that at this point.

Okay that’s very helpful, thank you Randy.

Thank you.

[Operator Instructions] The next question comes from Bruce Brown with Brown Capital Management Inc. Please go ahead.

Hi Randy, nice report and nice dividend increase. On the issue of CO2, you were saying that you will get a peer stream out of the NGL plant but it will reduce the volume because you are recycling CO2 with other gas components already in it, down into the field but as I assume so that would require you to purchase more CO2 correct.

It may and honestly we just don’t know that the physics is that, that lost volume needs to be replaced with something either water, oil or CO2, there is continuous process of very injecting water into the field as well as the CO2, the water is injected down to try to replace some of that loss volume and CO2 which is used for the recycle stream. We have seen a significant improvement in efficiency. They have done a lot better job with the efficiency of the CO2, in the field and they have got more production with less CO2 and that typically counter intuitive. So I think we are just, at this point I am just saying let's wait and see there is certainly a possibility we will see an increase in purchase CO2 but that really shouldn’t be a significant increase in our overall operating cost based on what we are seeing right now.

Okay thank you and another question on the derivative front. You mentioned that you had about 30% of production how far are you hedged in that regard at this point?

At this point, sorry I should have made that clear at this point we have no hedges in place we did have some what I was referring to was our hedges for the most recent quarters that just ended. We had a small percentage hedge and like I said we ride at a very tail end of our capital obligation on the NGL plant. We actually didn’t have the settlement in hand when we put those places, with those hedges in place. So we can hedge up to a year out and 70% of our production is our internal guide line this time based on the current makeup of the company.

70% non-hedge is what you are saying correct?

Sorry, we can hedge up to 70%. But at the moment we are -

All right I got it, sorry.

At the moment, we have no hedges in place, subsequent to September 30.

Okay and if oil price back up to 50, would that be an opportunity in your eyes to possibly pull down some edges?

It might be, our goal there would be to build a floor so we would almost certainly use colors, so we would select a price, somewhere in the 40s we felt comfortable and wanted preserve and we would select a price somewhere well above the current level that we would be willing to sacrifice any gains above that and that’s our collar that we would potentially put in place. So we might, we also might view based on the new information that the likely hood of it going higher is greater and therefore we wouldn’t be as concerned about the downside case.

All right, I understand.

All right. Good talking to you.

Good talking to you too. Yeah.

This concludes the question-and-answer session. I would like to turn the conference back over to David Joe for any closing remarks.

Thank you everybody for participating today and if any follow-up questions come up feel free to give Randy or myself a call. Have a great day.