Expand Energy Corporation (EXE) Q3 2020 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Southwestern Energy's Third Quarter 2020 Earnings Call. Management will open up the call for a question-and-answer session following prepared remarks. [Operator Instructions] This call is being recorded. I will now turn the call over to Brittany Raiford, Southwestern Energy's Director of Investor Relations. You may begin.

Thank you, Gary. Good morning, and welcome to Southwestern Energy's Third Quarter 2020 Earnings Call. Joining me today are Bill Way, President and Chief Executive Officer; Clay Carrell, Chief Operating Officer; Julian Bott, Chief Financial Officer; and Jason Kurtz, Head of Marketing and Transportation. Along with yesterday's earnings release, we also filed our 10-Q, which is available in the Investor Relations section of our Web site at www.swn.com. Before we get started, I'd like to point out that many of the comments we make during this call are forward-looking statements that involve risks and uncertainties affecting outcomes. Many of these are beyond our control and are discussed in more detail in the Risk Factors and the Forward-looking Statement sections of our annual report and quarterly filings with the Securities and Exchange Commission. Although we believe the expectations expressed are based on reasonable assumptions, they are not guarantees of future performance and actual results or developments may differ materially, and we are under no obligation to update them. We may also refer to some non-GAAP financial measures, which help facilitate comparisons across periods and with peers. For any non-GAAP measures we use, a reconciliation to the nearest corresponding GAAP measure can be found in our earnings release available on our Web site. I will now turn the call over to Bill Way.

Thank you, Brittany. Good morning everyone. We appreciate that you joined our call today and I hope that all of you are safe and well especially in this pandemic. The third quarter was incredibly eventful for our team and we very effectively managed the many challenges present from this pandemic with limited impact to our company or our people. While announcing an acquisition and completing two capital market transactions. Surrounded by volatility in the energy space as usual our team steadfastly delivered about target results, meeting our exceeding all consensus metrics. I want to turn for a moment to all of our employees across the country who are listening to this call and say thank you for your incredible dedication and commitment to our mission, I truly appreciate all that you do and I’m very proud of you. Over the past few years, we have executed a deliberate repositioning of our company reducing debt by nearly $2 billion, decreasing our expense cost structure by over $200 million, reducing well cost by 40%, strategically mitigating risk through hedging and investing in our high-quality Appalachia acreage to return the company to generating meaningful free cash flow. We now expect to generate $300 million in free cash flow in 2021 at current strip prices, once again we have delivered. In the third quarter, we announced the acquisition of Montage Resources further solidifying our position as a top Appalachia producer increasing scale, enhancing returns and positioning for greater free cash flow. We have been consistent in our message that the industry needs to consolidate to benefit shareholders. And we are pleased to have played an early role in this necessary trend. We approach this transaction with the same discipline that we exercised in all of our investment decisions and at market transaction with tangible synergies, which will be delivered at closing, while maintaining our balance sheet strength, adding scale to the existing assets enables us to leverage operational expertise, optimized commercial contracts, broaden and deepen our inventory base and enhance margins and returns and free cash flow all in a rising gas market. The integration process is on track and advancing as planned, in anticipation of closing following the Montage Resources shareholder vote scheduled for November 12. Having successfully repositioned the company, our two stated goals are free cash flow generation and a sustainable two times leverage ratio are expected to be delivered in 2021. We expect to release formal 2021 guidance early next year and based on current stock prices I've said before, our free cash flow estimate is approximately $300 million. We have no plans to invest about maintenance capital next year, holding production levels flat exit to exit from Q4 ’20 to Q4 ‘21. We expect to use free cash flow for debt reduction and to be clear, should seasonal prices improve further, we will not increase our activity level of maintenance levels. The third quarter included more examples of above target results as we once again delivered ahead of plan. Clay and Julian will detail that in just a few minutes. We further progressed our leading operational execution and efficiencies, setting numerous operational records’ we fortified the balance sheet and maintained our maturity runway by accessing the capital markets. And we delivered on further cost reductions we announced in the second quarter. Let me speak briefly about a core part of our strategy to continue our ESG leadership accountability and transparency. During the third quarter, we released our seventh annual corporate responsibility report, which highlights the results of our dedication to achieving sustainable returns for our shareholders and responsible energy development through a relentless focus on health and safety, practicing good environmental stewardship and being a good neighbor and active member of the communities where we work in lieu. It's not just something that we say or talk about, it's something we believe in and practice every day. So let me provide a few proof points supporting these beliefs and practices. SWN is a recognized leader in environmental stewardship, including a focus on reducing greenhouse gas emissions. SWN and our Appalachia gas peers are playing a vital role in providing clean burning low carbon natural gas to our country and the world, which is helping to drive reduced greenhouse gas emissions. SWN was one of the first companies in our industry to commit to a science-based methane leak loss rate target and we have consistently outperformed that aggressive goal. In 2019, we reported the lowest greenhouse gas intensity among AXPC peers in the annual EHS survey, and our methane intensity is 85% lower than the target rate for ONE Future. Another environmental and social focus is water, which is an important resource in our drilling and completion operations and for the public. Through a comprehensive approach to water usage optimization, water recycling and water conservation projects. We're delivering tangible benefits to the environment and the communities where we work and live. For the past four years, we've returned as much or more freshwater than we have consumed back to the watersheds in the communities where we operate. Another important pillar in our ESG strategy is to nurture and support a culture; we're fully engaged and committed people can thrive. And you can see from our results quarter after quarter after quarter, they're thriving. This is foundational in everything we do, developing our human capital and growing and maintaining an inclusive and diverse workforce is vital to our success. Before I turn over to Clay, I want to share our optimism about the future of the natural gas industry and SWN as a leader in that space. We believe that natural gas is foundational to a low carbon future, the benefits of natural gas and improving global emissions performance, the increased global reach of clean burning natural gas through LNG and the strengthening supply and demand balance all provides supportive outlook for natural gas fundamentals. Pairing these fundamentals with our culture of innovation at Southwestern Energy, we are poised to deliver differentiated and sustainable shareholder value. I'd like to turn the call over to Clay now for some operating highlights.

Thanks, Bill. Once again, this quarter, our operational teams achieved high-end performance, breaking company records, driving additional value and increasing capital efficiency. Our asset and operating teams continue to work safely and stay focused on the delivery of our operating and financial objectives. I'll start with a few highlights from the quarter. Total production was 221 Bcfe above the midpoint of guidance and up 9% from both third quarter of 2019 and the second quarter of this year. Gas production was 173 Bcf representing 78% of total production. Oil and NGL production was approximately 14,000 barrels per day and 73,000 barrels per day respectively. During the quarter, we averaged three rigs and three frac crews with capital investment totaling $223 million. Our full year capital investment will not exceed the top end of our capital guidance range of $915 million, including capital requirements related to Montage following the close of the transaction. This quarter we drilled 16 wells, completed 25 wells and brought 30 wells to sales with 18 in Northeast Appalachia and 12 in Southwest Appalachia. In Southwest Appalachia the wells were split evenly between the high rate, high volume rich gas area and the super rich condensate area. Well performance and 30-day rates for both areas are consistent with expectations and we continue to deliver well cost reductions through operational efficiencies, extended laterals and optimized completion designs. In the third quarter, we averaged $664 per lateral foot for all wells to sales. This included a new company single well record of $491 per lateral foot on a 13,000-foot lateral in Pennsylvania. We expect to beat our target of $650 per lateral foot for the second half of the year. Innovation and technology are core to continuing improvements in our operational performance. Our SWN rigs and frac fleet remain a differentiator as we continue to leverage and expand our operational and technical expertise. On a seven-well pad in Southwest Appalachia, our SWN frack crew tested an ultra efficient fracture simulation approach that simultaneously executes two independent zipper fracs on the same pad with one crew. Utilizing this approach, we set company records completing 22 stages in a single day and averaging 15 stages per day for the full path, resulting in greater than $400,000 per well savings. Another example of our innovation is in Northeast Appalachia, where we have been able to extract incremental value from our long live high-quality asset by drilling dual target wells that include a lateral that starts in the upper Marcellus interval before dipping down into the lower Marcellus. This process which requires precise drilling techniques, subsurface control, strategic leasing and land efforts has allowed us to improve well recoveries by capturing additional tier one resource in a single well through multiple intervals. We continue to drive innovation, which is core to our high-performance culture to challenge the operational and technical norms and maximize the value of our assets. We look forward to finishing the year strong while carrying our operational momentum into 2021. We're also excited to close the Montage transaction and get our SWN rigging crew up and running on the new assets. I'll now turn it over to Julian for the financial results.

Thank you, Clay, and good morning, everyone. In the third quarter, we reported adjusted net income of $47 million, EBITDA of $154 million, a net cash flow $135 million when excluding one-time non-cash charges. The quarter was in line with the updated guidance, reflecting a change in production mix due to our shift to high rate, high volume natural gas wells back in April. At the same time, we captured the savings across all expense categories that we announced last quarter as a result of our ongoing concerted cost management efforts. We continue to benefit from our disciplined hedging strategy, with $97 million in cash settlements in the quarter, bringing our total for the year to $310 million. We're taking advantage of the strong run up in gas prices for 2021 and have been layering in substantial protection. We now have over 75% of our expected 2021 gas production hedged with Collar's being the prominent instrument. $20 million of hedging gains this quarter were related to our basis hedges that largely offset the weaker differentials witnessed in the region during the third quarter due to high storage levels, lower seasonal demand and maintenance outages. Through our transportation portfolio, contracting strategy and basis hedges, we were over 90% hedged on basis in the third quarter with forecasting fourth quarter realizations in the $0.80 to $0.90 range per MCF discount to NYMEX. This will be partially mitigated by our expected $0.15 to $0.20 gain from financial basis hedges. As usual, we expect basis should improve later in the fourth quarter and throughout quarter one of 2021. NGL prices this quarter improved 62% compared to the second quarter of this year. We expect continued strengthening of NGL prices as we moved through the rest of the year, with fourth quarter expected realizations in the 28% to 34% of WTI, consistent with assumptions in our full year guidance. A highlight of the quarter was the announced at market acquisition of Montage and we were pleased with the execution of the associated capital markets transactions. While we're excited about the deal synergies and efficiency opportunities driving our increased free cash flow estimates, it was equally important for us to maintain our balance sheet strength and leading maturity runway. Although the capital markets have been challenged and volatile for E&P companies this year, we successfully accessed both the equity and debt markets with approximately 500 million in total net proceeds, which will be utilized to refinance the Montage 2023 notes upon closing of the acquisition, keeping our favorable maturity runway intact. Until closing the proceeds have been used to pay down our revolver and we ended the quarter with no borrowings a cash balance of $95 million and total debt outstanding of $2.5 billion. Subsequent to the quarter, we announced that our borrowing base has been reaffirmed at 1.8 billion, with bank commitments to increase to $2 billion at the closing of the Montage transaction. With current bank price decks, our reserves offer strong coverage well above the elected commitment level. We appreciate our continuing bank relationships and their demonstrated confidence in and support of the deliberate path we are on. Our quarter end leverage ratio was 3.2x and as we have previously discussed, we expect debt to EBITDA to decrease throughout 2021. With the accretive acquisition, cost reductions, operational efficiencies and improved commodity prices, we expect to achieve our goal of 2x by the end of next year based on current strip prices. As Bill mentioned earlier, we have successfully delivered on several key initiatives and we look forward to meaningful free cash flow generation and further debt reduction. With the actions we have taken and the progress we have made, we are well positioned for the future. That concludes our prepared remarks. So Gary, could you please open the line for questions?

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Charles Meade with Johnson Rice. Please go ahead.

Bill, I appreciate you guys directly, both in the press release and in your earlier comments given the outline that that you guys are going to hold the line on 2021 spending. And I think that will be welcomed in the market. But I'm just curious, if there are other aspects of flexibility you guys have in your plans for 2021 that you might be able to exercise if we do see more strength in the curve? Is it added compression, is it -- are there different transportation events? Are there any other things that you guys might be able to do in response to higher pricing?

I think it's very interesting and actually terrific that we're in a place where we're looking at higher pricing into next year and we're very excited about that. The duration of that higher pricing where that goes is a key factor in thinking about whether you invest further or you continue to pay down debt, we're going to be responsible, as we said and do exactly what we said. We've got a lot of examples throughout the business of optimization, whether it's driving lower well costs, you heard about the kind of incredible example of two simultaneous zipper facts at the same time on the same pad with one team, our lowering of well cost, our optimization of commercial agreements, a number of those kinds of aspects, all helping to drive our maintenance capital level down and drive the efficiency of our capital continuing to rise. So we have a lot of levers at our disposal and the team's -- most of them are listening on this call. But the teams are constantly finding ways to innovate past what we thought was even possible to excel. So I would tell you that commercially, operationally, financially, there's a number of different opportunities, even getting Montage integrated and enabling our SWN own drilling and completions teams access to those and integrating the Montage team that we've met and quite like into the company, there's lots of those levers that will pull. We've made changes and optimization around decline rates already that will continue, Clay could talk for days about all the things that have been done in the drilling side, completion side. And then, we've got quite a commercial and we've demonstrated this, we've got quite a commercial team working on optimizing agreements, integrating even the Montage production with our transportation, that sort of thing. So there is a lot of upside there. I think the other thing that is important as well is the, our work around hedging and assuring that we that we remain disciplined and deliberate in our hedging program, which is a 36-month program and optimizing the use of swap collars for the given market that we're in. So while we're very well protected on the downside, we have access to the upside. And that gives us further flexibility. But let me be clear that that we don't have any intent to invest the dollars that would take us beyond maintenance capital. And any excess cash flow that comes from seasonal price changes, at least at this point would go to pay down debt. And that's the right thing to do. And so that's what we would do.

Got it. Thank you for that Bill. And naturally I have a lot of questions around the Montage integration but I'm going to leave those for someone else and then just take a rifle shot at it at comment that Clay made in the prepared comments. Clay, can you go back over and give us a little more color on what's going on with those dual target wells between the upper and lower Marcellus and [indiscernible]. I guess I've a little confusion right now but what that does for you, but I'm sure you could clear that up for me, if you just or added comments.

Yes. We included it as another example of the innovation and technology that our teams are using, to just keep getting the most value we can out of our assets. And so, it's an example of the capability of our rigs and our crews and our technical teams, where there's areas in our fields in Bradford and Susquehanna County, where there's non-drained quality, lower Marcellus acreage that has not been accessed yet, that we're able to access via an S shaped lateral where we start off in the upper Marcellus, where we are generating good economics, testing and completing in that interval, but then dipping down into the lower Marcellus to go pick up that part of the acreage that has not been drained and do it on a long lateral that benefits from all the efficiencies of the long laterals, so that our economics benefit from it. And the team has done a great job of acreage trades, leasing, et cetera, to bring those opportunities to life. And they're just adding to the economic development of our fields.

Got it. Clay just a quick follow-up. So if I understand this is a segment of the lower Marcellus that is maybe strayed in the sense that it will only support like a one or 2000 foot lateral but you can tack it on to the end of an otherwise an upper Marcelle as well. And then, is that the right understanding?

Generally, you got it exactly right, short laterals turn into longer laterals by a combination of upper and lower, and then you get the full economic benefit of that.

The next question is from Arun Jayaram with JPMorgan. Please go ahead.

Bill, my first question, just kind of on the macro picture, you've been clear that you're going to be investing on a sustaining CapEx kind of mode in 2021. Post the merger, I guess, a bigger picture question we get from investors is, what gas price would Apalache operators need in order to incentivize some growth over the long-term?

Yes. I think that largely and if you think about spikes in gas versus breath of a strip over multiple periods of time, in our view, seasonal surges, six months, a quarter, even a year, it is a sort of a defined point in time. And if the rest of the strip isn't coming up with it, it's all about economics of wealth. And best use of capital and/or cash flow from the company. And so we've been pretty clear that a seasonal surge, you don't invest in that because wells are three years, four years economics, and you want to have and we don't use hedges. So when you look at it like that, it doesn't make sense to go further. If you step back from it and say okay, well, we have a sustained period of higher pricing, multiple years of higher pricing, that probably means that there's been something in the supply demand mix that has caused that shift and that it's sustainable. And then, if you can hedge it and assure yourself that those revenues and cash flows, then you have to reevaluate that. But that is a situation that isn't represented today in the curves and something scenarios that we analyze, but right now with what we can see in front of us and where we sit today, free cash flow generation is important to us investing that maintenance capital is what makes sense to us, so that we don't have decline in the company and paying down debt at least at this point, paying down debt is the other lever that we optimize Arun.

Great, great. Bill, it also seems one of the headlines in your update was the 300 million of free cash flow, which you did raise, I think from 100 million pro forma from Montage. Can you give us maybe some of the key assumptions around that obviously, production will be on a sustaining CapEx mode. So we can get that, but what are some of the assumptions around capital? Some of your differential assumptions to underpin that caught that $300 million number that you put in the press release?

Yes. This is Julian. Actually the -- so the 300 is really consistent with the way we were looking at the business back when we announced the Montage transaction and talked about that $100 million, we've obviously seen the biggest factor improvement in prices. So I think when we had done it and put the post announcement out, it was in the 270s. Now it's obviously close to three. So big run up in prices has certainly helped and we keep building our hedge position to get certainty around that as well. When we think about moving forward, we haven't yet outlined the activity levels. But we've obviously now said what we expect to roughly to spend in the way of a maintenance capital number. And we continue to project forward the cost realizations that we have been able to already accomplish. And that includes the $30 million of synergies that we saw in a Montage transaction, which we're now very confident will be realized, at closing, essentially. So, firming up of progression of costs, but not a large stretch in future cost savings just what we have already realized, is giving us that confidence.

And is that capital, Julian in the $850 million to kind of $900 million range. Is that a good starting point?

Yes. I think that's probably about right. I mean, $700 million to $750 million is the number on a D&C basis, and then you've got the CI&E.

The next question is from Neal Dingmann with Truist Securities. Please go ahead.

My first question, just you mentioned on some of these well designs, I guess my question is now is, how do you all think about what you determine optimal well design today, maybe size, scale, et cetera versus how you even thought about it a year or two ago?

Yes. My thought would be that it keeps evolving. We keep putting completion and drilling designs in place that are building on the knowledge that we keep gaining every time we're bringing wells on. And we keep trying to optimize the overall economics of the well, obviously, our lateral links are increasing. So we're going to average a little over 12,000 foot laterals for the program in 2020 and that was 10,000 foot laterals in 2019. The completion designs, like I said, we use data analytics and we keep evolving what the right mix of stage spacing, cluster spacing, proppant loading, fluid rates is in certain areas to optimize well performance. So as we go forward, it's going to be to methodically and smartly keep extending the lateral links on the wells as a result of the economic benefit that comes from that. And then continuing to fine tune and optimize in the different areas of our development where we can keep increasing the returns on the capital program.

So it's a great tension between manufacturing mindset, drive, every cost drive every revenue, and the appropriate tension that we're now going to be drilling in Utica with a Montage and upper in [indiscernible] and lower and liquids rich and not liquids rich and dry gas. And so the customization with the manufacturing mindset, we believe drives better economics even going forward and you'll see some improvements across the piece in well cost and well design.

Our next question comes from Holly Stewart with Scotia Howard Weil. Please go ahead.

Maybe first one for you Bill, just as you've kind of moved through this due diligence process with Montage and the assets. Have you learned anything that maybe you didn't realize sort of early in the process that would add additional value sort of post close?

Well, I think we did -- the teams did a great job of diligence along the way in course of the analysis. I think the ability to get and deliver a no premium at market transaction and really fine tune that action with how we invest in everything that we do, is certainly was played out in all of that. We've learned, they have some terrific people that are going to come join SWN and we're very excited about that. I think we knew this, but we also get a new learning lab to learn about Utica, because they've been drilling in Utica. And so our people are very excited about bringing this together, building on our culture and continuous learning. So we will, it's an ongoing learning process. I think that we have some -- a lot of optimism around additional commercial and marketing optimization or drilling and completion optimization, looking at their base production, their decline rates higher than ours. So how do we bring that, how do we learn from one another and get that down? With the increased scale, strategic sourcing and procurement opportunities there. It will be an ongoing learning process. It's a great question rooted in a one team approach with our new colleagues. And we're pretty excited about getting this thing closed.

Thank you. Great. Thank you. And then maybe just my follow up on the cost reductions. I know you've talked about midstream costs in the past is something you would kind of continue to pursue to drive down costs. Maybe how are those conversations going, I think one of your partners is DTE, and they've announced plans to spin out their midstream. I didn't know if there was anything to think through in terms of that.

We're in the middle of a lot of these discussions. So I'll respect the privacy of that till we get done. But if you think about it, as you look at all of our agreements, the performance of our teams and the reservoirs and the amount of gas that we've produced through time, has been very strong and ahead of what we anticipated in a respect. So rather than being in a position of carrying a bunch or paying out a bunch of empty seats, we've actually been building a lot of credit and a lot of goodwill with our gathers in particular, because we've overproduced versus what they thought that they were going to get. So there's always opportunity there, there's additional dedications, there's just thinking about how the contracts are structured and making adjustments necessary. So they work for both those companies, these are long-term strategic relationships and, and so building on those is critical. We completed some of the negotiations and some of that's got into the bottom-line. And they'll continue through the next several months. And then of course, again, as we bring Montage in and apply this production to some of our medium haul and long-haul commitments there's opportunities there. We have the same thing going on the liquid side, as we take more and more control of our own liquids, and market them and then look for commercial arrangements around some of the infrastructure we have tied to that.

The next question is from Harry Halbach with Raymond James. Please go ahead.

Julian have mentioned that Montage space declines a little bit higher than yours. How do you all thinking about it like consolidate base decline upon close and how is that changing after a year and maintenance though next year?

Yes. So their base decline is in the 35% to 40% range coupled with our low to mid 20s. And so when you combine all that, we think we're going to be mid to upper 20s initially and then we're going to be focused on utilizing similar techniques that we have used on our assets to shallow that base decline.

In our plans we announced, we will have activity in our two divisional areas, plus Montage their wells compete in our capital allocation plans that we have, it's all about economics. And so we've already integrated from a planning perspective, integrated what we know about that into our program. So our maintenance capital number and the maintenance capital planning is going on with that already includes what we believe to be from all of our due diligence, all of those details. From here, it won't -- it shouldn't change, unless it gets better because as we learn more and more about it, we've taken the company's decline rate down significantly with field optimizations and a number of things that that we've done around productivity, all of that learning just simply sweeps over to the assets that we will run together in, when this thing closes. And we expect to get some additional benefit out of that. And we'll talk more about that when we do that.

Great, thanks. And then, Julian have mentioned that you're expected to hit your 2x leverage target next year under strip and I guess I'm just wondering, what sort of leverage you're looking at before potentially returning cash to shareholders and what is the best way [indiscernible] do that, whether it be repurchases or dividend?

Yes. I think we've been very focused on getting back to sustainable 2x, we said that for several years now and we've accelerated getting there in light of the announcements we've made regarding price improvement and then the cash flow improvement. So, we want to get there and we want to sustain it. So first of all, two times sustainable. And then, when we do get there, we will consider return of capital to shareholders much in the way that we've always have, which is look at what makes the most sense for long-term value creation for shareholders and stack up the options and see which one is most favorable. But I think as Bill as said, free cash flow and then the balance sheet 2x leverage is a goal. And we do think we can get there. We're not there yet. So we haven't had to tackle the next question is what do you do when you get that.

And if you think back to the sale of Fayetteville, this team has demonstrated discipline to look at that objectively walk through the various uses of cash flow and as we did then distribute some to shareholders, pay down some debt and invest in the company to be sustainable. And we've arrived at that moment now, which is quite exciting.

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

Thanks again for all the questions and discussions and as I think you can tell, we believe the company is well positioned as a leader in responsibly produce energy, namely natural gas. And as we've discussed, there's a lot to be excited about the future of Southwestern Energy. So thanks again for your time on the call and have a great weekend and we look forward to the next call. Take care.

This concludes the Southwestern Energy's third quarter 2020 earnings call. You may now disconnect.