SandRidge Energy, Inc. (SD) Q4 2018 Earnings Report, Transcript and Summary

Good morning. My name is Mariama and I will be your conference operator today. At this time, I would like to welcome everyone to the SandRidge Energy Fourth Quarter 2018 Earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. I would now like to turn the call over to Johna Robinson. You may begin your conference.

Thank you, operator, and welcome everyone. With me today are Paul McKinney, President and Chief Executive Officer; Mike Johnson, Chief Financial Officer; and John Suter, Chief Operating Officer. We would like to remind you that in conjunction with our earnings release and conference call, we have posted slides on our website under the Investor Relations tab that we will be referencing during the call. Keep in mind today's call contains forward-looking statements and assumptions which are subject to risks and uncertainties, and actual results may differ materially from those projected in these forward-looking statements. We will also make reference to adjusted G&A and other non-GAAP financial measures. Reconciliations of these measures can be found on our website. Now let me turn the call over to Paul.

Thank you, Johna, and good morning everyone. Before we get started, I'd like to take this opportunity to thank Bill Griffin for his service and contribution to SandRidge. As most of you know, Bill served as our CEO during the last year. His leadership, hard work, and deep rooted knowledge of our industry were instrumental in achieving numerous accomplishments during his tenure and have set the groundwork for our path forward. Bill, you did an incredible job leading this company and I certainly appreciate everything you did to bring me up to speed. Collectively from me, and the employees of SandRidge, thank you for your leadership and service. Now with respect for everyone joining us on the call, we appreciate your interest in SandRidge and for taking time today to join us as we review our 2018 fourth quarter and full-year results, our new business strategy, and our outlook and guidance for 2019. We'll be referencing the investor presentation posted on our website earlier this morning. So I encourage you to use it to follow along. Now turning to Page 3 of our presentation, one of the first things we did upon my arrival was to develop a new business strategy. We deliberated on the principles and industry best practices that we believe lead to success and organize them so we can articulate them to our employees and to ensure they become a defining aspect of our culture. Our business strategy is focused on a few key components we believe will drive success as we acquire, explore for, and develop hydrocarbon resources in the United States. Simply stated, we will attract, retain, and motivate the people we need to succeed. We will be defined by our operational excellence and sense of urgency delivering low-cost consistent and efficient execution of our drilling programs and operations and we'll do that in a safe environmentally responsible manner continuously seeking ways to reduce our cash costs. We will prioritize and allocate our resources to project that deliver high margins and returns knowing full well that this would be the defining aspect of our future profitable growth. We also intend to reduce the break-even costs of our portfolio of investment opportunities through accretive acquisitions, mergers and dispositions because we know that this is key to profitably growing on a sustainable basis. Finally, we will continue to exercise financial discipline by protecting our balance sheet through the responsible use of leverage and hedging and financial strategies that sustain our capital program and ultimately delivers free cash flow with competitive debt adjusted per share returns. Believe me, when I say this, this management team knows not only do we need to do all of these things to be successful, we know that we need to do all of them, all of the time. So with that being said, we will turn this over to Mike Johnson and John Suter to review our 2018 fourth quarter and full-year results and once they're done, I will share more on our vision for the future and to provide a few more details associated with our guidance.

Thank you, Paul. And I'd like to extend a very warm welcome to you on behalf of the employees of SandRidge. We are all excited to have the opportunity to work with you and to build a brighter future for our company and our stakeholders. I'll be commenting broadly on various aspects of our earnings release as well as Slides 4 and 5 of our earnings presentation. Our fourth quarter and full-year results exceeded our expectations. We also met or beat full-year guidance on production, capital expenditures, LOE, and adjusted G&A. 2018 was a year of transition at SandRidge and we believe that the pillars for future growth and sustainable returns on our capital investments are now in place. We're very encouraged by our 2018 results and are anxious to move forward with a singular focus on our new business strategy and profitable growth plans. We posted fourth quarter net income of $54 million compared to a net loss of $19 million in 2017 and we generated fourth quarter adjusted EBITDA of $45 million compared to $49 million in 2017. With full-year adjusted EBITDA of $167 million and capital expenditures of $171 million, this level of outspend is a clear demonstration of our financial discipline. We also significantly reduced production costs by $10 million in 2018; a 10% decrease compared to 2017, and adjusted G&A by $19 million or 34% year-over-year. Our fourth quarter divestiture of legacy assets in the Central Basin Platform and the acquisition of working interest in the majority of our Mid-Continent properties were small but meaningful steps to simplify our portfolio, improve profitability, enhance value, and allow us to focus on our core operations and development strategy. The divestiture eliminated more than one-third of our well count which collectively averaged only one barrel of oil equivalent per day and contributed only marginally to our profitability. It also eliminated $27 million of asset retirement obligations. The simultaneous acquisition of additional working interest in most of our Mid-Continent properties was an effective way to redeploy the sales proceeds toward a bolt-on acquisition that didn't require any additional staffing. Although neither of these transactions were particularly significant in size, they are the first of many initiatives to maximize our returns and reduce our break-even cost. Shifting to the balance sheet, our liquidity remains strong with $11 million in cash and an undrawn $350 million credit facility as of February 20. While we remain committed to maintaining attractive debt metrics, we're very pleased to have this level of liquidity available as we grow the company and execute our development plans in 2019 and beyond. On the derivative front, as oil prices drop throughout the fourth quarter, and approached levels we didn't believe were sustainable, we lifted all of our oil derivatives for a nominal payment and placed swaps on 4.5 Bcf of natural gas production in the first quarter of 2019 at an average price of $4.28 per MMBtu. We intend to layer on additional commodity price derivatives during 2019 as opportunities arise. Lastly, as you'll review our 2019 guidance, I'd also like to point out some important changes we've made to conform our guidance and related financial reporting to the way we intend to present certain results of operations beginning in 2019. These changes are intended to improve transparency and better align our reporting conventions to those used by the majority of our peers. First, production expenses will be retitled lease operating expenses. Second, ad valorem taxes, the majority of which were previously included in production expenses will be included in a new expense category labeled severance and ad valorem taxes. That's it from me at this point. I'll turn it over to John for his thoughts on the fourth quarter operational results and his outlook going forward.

Thanks Mike. Let's look at the operational results for the full-year 2018. Our performance allowed us to meet or beat our full-year guidance for production lease operating expenses and capital expenditures. The company spud 36 wells with total CapEx of $171 million while producing 12.3 million barrels of oil equivalent at an average lifting cost of $7.52 per BOE. Moving now to our North Park Basin asset in Colorado on Slide 6. We utilized one rig approximately seven months in 2018. We spud 13 wells consisting of 12 XRLs and one SRL. At the beginning of 2018, we outlined plans to drill two spacing tests and to further delineate the southern edge of the field. As you will recall, we began the year drilling the next four wells of an eight well Eastern spacing test that utilized a 12 well per section spacing pattern. This test spaced wells 1,320 feet apart on each of three offset stacked rows within the Niobrara interval. These wells were completed and came on line in Q3. On Slide 7, you'll see the average production of eight wells drilled so far in this test is cumulatively beating the type curve by 14% after 320 days with minimal pressure interference. This group has already cumulatively produced over 1.1 million barrels of oil since inception. Returning to Slide 6, the next six wells in the Western spacing test utilized the 23 well per section pattern. These wells were spaced 660 feet apart on three offset stacked rows, twice the spacing density of the Eastern test. We used micro-seismic testing during completion of these wells to help determine optimal spacing considering well placement, simulation size, and drainage pattern overlap. These wells recently went to sales. We anticipate a full review of results versus type curve and micro-seismic learnings on our next call. The results from both spacing test will help determine the proper well density to use in our core acreage. We're excited about the potential impact of these tests may have on our drilling inventory. The final two wells of the year were drilled on the far Southern end of the field. There are the first two wells of three wells set roughly a mile east of the Legacy Surprise 2-8 one of the best performing SRLs in the field. Those wells have been stimulated subsequent to the quarter and should be online by the end of Q1. New drilling in 2018 helped push our North Park Basin oil production to new heights. For the year, net production was 1 million barrels of oil, a 53% improvement over 2017 production. We achieved a monthly average peak net rate of 5,060 barrels oil per day in August. In the fourth quarter with no new wells going to sales due to continuous multi-well pad drilling, we produced 314 MBO. Production increases from the field will be irregular due to the utilization of cost effective pad drilling with one rig. The graph on Slide 8 shows the expected oil surge in early 2019 due to 11 wells going to sales in the first quarter. Now moving to Slide 9, progress is being made on our gas processing facility installations. Our mechanical refrigeration unit has been up and running since January 2019. The unit reduces emissions by stripping natural gas liquids out of approximately 2 million cubic feet per day or 30% of the total field gas stream. Fabrication continues on a gas to liquid skid at the same site and is scheduled to be in service Q2 2019. The new GTL skid funded by a third-party will process 500 Mcf per day and is designed to completely convert the gas into marketable liquids leaving no residual by-products. The process reduces emissions while providing a minimal revenue stream. Upon a successful outcome, additional GTL facilities could be viable alternative to a large scale pipeline installation. We continue to examine both options as we evaluate the total resource potential of the field. On Slide 11, our 2019 strategy for North Park will be a balanced program of drilling including PUD, delineation, and extension wells. We intend to drill two to four vertical extension tests on the eastern flank. This side of our acreage has a deeper structural position and is anticipated to have higher pressure. The test should provide further validation into the resource potential with commodity mix using minimal capital before committing to horizontal development options. Additionally, we intend to expand operations further into the Peterson Ridge Federal Unit on the northern side of the play. This will improve our understanding of natural fractures, reservoir pressure, and hydrocarbon content while meeting unit obligations. Finally, we plan to continue development drilling efforts on the southern side of the field with infill development between the Surprise Federal Unit and the Big Horn facility. Switching to our Mid-Continent assets, we utilized one to two rigs during the year with D&C capital expenditures totaling $27 million to develop both Meramec and Mississippian targets. Total production from the Mid-Con was 10.9 million barrels of oil equivalent, 20% oil with further unit lease operating expenses of $6.11 per BOE. Referring to Slide 10, our Northwest STACK objectives for 2018 were to utilize the drilling participation agreement, to delineate and hold high graded acreage, improved targeting, and optimized drilling and completion techniques. Through the agreement, we drilled 15 wells or $6 million net D&C costs and converted 5,800 acres to a held by production status. We also were able to improve our completions utilizing 2,000 pound per foot sand concentration from 1,200 pound per foot, while adopting different fluid combinations with multiple stages of diversion. Realized cost improvements came from our average cost per foot which was a 19% decrease from 2017. Additionally, our most recent well had the fastest spud to rig release cycle time to-date of 12 days. As a result of core area delineation, three higher interest wells were drilled outside of the agreement acreage and are now on flow back. On the bottom of Slide 10, you'll see we drilled and completed four Mississippian wells in the second half of 2018 with mixed results. These wells had an average 30 day IP of 399 BOE per day, 58% oil. Two were located at least one half mile from the nearest offsets but encountered 48% lower initial pressure than their parent wells. We will continue to monitor performance and assess future opportunities. Back on Slide 11, our 2019 Mid-Continent development program will focus on finalizing the first tranche commitment under the drilling participation agreement by mid-year. Based on the learnings from this program, we will have an inventory of high interest Northwest STACK infill wells available. As commodity prices allow, we will look at these as well as our Mississippian assets for development opportunities. In closing, we had a year of operational successes. We met or exceeded all of our guidance metrics and drove value improvements in both plays. Our 2019 strategy will allow us to build upon the learnings from 2018 and set us up for cost effective development and expansion in future years. I also want to thank our team for continually focusing on safe practices, innovation, and operational excellence. I'll now hand it back to Paul for final remarks.

Thank you, John. And before sharing with you my vision for SandRidge, I believe it is appropriate to share a little about me, my background, and the events in my 35-year career that shaped my world view. I began my career in 1983 with Anadarko Production Company which was at the time a wholly-owned subsidiary of Panhandle Eastern Pipe Line Company. Technical excellence was a defining aspect of Anadarko's culture during my tenure of almost 24 years there. Later after moving on to Apache Corporation, I was impressed by their insatiable quest for operational excellence and their sense of urgency to get things done. During my most recent experience at Yuma, I learned the incredible importance of liquidity, the need for accurate forecasts, and to consistently look for ways to reduce cash costs. Throughout my career, I have learned that integrity trumps all and that discipline, hard work ethic, and humility are important traits of the best leaders. Now with this new role, I bring the best aspects of my experiences to SandRidge with a very clear vision of building an organization that delivers a competitive and sustainable rate of return to our shareholders. And while doing so, improving lifestyles in the communities in which we operate, and our reputation with our partners, stakeholders, and the regulators with whom we do business. Switching gears now to address our vision, the SandRidge board has given me a very clear mandate to profitably grow this company in a disciplined manner with a long-term focus. Having said that, we believe, we can grow SandRidge in essentially two ways this year. We can grow organically by investing in the opportunities we have in-house and we can grow by pursuing accretive M&A opportunities in the marketplace. With respect to the organic growth, and as John said earlier, results from our North Park drilling program continue to exceed our expectations. So we plan to allocate approximately 80% of our 2019 operating cash flow to support the development and extension program going on there. This capital program is the primary reason our oil production is estimated to grow 9% year-over-year allowing all to make up approximately 32% of our total production and when combined with NGL estimates, hydrocarbon liquids are estimated to be slightly more than 50% of our 2019 production. We believe North Park offers good risk adjusted rates of return and the upside could be very compelling for a company of our size. Part of our North Park capital program, as John mentioned this year, is designed to help reduce the uncertainty with respect to the resource in place because we truly don't know how big it is. If we find that all of our acreage is equally commercial as our approved area, we could have as many as 2,000 wells or more to drill there. Hence the reason why we're so excited about North Park. Now with respect to drilling opportunities, we have in the Mid-Continent area, we intend, as John said, to continue drilling our Northwest STACK locations until the first tranche of our drilling partnership comes to an end. And that should occur sometime in late spring or early summer. As many of you know, we have additional Northwest STACK in Miss Lime location to drill but their economics are not as compelling at today's prices as we'd like. We consider the volatility recently seen, the marketplace needs to offer more confidence to our product prices are going before we're willing to ramp-up those programs. As summarized in our guidance, total production is estimated to decline this year by 5% to 6% due to declines we have experienced in our largest asset, the Mississippian Lime. The capital program necessary to arrest this decline and grow our production in 2019 would need to appreciably exceed our estimates of operating cash flow and we're just not going to do that. This puts pressure on us to further reduce our cash costs below the levels achieved in 2018 and it also puts pressure on us to find new opportunities to increase our production. Because of these and other considerations, we have decided to preserve our liquidity to pursue acquisitions in 2019. We believe that accretive opportunities are available in several attractive U.S. plays and we also believe that some of them appear to be in somewhat of a buyer's market. When considering the support we have and the pristine balance sheet we possess, we can bring the necessary resources to the table allowing for a quick close which should be an advantage for us in the eyes of potential sellers. We intend to take advantage of these circumstances and hope to be an active participant in the M&A markets this year. In closing, I'd like to share my sentiments with respect to our current stock price and how I believe that compares to most industry standard valuation metrics. Simply stated, our spending I'm sorry after spending time, getting up to speed on the company and its capabilities, I believe our stock is very attractively valued. We look forward to changing the market perception of SandRidge through delivering results from our new business strategy that focuses us on the right components that lead to success, building a winning team, pursuing operational excellence with an eye on improving our efficiencies and reducing our cash costs, allocating our capital to high margin, high rate of return investments, upgrading our portfolio by reducing our breakeven costs, all while doing so in a framework of financial discipline, balancing our growth plans with the need to retain a strong balance sheet and a razor sharp focus on providing competitive debt adjusted per share returns to our shoulder. Having said all of that, at this point I'd like to express my sincere appreciation to all of you joining us on the call today. We'll now turn the call over to our moderator and open it up for questions.

[Operator Instructions]. Your first question comes from the line of David Beard with Coker Palmer. Your line is open.

Hi, good morning everybody. Thanks for the clear description and slides.

You're welcome. How are you, David?

Good, good. A couple of small questions and move to some bigger picture questions. Could you give any color relative to your assumptions behind your 2019 production guidance from the North Park? Really I'm trying to triangulate between you gave first and second quarter in the slides and where you kind of expect to end up third quarter, fourth quarter relative to the full-year?

Yes, thank you, David. This is John Suter. Yes, certainly the Q1 and Q2 that we show on Slide 8 is in reference to all the wells coming on in Q1. And then with the current capital program, we finish up potentially drilling in Q2 and then it should be done until about the end of Q4. So as far as Q3 and Q4 production, I need to look that up here real quick but should be seeing some declines off of that Q2 number that you see without new drilling, we don't generally guide per basin on production.

Right, right. Now that's helpful. I know there's a lot of seasonality associated with drilling, so just trying to get some color on that, so that's helpful. And then would you look at this GTL project you'd said hey we want to see some metrics before we can determine if it's scalable. Can you give me a little color of what you're looking for? It doesn't seem like there's any hurdles at least from the outside to having this be scalable but obviously you guys are on the ground. And so what do you need to see to scale this?

Yes. So this is -- this is an existing technology but it is relatively, relatively new patented process that makes this process work. We just want to see it executed with our gas stream but there's no surprises. We feel confident that it will. But we want to see that. And then as Paul mentioned understanding the resource potential play especially on the Eastern Flank where there's a dramatic amount of acreage there that could make a significant difference of what product needs to be processed or moved out of basin gas wise that would make a difference whether gas to liquids would be a reasonable alternative or whether the Midstream solution makes more sense. But again we have no, no real big surprises anticipated here. We want to see it work. And then, as we gain more information through the year, we'll work that decision little harder.

Yes, David. This is Paul. I'll jump in on that. Again it goes back to what John said it's a function of the resource in plays. If the GOR continues to be the same across all of our acreage, that will suggest that we'll have relatively less gas and so perhaps that won't be enough to -- won't be enough gas to justify bringing in a pipeline. So maybe GTL will work. But if we find that we have a larger gas component of the resource in plays well then that could justify a pipeline. So that's part of the reason for the capital spend this year in terms of the vertical wells trying to understand the resource in plays because all of that will come together towards the end of the year, we'll know a lot more towards the end of the year. Does that help?

That makes sense, really it's geology driven versus engineering of the plant driven so that makes sense. And then just a little bit on the density tests, it is all surprising you went so dense on that Western testing, are trying to push an upper boundary or just give me some thoughts behind that Western testing?

Yes, it goes back to what we're seeing in the marketplace. If you look at the history of what's happened in our industry back when oil prices were really high, companies were very quick to go to down spacing and putting more wells in acreage than perhaps they needed to. The right way to do things is basically what this company did before I arrived and they started to test. And so when you consider that you have potentially a tremendous number of wells to drill, the best thing you can do is learn what the proper spacing is early upfront and if that takes a few wells that might be more tightly spacing, they should have. That gives you the information so that the rest of your development can be developed on the proper spacing. So that's the purpose of both of these tests. And so, yes, some people could say that the 23 wells per second test might be a little bit too many but we'd rather know that now than spend than learn that 500 wells from now. And so that's the whole purpose of this. This is the SandRidge team has taken pretty much a classic engineering view to solving the problem before you spend significant dollars.

And David I will add that even though it's a 23 well per section pattern, we do understand how drilling the full section up would be too early. So we've drilled six wells on that pattern, two in the B, C, and D benches. So we have really only put minimal capital into that. That should give us some, some pretty strong results we think. But we haven't…

Right, yes I totally understood. It's not a 23 well test, it’s six well test and I guess in a way we should expect some interference as you say you try to push an upper boundary and so we should expect interference at some point in time and I guess the upside is if you saw minimal at that level, that would be quite a positive surprise. Am I thinking about that properly?

That's absolutely correct. We would anticipate the ultimate density to be somewhere in between these two book ends. And again similar to the D.J. Basin, it’s a little different Niobrara but still 20, 15 to 20 wells per section there is not unheard of. So it's I think it's prudent book ends for us to evaluate.

Right. Right. And there's been some test higher in the D.J. too, so you're not out of bounds from if I drew the line there. And just lastly, well would -- just remind us that all of what percent of the acres you've delineated in your inventory there and the spacing assumptions behind that?

I'd have to look at the acreage count. But in my mind this core area and as you can see from the little map inserts on Slide 6, we have probably a 50 section core area that's pretty well delineated. We certainly have the boundaries of it delineated and now we're working on coming back in like at the end of the 2018 year, we'll do some infill drilling. But it's roughly; I would say roughly 30% of our total acreage that exist in this delineated portion.

All right, good, that's helpful. And if I may just take a bit more time to switch over to a big picture question relative to M&A. You seem to state that you're going to be active but that your stock is undervalued which would imply M&A is going to be mostly if not all debt focused. Am I thinking about that right? And how much leverage would you be willing to use depending if you buy something that's with production and EBITDA or without?

Yes, there's multiple financial strategies that can be pursued. But right now, it’s also a function of what we encounter and how accretive it is to our portfolio. Of course there will always be an adjustment to our borrowing base with any added new production that we bring on. But yes, leverage is again a responsible use of leverage is primarily the way we'll go. If you look at that from the standpoint of what's out in the marketplace though and yes, we do want to be active. But as you know, it takes two people to agree to every deal. And so we'll see -- we'll see how that participation actually goes throughout the year.

There are no further questions at this time. I will now turn the call back over to Paul McKinney for closing remarks.

Okay, thank you very much. And thank you everyone for participating in this call. We are truly excited about what the future holds for SandRidge and our investors and we're very encouraged by your support. And so this brings our conference call to an end. Thank you guys and we'll talk to you again at the end of next quarter.

This concludes today's conference call. You may now disconnect.