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Edited Transcript of AREX earnings conference call or presentation 2-Nov-17 3:00pm GMT

Q3 2017 Approach Resources Inc Earnings Call

FORT WORTH Nov 21, 2017 (Thomson StreetEvents) -- Edited Transcript of Approach Resources Inc earnings conference call or presentation Thursday, November 2, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* J. Ross Craft

Approach Resources, Inc. - Founder, Chairman and CEO

* Qingming Yang

Approach Resources, Inc. - President and COO

* Sergei Krylov

Approach Resources, Inc. - CFO and EVP

* Suzanne Ogle

Approach Resources, Inc. - VP of IR and Corporate Communications

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Conference Call Participants

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* Irene Oiyin Haas

Imperial Capital, LLC, Research Division - MD & Senior Research Analyst

* Philip Stuart

Scotia Howard Weil, Research Division - Associate

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Presentation

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Operator [1]

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Welcome to the Approach Resources Third Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded. A replay of the call will be archived on the company's website. I would now like to turn the call over to Suzanne Ogle, Vice President of Investor Relations and Corporate Communication.

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Suzanne Ogle, Approach Resources, Inc. - VP of IR and Corporate Communications [2]

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Good morning, everybody. Thank you for taking time to join our call. With me this morning are Ross Craft, Chairman and Chief Executive Officer; Qingming Yang, President and Chief Operating Officer; and Sergei Krylov, Chief Financial Officer.

After the speakers' remarks, there will be a question-and-answer session. The company's earnings release and conference call presentation slides that the management will refer to during our prepared remarks can be downloaded from our Investor Relations section of our website.

Please note that management's remarks and answers to the questions include forward-looking statements that are subject to risks that could cause the actual results to differ materially from those in the forward-looking statements.

Additional information concerning these risks is on Slide 2 and in the company's earnings release. Reconciliations of the non-GAAP measures management refers to and the applicable GAAP measures can be found in the company's earnings release, on the non-GAAP financial information page of the company's website and at the end of the company's earnings presentation.

Now I'll turn the call over to our Chairman and Chief Executive Officer, Ross Craft.

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J. Ross Craft, Approach Resources, Inc. - Founder, Chairman and CEO [3]

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Good morning, everyone, and thank you for joining us this morning. I will open with an update on the progress we're making executing our strategy, including last night's announcement of a bolt-on acquisition adjacent to our Pangea West acreage. I will then talk about some of the things we're doing that are driving well performance.

Qingming will provide an update on operations and Sergei will then review financial results. I will finish up with a review of the asset acquisition and Q&A. The asset acquisition represents an important step as we work toward value realization and executing our strategy of disciplined capital efficiencies, low cost operations and return focus to development.

Slide 4 covers the highlights of the bolt-on acquisition. When we think about how to be successful in this dynamic landscape, value creation, with thinking about -- and value creation, we're thinking about where to efficiently deploy capital. That's important. We believe our in-depth knowledge of the Southern Midland Basin gives us a competitive advantage.

On Slide 6, you can see our 14-year history in the Basin. Since entering the Basin, we have drilled over 750 wells. Approximately 75% of these wells are vertical gas wells. At the end of the third quarter 2017, we have 178 producing horizontal wells, and 9 wells waiting on completion.

We believe our operational efficiency in reservoir management and geological expertise gives us an edge in maximizing the value of our acquired assets. Our emphasis for the remainder of the year and '18 will be continued focus on 4 strategic elements, which we believe make a critical difference in delivering performance and returns for our shareholders through the cycle.

First, cost discipline and productivity gains that optimize working capital; second, focus on core of our geographical footprint; third, take a strategic, disciplined, long-term approach to mergers and acquisitions that are accretive and will add to operating profits and fuel balanced growth; fourth, make the best use of our infrastructure to improve well performance, lower capital intensity and provide operational flexibility.

Turning to Slide 8, you will see the average producing rate of the third quarter wells are tracking the 700 MBoe type curve.

Slide 9 compares 2007 completions by quarter to the 700 MBoe type curve. We adjusted our completion design in early 2015 and since then, have been incorporating tighter stage spacing, increased proppant loading. The results have been encouraging with the average well outperforming the 700 MBoe type curve.

You can see the collective results on Slide 10. Importantly, we're concentrating on return focused completions. Since 2015, we have achieved approximately 37% performance improvements and 11% reduction in D&C cost. At this point, we believe we've reached the pinnacle of our completion design. Further enhancement of improved reservoir recoveries is most likely from the use of combination of nanoparticles and blended surfactants along with secondary gas injection.

Finally, on Slide 12, you will see a graph that demonstrates the uniqueness of our asset base and the low capital intensity that is required for maintenance. As a result, we can better utilize cash flow.

From February 2016 forward, you can see the decline is virtually flat. As can be seen on this slide, is the impact of our gas production in September caused by Hurricane Harvey. Due to our large-scale infrastructure system that supplies gas to the majority of our Wolfcamp wells, our oil production during this disruption was not significantly impacted. Due to our gas lift system, we were able to divert, inject over 300 million cubic feet of gas back into the Wolfcamp formation by temporarily converting 20 horizontal wells into injection wells, allowing us to continue to produce the majority of our horizontal wells during this disruption.

This injection period allowed us to gain important injection data, which will be used in designing our secondary gas injection program. We see this as a distinct advantage over other producers with steeper declines that will require higher level of capital to maintain their production.

With that, I'll turn the call over to Qingming.

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Qingming Yang, Approach Resources, Inc. - President and COO [4]

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Thanks, Ross, and good morning, everyone. I will start with Slide 13 and provide a summary of our operating activities and results for the third quarter 2017. Our production totaled 11,500 BOE per day. Production for the third quarter 2017 was 61% liquids and 39% gas.

During the third quarter, we drilled 1 horizontal well in the Wolfcamp B Bench and we completed 2 horizontal wells, 1 well in the Wolfcamp B Bench and 1 well in the Wolfcamp C Bench. All wells completed this quarter are outperforming the 700,000 BOE type curve.

At September 30, 2017, we had 9 horizontal wells waiting on completion. As you can see, we have a solid inventory of drilled but uncompleted wells that provide agility to respond to changes in the commodity price environment.

On Slide 14, you see our infrastructure system. When we designed the system, our objectives were twofold: cost savings and operational flexibility. Quarter-after-quarter, we see the cost/benefit when we deliver best-in-class lease operating expense. This quarter, operational flexibility is a benefit that stands out.

During Hurricane Harvey, we were able to leverage the functionality of the system and significantly demarcated the effect of shut-ins, curtailment, and high line pressure by using our gas lift system to continue to produce oil from certain wells, limiting the impact to only approximately 500 barrel of oil equivalent per day.

On Slide 15 through Slide 17, you see that we operate with the mindset of continued cost improvement and CapEx optimization. During commodity prices downturn, most operators are quick to reduce costs. However, when commodity prices recover, almost all the cost savings most operators achieved evaporate immediately as we wait on this over most of 2017. As you can see from this slide, the philosophy of cost discipline is part of our DNA, and we have continually driven down costs through the cycle.

As Ross mentioned earlier, we have successfully evaluated and executed the bolt-on producing property acquisition. We will continue to look for strategic opportunities to be added into our asset portfolio by taking advantage of our knowledge base and low cost operating expertise.

Now I will turn the call over to our CFO, Sergei Krylov, who will review our financial results.

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Sergei Krylov, Approach Resources, Inc. - CFO and EVP [5]

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Thank you, Ming, and good morning, everyone. We had another strong quarter as we continued to focus on improving margins. We positioned ourselves to be able to take advantage of improving commodity prices and saw a 13% improvement in our unhedged cash margin.

Staying focused on cost discipline, we continue to maintain our best-in-class lease operating expense. Third quarter lease operating expense of $4.16 per BOE was at the low end of our guidance target. Additionally, we had a 25% year-over-year reduction in interest expense that was redeployed to the development of our assets.

Third quarter revenue of $25.6 million, was up 8% year-over-year due to improvement in average realized commodity prices. Third quarter EBITDAX totaled $13.8 million, up 7% over prior quarter. Production and ad valorem taxes averaged $1.71 per BOE and represented 7.1% of oil, NGL and gas sales. Exploration costs were $0.09 per BOE. Total general and administrative costs averaged $6 per BOE, including cash G&A of $4.75 per BOE.

D&A averaged $15.88 per BOE, and interest expense totaled $5.3 million. Benefiting from the exchange transactions completed in the first quarter of this year and the resulting decrease in the interest expense and increased revenue, net loss for the quarter was $8.5 million, an 8% improvement year-over-year or $0.10 per diluted share.

Excluding the unrealized loss for the third quarter on commodity derivatives of $3 million, on adjusted basis, our net loss totaled $6.5 million or $0.08 per diluted share.

Capital expenditures for the quarter totaled $7.9 million and consisted of $7.1 million for drilling and completion activities, $0.6 million for infrastructure projects and equipment and $0.2 million for acreage extensions. Third quarter realized prices, excluding the impact of hedges, totaled $23.65 per BOE, an 8% increase year-over-year.

Turning to Slide 18, our hedge book for 2017 covers roughly 80% of expected fourth quarter production. We recently added additional oil hedges for the first quarter of 2018 and continue to monitor the market for additional hedge opportunities.

Finally, on Slide 19, we summarize our financial position. At September 30, 2017, we had a $1 billion senior secured revolving credit facility with a $325 million borrowing base and commitment amount. At June 30, 2017, our liquidity totaled approximately $32.7 million. We're compliant with all of our covenants, and we are currently in the process of completing our semi-annual borrowing base redetermination. The lead bank under our credit facility has recommended to the other lenders that our borrowing base be maintained at the current level of $325 million.

I will now turn the call back over to Ross.

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J. Ross Craft, Approach Resources, Inc. - Founder, Chairman and CEO [6]

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Thanks, Sergei. This acquisition that we announced last night checks all the boxes on our list in terms of synergy. It is a complementary fit, allowing for seamless integration of operations. It reduces leverage and is accretive to earnings and cash flow. And as we have discussed previously, the Pangea West acreage has the highest oil cut in our asset base. As we have discussed in the second quarter call, we completed one A Bench well in Pangea West area utilizing nanoparticles, reduced stage spacing and increased proppant loading. The well has been producing for over 180 days with an average oil rate of 267 barrels of oil per day since completion. We're encouraged with the early results of our enhanced completions, and will apply similar completion techniques to future wells in this area.

Our process consistently demonstrated the value enhancing competitiveness of strict capital discipline, low-cost operations, full cycle returns, focused management. So the renewed interest focus -- industry focus on this topic is refreshing to us. Our credentials as a disciplined oil and gas operator precedes the industry's recent interest in this topic.

In 2015, as we assumed -- as we assessed the commodity price decline, we were the first public company to suspend drilling, because we did not believe that growth at any cost was a responsible way to deliver shareholder value. We are delivering on our priorities and continuing to build momentum.

Our operation team continues to be able to generate value from asset (technical difficulty) whose value is underappreciated by the market. Even with deferred wells, we will still meet the low end of our production guidance. This is a testament of our team's assets -- of our team and assets. We will continue to focus on improving the balance sheet, controlling things that we have control over, as commodity prices recover.

Now I'll turn the call over for questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Irene Haas of Imperial Capital.

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Irene Oiyin Haas, Imperial Capital, LLC, Research Division - MD & Senior Research Analyst [2]

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Congratulations on the acquisition. My question is for Ross. I mean, you mentioned that during the storm, you guys actually reinject the gas back into a number of horizontal wells. This is really interesting. Are you the first to actually kind of go through this particular exercise? And sort of the implication? Can this be kind of executed more on a full-scale basis for either reservoir maintenance or would it have sort of implication on your future production mix in terms of making a little oil there? Just more color on this, please?

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J. Ross Craft, Approach Resources, Inc. - Founder, Chairman and CEO [3]

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Yes. We've done this in the past through various downturns, such as when DCP had gone down for maintenance, we had injected in a various -- in a few horizontal wells, but nothing to this scale. This was a long-term duration as Hurricane Harvey impact was over about a 2-week period, if not longer. So because of our infrastructure, our gas lift infrastructure, it allows us the flexibility. We knew we could inject into the Wolfcamp formation with the gas lift system. We'd already proven that. But we've never really injected this much gas into -- we picked 20 wells to do it in and never really injected this much.

What we saw from the injection profile and offset wells was very encouraging. Obviously, we have a long ways to go, but if you look at the advancements being made in gas -- immiscible gas injection back into oily shale reservoirs, we believe that with the combination of our infrastructure system and with the way the wells are set up, that this will have merit down the road. The good news about this was, because we were injecting over a longer period of time, the data we were able to collect will pay dividends as we design a secondary type injection program for this field.

It's way too early to determine what true impacts we're going to see off of it. I will say that the impacts on a BOE basis for the wells affected by this injection were all positive. So as we design and further test this injection, I believe you'll see it to be a common practice. And hopefully, over the next year or so, we'll be able to give more color to the injection process and results.

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Operator [4]

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(Operator Instructions) Our next question comes from the line of Philip Stuart of Scotia Howard Weil.

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Philip Stuart, Scotia Howard Weil, Research Division - Associate [5]

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Guys, I apologize if some of this was covered in the prepared remarks, I was a little late getting on the call. But when you talked about that well that you completed earlier this year in Pangea West, and with it being oilier, how is that well performing relative to the 700 MBoe type curve?

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J. Ross Craft, Approach Resources, Inc. - Founder, Chairman and CEO [6]

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That well right now is exceeding the 700 MBoe type curve, 180 days into production. The beauty about that well was, it didn't have a high IP rate, but the oil production, actually, has been holding very consistent in that well. And so when you look at over 180 days, the well is -- the oil production is increasing -- or it's not increasing, but it's holding in there. The EUR projection for this well as far as the oil portion is over 54% of the EUR is oil. So it definitely worked by reducing spacing.

As far as the nanoparticles we've pumped into this well, it's still a bit early to tell if the nanoparticles are significantly impacting this production like it is, but we're confident that it's helping. The beauty about this, this is by far the best well ever in Pangea West area. This bolt-on acquisition, as you may recall, is adjacent to our Pangea West property. So taking this enhanced completion approach on all future wells in this area, I think you're going to see some positive results from it.

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Philip Stuart, Scotia Howard Weil, Research Division - Associate [7]

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Okay, that's helpful. And then what are the near-term plans for the acquisition acreage, and were there any DUCs on the acreage that you acquired?

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J. Ross Craft, Approach Resources, Inc. - Founder, Chairman and CEO [8]

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The near-term plans are, we're going -- we have some options we're evaluating right now, and we plan on executing several of these options over the next month or so. There was no DUCs on this. It's pretty much of a PDP set up right now with a lot of option acreage on it.

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Philip Stuart, Scotia Howard Weil, Research Division - Associate [9]

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Okay. And then the 35,000 net acres, you'll just have to go and try and re-lease that acreage once it's past its expirations? Or what's going to be kind of the process there?

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J. Ross Craft, Approach Resources, Inc. - Founder, Chairman and CEO [10]

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Well, it's got a -- what is typical for this area, 180-day continuous drilling clause in the lease. We still have time on that. And so we are evaluating our options right now. Obviously, trying to get a rig in there and get this thing held is one of the option. So we'll be evaluating that. And looking at -- there is a wellbore out there, looking at possibly doing something with that wellbore as well.

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Philip Stuart, Scotia Howard Weil, Research Division - Associate [11]

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Okay. And how many wells would you need to drill and complete to hold that acreage?

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J. Ross Craft, Approach Resources, Inc. - Founder, Chairman and CEO [12]

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To hold it, you just have to drill 1 well every 180 days.

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Operator [13]

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(Operator Instructions) As there appear to be no further questions in queue, I'd like to turn the call back over to Ms. Ogle for any closing remarks. Ma'am?

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Suzanne Ogle, Approach Resources, Inc. - VP of IR and Corporate Communications [14]

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Actually, that would be Ross Craft. But I think we already covered closing remarks.

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J. Ross Craft, Approach Resources, Inc. - Founder, Chairman and CEO [15]

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Yes, I mean, we appreciate everybody's taking time to listen to the call. Obviously, this quarter we had several impacts; the Hurricane Harvey impact was prime and it affected everyone. But we also gained some valuable information on our testing of gas injection. We also gained valuable information on our completion techniques. We also executed our plan, which was to go out and look at complementary bolt-on acquisitions. I think, looking forward, we're still going to be under the mindset, which we've always been, that capital discipline is key. We have always been into that mindset. We still will continue to look at mergers, acquisitions with a very special focus. And we still will maintain our properties under this low-price environment with minimal drilling like we have done in the past, living within cash flow. I think from all of that, I think you can see a track record of what we've said we'd do, we've done, and we'll continue to do. With that, thank you all and look forward to talk to you next quarter.

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Operator [16]

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Thank you, sir. Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day.