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Edited Transcript of AREX earnings conference call or presentation 2-Aug-18 3:00pm GMT

Q2 2018 Approach Resources Inc Earnings Call

FORT WORTH Aug 15, 2018 (Thomson StreetEvents) -- Edited Transcript of Approach Resources Inc earnings conference call or presentation Thursday, August 2, 2018 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 & CEO

* Qingming Yang

Approach Resources, Inc. - President & COO

* Sergei Krylov

Approach Resources, Inc. - Executive VP& CFO

* Suzanne ogle

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

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Conference Call Participants

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* Jiuying Ye

Imperial Capital, LLC, Research Division - Associate

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 Approach Resources, Inc., Earnings Conference Call. (Operator Instructions) As a reminder this conference is being recorded.

I would now like to turn the conference over to Mr. Suzanne Ogle, Vice President, Investor Relations and Corporate Communication. Ma'am, the podium is yours.

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

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Thank you. Good morning, everybody, and thank you for joining us on the call today. We appreciate your interest in Approach.

On the call with me this morning are Ross Craft, our Chairman and Chief Executive Officer; Sergei Krylov, our Chief Financial Officer; and Qingming Yang, our President and Chief Operating Officer. All will be available for questions after the call. In just a moment, I'll turn the call over to Ross, who will update you on our second quarter results and progress. Qingming will review the operational results. And Sergei will review the financial results.

Our earnings release and the conference call presentation slides that we will refer to during our prepared remarks can be downloaded from the Investor Relations section of our website at approachresources.com.

Please note that the remarks and answers to the questions include forward-looking statements that are subject to risks that could cause actual results to differ materially from those in the forward-looking statements. Additional information concerning these risks is set forth on Slide 2 in our earnings release presentation.

Reconciliations of non-GAAP measures we refer to and the applicable GAAP measures can be found on our earnings release on the non-GAAP financial information page of our website and at the end of our earnings presentation. We plan to file our 10-Q this afternoon.

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

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

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Thank you, Suzanne. Good morning, everyone, and thank you for [attending our call] today and your interest in Approach.

We wrapped up a good quarter, delivering growth in oil production, revenue, EBITDAX while lowering lease operating expense and maintaining an impressive D&C cost of plus or minus $4.4 million per well. We continued to refine our completion techniques utilizing tighter stage spacing, formation compatible fluids and nanoparticles. We've utilized nanoparticles in 8 completions thus far.

Although we have limited production [guides] in the majority of these wells, early indications suggest a 30% to 34% increase in all EURs as compared to our 700 MBoe type curve. When you look at the cost of our horizontal wells, both D&C and LOE costs as compared to projected EURs, the results are compelling.

The first half of the year has been attention grabbing for our Permian producers. We have benefited from strengthening in oil prices but now are faced with our success. This is causing a lot of interest in the Permian infrastructure and basis differential issues. The too much, too soon dynamic is nothing new to this industry. It is a function of growth and/or forecasted growth within the basin.

In response to the recent oil/gas takeaway bottlenecks out of the Permian Basin, several midstream companies have completed and/or started construction of additional capacity out of the basin. Current oil projects consist of additional 3.7 million barrels per day takeaway by late 2019 with an additional 2.1 million barrels per day capacity either in the planning stage or financing stage by late 2020 and early 2021.

Natural gas projects currently under construction will have approximately 4 Bcf per day of additional capacity by mid- to late 2019. Mexico has been slowly increasing natural gas imports from U.S. but delays in Northern Mexico's infrastructure buildout has curtailed imports. A major TransCanada project was put into service July 2018 that adds additional 0.67 Bcf per day of import capacity, which will have a positive impact on Waha constraints.

With market conditions changing daily and escalating service costs back to predownturn levels, it's important to be able to quickly evaluate and react to changing market conditions. We demonstrated this ability in 2012 when the oil differentials escalated to around $15 and trucking differentials to Midland jumped to $10 per barrel. We responded a year later with the completion of a 50-mile oil pipeline with capacity of 100,000 barrels per day, thus eliminating all trucking differentials and guaranteeing uninterrupted flow capacity to the Cushing and our Midland markets. Within a year, we sold the system for a 6x return while maintaining favorable transportation rights on the system.

2012 through 2014, investments in our large-scale water recycling and disposal systems, our high-pressure gas lift and enhanced recovery systems, and low-pressure gathering systems is another example of reacting to market conditions. Sourcing and securing water at that time for completions and then disposing the water extremely high represent a large portion of our D&C and LOE cost. Once our systems were installed, we realized a significant reduction in D&C cost, approximately $1 million per well, and a large reduction in our LOE cost. In early 2015, we told the market that if we didn't see an appreciable increase in commodity prices midyear, we would shut down all drilling and completion operations.

Mid-2015, we re-leased our last rig and shut down all completion activities until June 2016. We knew being the first Permian company to shut down all activities was not going to be received well by the market, but it was absolutely the right decision to make. We did not have to drill to hold leases because of our HBP status. Commodity prices didn't support growth. So it's, again, the right decision. Another example is the ability to quickly evaluate and react to market conditions.

We built this company on 4 strategic pillars that provide the foundation of long-term value creation. Turning to Slide 4 on our presentation. The first competitive strength we have, a balanced production portfolio. So we're not overly exposed to any one commodity.

The second competitive strength is our large-scale company-owned infrastructure system that is key to our low operating cost structure as well as our impressive D&C cost structure. This infrastructure system is including high-pressure gas lift system is the primary reasons for our low decline -- low production decline rates.

The third competitive strength is our contiguous acreage position that encompasses 150,000 net acres. Having everything in close proximity to oil wells and equipment are connected via SCADA System. Collection of Big Data allows us to operate with fewer individuals, thus reducing overhead.

The fourth competitive strength is our ability to respond in realtime to changing market dynamics. Since our acreage position is largely HBP as a result of our deeper legacy vertical well program and horizontal Wolfcamp program, we can better match our capital deployment to commodity prices, i.e., speed up, slow down as needed.

Moving to Slide 6. On the southern part of the Midland basin where our assets are located, we had not realized any significant increase in downstream pipeline pressures and/or takeaway capacity constraints at this time, nor do we anticipate any significant future capacity issues.

What we have witnessed, along with the majority of operations in the Permian Basin, is a sudden unprecedented increase in differentials out of the basin beginning in late 2017. Oil differentials within the basin, Midland (Argus) to Cushing, which normally run around $3 to $4 per barrel, have widened to unprecedented levels.

September 2018 futures Midland (Argus) contract is minus $17.05 currently. We're in a better position than many operators because we sell our oil based on Cushing prices through our long-term oil marketing agreement, avoiding the Midland to Cushing differential blowout.

Unfortunately, we're realizing the effects of the unprecedented Waha gas differentials you see on Slide 7, which is projected to be north of $1 for the remainder of the year. We feel these unprecedented differentials are temporary and will begin to normalize closer to historical pricing by the second half of 2019 as additional takeaway capacity is put into service.

Moving to Slide 8. You'll see a number of options that we're evaluating that will allow us to continue to reduce leverage and increase cash flow, thus increasing shareholders value.

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

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

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Thanks, Ross. And good morning, everyone. Please turn to Slide 9 in our presentation.

Because of our continued focus on execution and low-cost operations, we delivered production at the high end of quarterly guidance and reduced this operating expense. Production this quarter was 1,056,000 BOE or 11,600 BOE per day, an increase of 2% over first quarter. The increase was driven primarily by liquids growth.

On Slide 10, you will see the efforts of our daily focus on efficient operation and the benefit of our infrastructure system. We reduced the leased operating expense per BOE this quarter by 8% from first quarter and delivered peer-leading LOE of $4.77 per BOE.

As I report this peer-leading LOE number, I want to take time to acknowledge and thank our operations team and field staff, who do a good job of understanding the production characteristics of our wells, coming up with great ideas of optimizing our field operations and taking full advantage of what our infrastructure systems can offer.

In the second quarter of 2018, we completed 3 horizontal Wolfcamp wells. Of the 3 completions, 1 well was in our Pangea West area, parked in the Wolfcamp A bench; and 2 wells were in our Baker area, 1 well parked in the Wolfcamp B bench; and 1 well parked in the Wolfcamp C bench.

On Slide 11, you can see the performance of the 3 wells completed during this quarter. Individually, the 2 Baker wells are performing well above the 700,000 BOE type curve. As you may recall from our previous earnings calls and discussions, the Pangea West area is very oily, as such, it has a slightly different production profile, lower IP, higher oil and shallower decline. In aggregate, the average cumulative production of the 3 wells outperformed both oil and well EUR of our 700,000 BOE type curve.

Currently we're running 1 rig to drill 6 horizontals wells. We plan to complete 2 wells during the third quarter and expect our production to be between 11,400 and 11,600 BOE per day.

After we're done with the prepared remarks, Ross and I will be available during Q&A session to discuss completion techniques and additional operational questions you may have. Now I'll turn the call over to Sergei to go over financial results.

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Sergei Krylov, Approach Resources, Inc. - Executive VP& CFO [5]

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Thanks, Qingming. On my (inaudible), I'm happy to report increased margins. We saw both top line and bottom line improvement this quarter. Revenue was up 21% over the prior year quarter. Revenue for the quarter prehedged was $30.3 million and was supported by an increase in commodity prices.

The strong oil price realization is a product of our existing oil transportation contract with oil sold at Cushing benchmark price and a fixed transportation fee. Net loss for the quarter was $9.1 million or $0.10 per share. Net loss for the first quarter included the commodity derivative loss of $4.9 million. Excluding the decrease in the fair value of our commodity derivatives of $2.9 million, adjusted net loss was $6.8 million or $0.07 per diluted share.

The second quarter reported EBITDAX of $15.3 million, 18% higher than what we saw a year ago. Going to the third quarter, we're expected to see higher oil realization due to higher commodity prices and expiration of our legacy hedges below current market prices. Our current hedge schedule can be found in the appendix of this presentation.

Lease operating expenses for the second quarter was $4.7 per BOE, reduced LOE quarter-over-quarter by 8%, and LOE was in line with the midpoint of guidance. Production and ad valorem taxes totaled $2.5 million and were 8.5% of oil, NGL and gas sales. Cash, general and administrative expense per BOE for first quarter was $5.14 per BOE. D&A for the quarter was $16.8 million or $15.96 per BOE.

On Slide 12, you can see there's a focus on control of cash operating costs along with higher product prices provided a 37% improvement in unhedged cash margin per BOE compared to second quarter 2017. Capital expenditures incurred for second quarter were $13.5 million and included $11.2 million for drilling and completion activities and $2 million for infrastructure projects and equipment and $0.3 million for lease acquisitions. For the 6 months ended June 30, 2018, our capital expenditures totaled $27.2 million, in line with annual guidance.

Slide 13 will summarize our financial position. We'll continue to maintain a simple capital structure and are working to further strengthen our balance sheet. On June 30, our liquidity was $27.2 million. We remain focused on operating substantially within cash flow and will align our capital expenditures as closely as possible within our anticipated annual cash flow.

Now I'll turn the call back over to Ross.

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

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Thanks, Sergei. We believe an important component of our operational success is attributable to our long-term strategic planning. The 4 foundational pillars that this company is built on -- a balanced commodity portfolio, 100% owned infrastructure, contiguous leasehold, low decline, low-risk assets and asset portfolio optionality -- create operating efficiencies now and will provide significant upside for Approach in the future.

Our out-of-the-box thinking, focus on day-to-day operations and experiencing -- and experience managing through cycles has served us well and has allowed us to deliver consistent quarterly results. Our focus for the remainder of 2018 is strengthening our balance sheet through acquisitions and other deleveraging opportunities so that we have the appropriate capital structure to execute a growth strategy that is accretive to our shareholders.

Now I'll turn the call over for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we do have a call from line of Irene Haas from Imperial Capital.

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Jiuying Ye, Imperial Capital, LLC, Research Division - Associate [2]

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This is Claire Ye for Irene. Our first question is about LOE. So how do you look at LOE reduction going forward? And what are some of the catalysts?

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

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Well, our LOE, as we stated in our first quarter and then it's been historically high in the first quarter due to winter weather and things like that. But one thing to keep focused on about our LOE, which is quite impressive, is, when you look at LOE on a BOE basis, we've been pretty much having -- our production has been range bound due to the capital constraints we're under, and for us to continue to drive down LOE cost through this is quite impressive. The key to our LOE, and it's a permanent key, is our infrastructure. Being able to handle everything through our pipeline systems that we own facilitates a continuation of this low LOE that you're seeing. So I don't really see anything that's going to drive it one way or the other. You might see quarters that it goes up because we do something -- some unplanned workovers because of SWD wells that need to be worked on, but other than that it's pretty simple, and I don't foresee any major issues in the future. Q?

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

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And I agree with Ross. (inaudible) April to keep a very low LOE number during this downturn and also during, as you know, lower production, daily productions. As we find opportunities to grow this company, when we increase activities going forward and when we increase production, we see additional opportunities drive down the LOE. As you can see right now, our LOE is pretty low. If we increase productions in the future, obviously we can continue to drive the LOE down even further.

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Operator [5]

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(Operator Instructions) And we do have a question from the line of [Joshua Wolf], a private investor. It looks like [Joshua] is not on the call. And there are no further questions in queue at this time. I turn the call back over to our presenters.

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

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We appreciate your all's interest today. We look forward to the next quarter. We're working hard to rightsize the balance sheet, continue to work on that. I think with everything we're seeing right now, what we've done in the past, I think we're well on our way to once again showing the investors what Approach can really do. With that, we appreciate your time.

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Operator [7]

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