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Edited Transcript of AREX earnings conference call or presentation 9-Nov-18 4:00pm GMT

Q3 2018 Approach Resources Inc Earnings Call

FORT WORTH Nov 21, 2018 (Thomson StreetEvents) -- Edited Transcript of Approach Resources Inc earnings conference call or presentation Friday, November 9, 2018 at 4:00:00pm 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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Presentation

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Operator [1]

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

I would now like to turn the conference over to Ms. 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 today. We appreciate your interest in Approach.

On the call with me this morning are Ross Craft, our Chairman and Chief Executive Officer; Qingming Yang, our President and Chief Operating Officer; and Sergei Krylov, our Chief Financial Officer. All will be available for the questions after the call.

In just a moment, I'll turn the call over to Ross, who will update you on our third quarter achievements, our progress year-to-date, and finally our focus areas for the remainder of the year. Qingming will review our operational results. And Sergei will follow with the review of 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 our remarks and the 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 in our earnings release on the non-GAAP financial information page of our website and at the earnings -- at the end of our earnings presentation.

We filed our 10-Q last night.

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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Good morning, everyone, and thanks for being on the call today and for your interest in Approach. I'll start the call with the discussion of our recent highlights and accomplishments for the third quarter followed by commentary along our focus for the remainder of the year.

Before I get into the details of the presentation, I'd like to make 3 important points up front.

Starting on the Slide 4 of our presentation, first, our strong performance for the first 9 months is a direct result of solid execution. Secondly, we're making steady organic progress toward recovery from the downturn. And thirdly, we're strategically managing Approach's growth and future profitability, balancing the exploration of new opportunities with the exploitation of our core competencies. We have a good quarter -- we had a good quarter and delivered growth in revenue, earnings and EBITDAX, as you can see on Slide 5. The strengthened price in oil and NGLs and the exploration of legacy hedges combined with the focus on controlling costs drove $4.5 million of operating income, our best quarter for operating income since the fourth quarter of 2014.

We beat consensus estimates for adjusted EPS by 43% and EBITDAX by 8%. We drilled 6 wells during the quarter and completed 2 wells in the second half of the quarter, fulfilling our 2018 program ahead of schedule.

By year-end, we plan to spend 21% less than the midpoint of our prior annual capital expense guidance, while managing annual production to within 6% of the midpoint of our product forecast. Despite improved oil and NGL prices, the extreme Waha natural gas price discount in the Permian Basin has persisted, as do many of the pressures facing the energy industry. All price volatility, extreme differentials, service cost escalation, market access and geopolitical uncertainties are few to come to mind.

However, in a very fluid environment, Approach has maintained our industry-leading lease operating expense, which is one of the lowest per BOE in the basin and 27% lower than our peer average. We are making steady, organic process -- progress towards delivering the value that we believe exists in the Southern Midland Basin. A core component of the Approach's value proposition is discipline, discipline that results in operational excellence, cost control and prudent capital spending. We manage the business with a long-term perspective. Considering the current Waha natural gas price discount, we elected to defer several third quarter completions and reschedule planned fourth quarter completions.

So now put the Waha differentials perspective, on Slide 6, you'll see the impact of the revenue from the Waha differential for January 1 through September 30 this year equates to approximately 2 additional completions or 3 to 4 additional drilled wells. We understand that the market often demands production growth under any circumstance. Given that a significant portion of the shale's oil net present value is achieving the first 2 years of production and our core acreage position is largely HBP, bringing new production online into a heavily discounted market for the sole purpose of showing growth is not a prudent management of our resources and not in the long-term interest of Approach and our shareholders.

Before I turn the call over to Qingming to discuss third quarter operational results, I'll briefly discuss market dynamics and focus for the remainder of the year. Permian pipeline capacity constraints and widening basin differentials has not deterred production growth within the basin. Permian gas production is up approximately 5% quarter-over-quarter, approximately 11.5 Bcf per day, an improved production that's up 3.5 million barrels of oil per day. NGL volumes heading to Mont Belvieu, around 1.3 million barrels per day. The associated gas produced in the core areas of Delaware and Midland Basins will continue to increase as more wells are placed online and as core areas of the basin mature, placing additional capacity constraints on inter-basin pipeline systems as well as some mainline systems leaving the basin.

As of November 1, we're looking at $1.72 differential, a 53% discount to Henry Hub. I expect to see basin differential start narrowing possibly by the first quarter of '19 when several brownfield repurpose or expansion projects are expected to come online, adding in approximately 350 million cubic feet of gas per capacity.

The longer-term solution will be numerous greenfield large scale pipeline expansions, totaling close to 12 Bcf per day. Of additional takeaway capacity, we've announced in-service dates between 2019 and 2021. Considering current market dynamics and large-scale pipeline forecasted in-service dates, we've made a strategic decision to recalibrate our completion schedule to better align with the anticipated pipeline in-service dates. This is consistent with our disciplined approach to asset management, our focus on long-term execution of profitability, an example of our ability to quickly evaluate and react to market conditions.

It's important for our shareholders to understand that in addition to staying focused on day-to-day operations, we have been working diligently evaluating highly accretive transactions. Since our debt exchange with the wells was completed in early 2017, we have examined approximately 20 potential strategic transactions, representing over $7.5 billion of value.

In addition, as we have previously disclosed, we remain in discussion with a variety of potential counter-parties regarding a range of transactions designed to further reduce our leverage and position the company for sustained growth once conditions justify growth. We have one of the best technical teams in the industry. This same team has been responsible for many of the new concepts and techniques utilized by their operation within the basin. The same team will continue to work diligently on transformative solutions that are accretive to all of our shareholders.

Now 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 7 in our presentation. Our operational highlights this quarter includes drilling and completion activity, continued cost control and DUC inventory. Production this quarter was 113,000 BOE per day. As Ross mentioned, a few minutes ago, we elected to defer several of our planned third quarter completions due to the Waha differential. Even with these deferrals, we can evert quarterly production within less than 1% of quarterly guidance.

We completed our 2018 drilling program ahead of schedule and under budget. This quarter, we drilled 6 horizontal Wolfcamp wells. 4 in the Wolfcamp A bench, 1 in the Wolfcamp B bench and 1 in the Wolfcamp C bench. It is an important distinction that Approach is actively drilling in each of our Wolfcamp benches. All 3 benches in the Approach's acreage have been prudent and are productive. This provides significant upside when market condition support an accelerated drilling program. We completed a 2-horizontal Wolfcamp wells during the second half of the quarter, both in project Pangaea area.

Now turning to Slide 8. You see the continued efforts of our daily focus on efficient operation and the benefit of our infrastructure systems, which collectively contributed to our industry-leading LOE. Third quarter lease operating expense of $5.57 per BOE included strategic spending on certain workovers and maintenance. Our year-to-date LOE at September 30, which includes normal operations and additional strategic spend and workovers and maintenance is 27% lower than our peer average.

Ross mentioned in the opening of the call that a core component of the Approach value proposition is discipline. We manage our business with a long-term perspective. Slide 9 illustrates our track record of aligning production growth to commodity prices.

As previously noted, in light of the extreme Waha gas differential in the basin, we deferred several third quarter completions and rescheduled fourth quarter completions to preserve capital until the basin gas differential shows signs of improvement. We now expect full year capital expenditures to be $47 million or 21%, below the midpoint of our prior guidance. And the full year production to be between 4.05 million and 4.15 million barrels of oil equivalent or 6% below the midpoint of our prior guidance.

We have provided revised guidance on Slide 15 in the appendix.

On Slide 10, you can see the 9 wells completed during this year. 5 of the 9 wells have included the use of nanoparticles, and 2 of the 9 wells completed this year have used West Texas sand. At September 30, 2018, we had 7 DUCs in our inventory. With these DUCs, we're ready to accelerate when market condition warrant.

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. For the third quarter, I'm happy to report increased profits and cash margins. We saw both top line and bottom line improvement this quarter. Revenue was up 27% over the prior year quarter. Revenue for the quarter pre-hedged totaled $32.6 million and was supported by an increase in oil and NGL commodity prices, as shown on Slide 11.

Our strong oil price realization is a product of our existing oil transportation contract with oil being sold at Cushing benchmark price and the fixed transportation fee. We have the benefit of this contract through the end of 2019, which aligns with the expected normalization of the Midland Cushing differential.

Net loss for the quarter was $4.3 million or $0.05 per diluted share. Net loss for the third quarter included a commodity derivatives loss of $3.3 million. Excluding the decrease in the fair value of our commodity derivatives of $0.1 million, adjusted net loss was $4.2 million or $0.04 per diluted share.

For the third quarter, our reported EBITDAX of $16.5 million was 19% higher than what we saw a year ago. Taking advantage of the improved oil and NGL prices, we have added to our hedge book. Our current hedge schedule can be found on Slide 16 in the appendix of this presentation.

Lease operating expense for the third quarter was $5.57 per BOE. LOE for the third quarter includes important workovers and maintenance. We expect LOE to decrease in the fourth quarter and fall within guidance for full year.

Production and ad valorem taxes totaled $2.1 million and were 6.5% of oil, NGL and gas sales. Cash, general and administrative expense per BOE for third quarter was $4.73 per BOE. Depreciation for the quarter was $14.5 million or $13.90 per BOE.

Our focus on the control of cash operating costs along with higher product prices provided a 40% improvement in unhedged cash margin per BOE, compared to third quarter 2017.

Capital expenditures incurred for the third quarter were $19.3 million and included $17 million for drilling and completion activities and $2.2 million for infrastructure projects and equipment and $0.1 million for lease extensions.

For the 9 months ended September 30, 2018, our capital expenditures totaled $46.5 million, which was 21% below our annual guidance.

On Slide 12, we summarized our financial position. We continue to maintain a simple capital structure and are working to further strengthen our balance sheet. At September 30, our liquidity was $29.2 million.

Now I'll turn the call back to Ross.

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

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Before we open the call for questions, I'd like to emphasize the 3 important points that I opened the call with: first, our strong performance for the first 9 months is a direct result of solid execution. We remain disciplined and focused. So many in the operations team would be commended for consistently delivering first-rate operations quarter-after-quarter and year-after-year. The implementation of integrated development plan provides a solid foundation to continue to look for innovative ways to drive down cost and well delivery cycle times. Secondly, we're doing what we say we'd do, align our capital expenditures with free cash flow. We are executing the strategy that we articulated and are making steady organic progress. Organic recovery is slow, but it's possible. Third point, our relative debt levels constrain our ability to grow and spread our fixed cost over a large production base. As much as our shareholders would like to see and as much as we'd like to provide a faster, easier innovation, there are many variables in play. Timing, patience and discipline are the key to strategically managing Approach's growth and future profitability.

With that, I'll turn it over for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) I would now like to turn the call back over to Mr. Ross Craft, for further remarks.

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J. Ross Craft, Approach Resources, Inc. - Founder, Chairman & CEO [2]

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Guys, we appreciate your time today. And we look forward to keeping you posted in the progress we're making. This is a challenging environment. We're seeing oil prices once again dip. Waha differential blown up above $0.70 current. Obviously, there's a lot of positives on the horizon with addition of pipes in the basin. It's going to be a slow and steady progress, but we've got the firepower to manage through this and think that the outcome will be favorable to all shareholders. Thank you.

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Operator [3]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.