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Edited Transcript of AREX earnings conference call or presentation 10-Mar-17 3:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Approach Resources Inc Earnings Call

FORT WORTH Mar 10, 2017 (Thomson StreetEvents) -- Edited Transcript of Approach Resources Inc earnings conference call or presentation Friday, March 10, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Suzanne Ogle

Approach Resources Inc - VP of IR & Corporate Communications

* Ross Craft

Approach Resources Inc - Chairman & CEO

* Qingming Yang

Approach Resources Inc - President & COO

* Sergei Krylov

Approach Resources Inc - CFO

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Conference Call Participants

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* Welles Fitzpatrick

Johnson Rice & Company - Analyst

* Irene Haas

Wunderlich Securities, Inc. - Analyst

* Patrick Fitzgerald

Robert W. Baird & Co. - Analyst

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Presentation

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Operator [1]

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Good day ladies and gentlemen and welcome to the Approach Resources Inc. Q4 2016 earnings conference call.

(Operator Instructions)

I would now like to introduce your host for today's conference. Miss Suzanne Ogle, Vice President of Investor Relations and Corporate Communications, you may begin.

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

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Good morning, everyone thank you for taking the time to join our call today. With me this morning are Ross Craft, our Chairman and Chief Executive Officer; Quingming Yang, President and Chief Operating Officer; Sergei Krylov, our Chief Financial Officer. After the speakers' remarks, there will be a question and answer session.

The Company's earnings release and conference call presentations that management will refer to during our prepared remarks can be downloaded from the investor relations section of our website at www.approachresources.com. Please note that management's remarks in answer to the questions include forward-looking statements that are subject to risks that could cause such results to differ materially from those in the forward-looking statements. Additional information concerning these risks is set forth on slide 2 in the Company's earnings release.

Reconciliations of non-GAAP measures management refers to and the applicable GAAP measures can be found in the Company's earnings release or 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 CEO of Approach Resources, Ross Craft.

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

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Good morning everyone and thank you for being on the call this morning. In 2016 we successfully delivered on our key initiatives; improving our balance sheet, decreasing costs, and increasing well productivity. A

s promised, we operated within cash flow and 2016 we generated $26.1 million in operating cash flow. Using cash flow generated from our operations, we funded a capital expenditure of $19.8 million.

We continued to hone our completion techniques. The five wells completed in 2016 had stage links that ranged from 152 to 194 feet with the average stage link being about 180 feet. The average tank concentration was 1,625 pounds per foot of completed lateral, and average fluid was 36.9 barrels per foot.

The cumulative results of these enhancements has an average EUR projection per well of 678,000 BOEs, a 33% improvement over our current 510 type curve. In spite of volatile commodity environments, Approach continues to execute at a high level, providing exceptional operational results while maintaining our focus on reducing costs and increasing operational efficiency.

Our strategic investment in our infrastructure and our continuous operational efficiency improvements return repeatable benefits for Approach. During the year we achieved annual record low lease operating expense of $4.24 per BOE and enjoying completion cost of $3.5 million per well while exceptionally managing our natural production decline.

We also negotiated and so -- sequentially closed in January 2017 a transformational strategic deleveraging transaction that reduced outstanding debt by $130.6 million and future interest by $40 million and launched an exchange offer for the remaining $99.8 million of senior notes. As a result of recapitalization, our total debt has decreased from $500 million to $370 million on a pro forma basis.

Capitalizing on the increase in commodity prices, we hedged approximately 85% of our 2017 forecasted natural gas and 50% of our NGL production. As well, we are fully realizing the benefits of oil price improvement as demonstrated by the 210% improvement in unhedged profit margins since the first quarter of 2016. We will continue to optimistically add to our hedge position as market condition allows.

Looking forward to 2017, we continue to operate within cash flow. We expect to resume production growth -- our year-end 2016 -- from our year-end 2016 exit rate. We have set a preliminary capital budget funded from operating cash flow of $50 million to $70 million, depending on commodity pricing.

Based on our CapEx midpoint, we plan to drill 13 wells and complete 17 wells. This will be with the second half of the year.

We have cash flow to fund an accretive drilling program and our paid down additional debt. If we see continuous commodity price improvements, we will have the ability to ramp up, accelerate our drilling schedule. In 2017 we will continue to work and to maximize well performance, strengthen our balance sheet, bill on our asset base, and maintain our position as the lowest-cost producer in the Permian Basin. 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. I will start with slide 4, and provide a summary of our operating activities and results for the fourth quarter and the full year 2016.

Commodity prices were volatile in 2016, but improved throughout the year, ending the year just about $50 a barrel. With this improvement, we resumed the drilling and completion intermittently. We drilled two horizontal wells in the fourth quarter; University 42-1509, a D bench well; and 1511, a C bench well and produced 12,000 BOE per day, exceeding quarterly guidance.

During 2016, we drilled a total of six and completed five wells and produced 12,400 BOE per day, near the high end of annual guidance. At year-end 2016, we had six horizontal wells waiting on completion.

During 2016 we continued to make significant progress towards further reducing our industry-leading horizontal Wolfcamp drilling and completion costs. Profiting from our previous infrastructure investment, as you can see on slide 5, are; water storage, transportation, recycling and short water disposal system continues to provide a competitive advantage for Approach, helping to drive down our 2015 already low drilling and completion costs by 22% to $3.5 million per well in 2016.

On the operational front, we continue to optimize our surface facilities and increase our operating efficiencies. Our fourth-quarter cash operating expense decreased by 14% from the fourth quarter of 2015 and achieved a record low quarterly (inaudible) of $3.40 per BOE, down 37.5% from fourth-quarter 2015.

As Ross mentioned earlier, 2016 marked another important stage in the evolution of our horizontal Wolfcamp completion design. Using new generation design, 2016 wells on average are tracking approximately 33% above our current 510,000 BOE type curve at 678,000 BOE EOR. We currently are running one horizontal rig in Project Pangea, and are very encouraged by the early results of this well.

As outlined on slide 8, we expect to increase our type curve by year-end 2017, once additional production data is gathered and analyzed. We have just completed two University wells that are in the early stage of flow back.

Slide 9 highlights our year-end 2016 proved reserves, held (inaudible) 156.4 million barrels of oil equivalent, and offering [advantage] portfolio mix of 32% oil, 30% NGLs, and 38% natural gas. Extensions and discoveries for 2016 were 16.7 million barrels of oil equivalent, primarily attributable to our development project in the Wolfcamp shale oil resource play. During 2016, we reclassified 22.4 million barrels of oil equivalent of proved undeveloped reserves that are not expected to be developed within 5 years under SEC rules into probable reserves.

Revisions during 2016 included an increase of 2.1 million barrels of oil equivalent proved reserves, resulting from cost reductions, updated well performance and technical parameters, offset by a decrease of 1.9 million barrels of oil equivalent proved reserves, due to lower commodity prices. Our PB-10 at year-end 2016 using SEC price, was $307.9 million non-GAAP, and $730.2 million at NYMEX rate. Our reserve replacement ratio was 350%.

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

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Sergei Krylov, Approach Resources Inc - CFO [5]

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Thank you, Qingming. Slide 10 would summarize our financial results for fourth-quarter and full-year 2016. As Ross and Qingming mentioned, the highlights for this quarter are higher revenue and further operating cost improvements. Lease operating expense fell 38% to $3.40 per BOE over fourth-quarter 2015.

Production and ad valorem taxes totaled $2.43 per BOE, and represented 10.1% of oil, NGL and gas sales. Exploration costs were $0.62 per BOE.

Total general administrative costs averaged $6.35 per BOE, including cash G&A cost of $4.55 per BOE. G&A averaged $17.54 per BOE, and interest expense totaled $7.1 million.

Overall our cash operating costs were down, representing a 14% improvement over the prior-year period. Revenue for the quarter was $26.5 million, up 12% over last quarter. Fourth-quarter EBITDAX totaled $15.5 million and net loss for the quarter totaled $13.5 million or $0.32 per diluted share.

On an adjusted basis, our net loss totaled $11.3 million, or $0.27 per diluted share. I want to note that our adjusted net loss included a charge of $0.04 per diluted share for non-cash deferred tax reversal arising from our share-based compensation. Without that charge, our adjusted net loss would have been $0.23 per diluted share.

As previously mentioned, we generated $26.1 million of operating cash flow. Using cash flow generated from our operations, we funded annual capital expenditures totalling $19.8 million and included $17.8 million for drilling and completion activities.

Delivering on one of our key initiatives for the year, we continued to improve our financial flexibility and strengthen our balance sheet through a large-scale recapitalization. Slide 11 details the highlights of the exchange transaction and the immediate benefits to the Company, most notably increasing our cash from operations and allowing the Company to resume production growth.

On slide 12, we summarize our pro forma financial position. At December 31, 2016 we had a $1 billion senior secured revolving credit facility with a $325 million borrowing base and commitment amount. At December 31, our liquidity totaled approximately $51.4 million, and we were in compliance with all of our covenants. We have no near-term debt maturities.

As slide 13 highlights, we have strengthened our hedge book as well for 2017 to now cover approximately 85% of our forecasted natural gas production and 50% of NGL production based on the midpoint of guidance.

Turning to slide 14, you'll find our production expense guidance for 2017. We have set a preliminary capital budgets funded from operating cash flow of $50 million to $70 million. With this budget, we expect to resume production growth from our year-end 2016 exit rate. During 2017, we will continue to focus on living within cash flow, however the budget is highly flexible and allows us to make adjustments depending on direction of commodity prices.

With that, I'll turn it over to Ross.

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

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Yes, thank you, Sergei. Before we open up for Q&A, I want to take a moment to welcome our new Board members. I also want to thank the entire Approach team for the continued hard work and dedication.

We have some of the best people in the industry, as evidenced by our solid execution. They allow us to deliver our industry-leading execution and cost structure and capital discipline. With our strengthened balance sheet, we are ready to get back to work using our return-driven strategy, growing production organically as well as through strategic acquisition and bolt-ons, building on our asset base and continuing to be the lowest-cost producer in the Permian.

Now I'll turn the call over for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Irene Haas, Wunderlich Securities.

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

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Hi, Irene.

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Operator [3]

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And our next question comes from the line of Welles Fitzpatrick, Johnson Rice.

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Welles Fitzpatrick, Johnson Rice & Company - Analyst [4]

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I had a couple quick ones, really on the newer designs -- obviously you are tightening up that stage spacing, but can you give some more specifics on exactly what that spacing is looking like, what type of load-ins you're putting away, et cetera?

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Ross Craft, Approach Resources Inc - Chairman & CEO [5]

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Appreciate the question. What we've been focusing on since mid-2015 is reducing stage spacing. Obviously we started out in our new completions in 2015 at around 200 feet, and then we gradually decreased it roughly 20 to 30 feet at a time, with our lightest well down around 150 feet that we completed.

So what we are looking at on sand loading, is somewhere -- right now -- around 1,600 pounds per foot if you average over the last five wells. But we are steadily moving up to that 1,800 and 1,900 pounds. And we think that's, right now, will be an appropriate level.

But more importantly I think is a combination of our sand sizes we are running. We are also running 100 mesh, a fairly large chunk, 55% of our sand loading is 100 mesh. That we ramp up pretty high.

We ramped up to 2.5 pounds per gallon. Followed by a stage flush, and then we saw our [40/70], and we bring that up to a high concentration at 2.5 pounds per gallon as well. We think that does a lot for the microfractures and we think that's giving us some positive results as well.

So going forward, I would say that our stage spacing is going to average somewhere between 150 and 175 feet on these wells. We think that's going to give us an optimal position. We are also looking at playing with the initial fluid loadings.

The pad stage, and possibly running some different types of sand particles starting at the beginning of the pad. But that's kind of the outline. I think it mirrors what a lot of folks are doing in the industry, and we are seeing positive results from it.

One thing to point out during this downtrend, even though we've increased our stage spacing -- we've decreased our stage spacing, which results in more stages, we have been able to keep the cost of these wells pretty flat. I think that shows improvements and our operating structure and our ability to significantly negotiate contracts. And so from that -- that's kind of our how we are looking at it going forward.

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Welles Fitzpatrick, Johnson Rice & Company - Analyst [6]

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That's great, I appreciate the color, and that leading edge design, I assume is in the [$3.5 million] that you guys cite on page 6?

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Ross Craft, Approach Resources Inc - Chairman & CEO [7]

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That's exactly right. Its pretty much, if you look at the average wells for 2016, that is the design for those wells

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Welles Fitzpatrick, Johnson Rice & Company - Analyst [8]

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Okay, perfect. And it seems like you guys are highlighting the water recycling center a little bit more in this presentation? Sort of an emerging theme of frac water, maybe not shortages but maybe bottlenecks at least from a logistical standpoint -- are you guys, is that the rationale behind that water recycling plant? And can you remind us if you do any third-party work with that plant?

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Qingming Yang, Approach Resources Inc - President & COO [9]

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This is Qingming. That is a very good question, and initially, when we designed the recycling center, really to address the three issues you just mentioned. The first issue is to address the shortage of frac water supply, given significant ramp up of activities in the Permian Basin.

Second, it is also to reduce drilling completion costs and also these operating cost as well. We have reused that recycling center -- we have recycled 2.2 million barrels of water, which helped us to save our drilling completion costs in 2005 $400,000 to $600,000 per well. During this downturn, we actually utilized the recycle center as a buffer zone, and also to continue to reduce our lease operating cost. Now our acreage is, we're able to send our produced water directly to the recycling center and then distribute it to the SWD directly.

Going forward, as we resume drilling and completion activities, we are right now thinking about restarting the recycling center to not only get the benefit of reducing costs, but also get the benefit of using the processed water to frac our wells. And we think using this water to frac our wells, our wells are actually performing better.

So this recycling center is working out very well for us, and we are also exploring the possibilities to partner with some of our offset appraisers to fully utilize this recycling center to help them reduce drilling company costs, and also [this opportunity] costs as well. And the two get the benefit that Approach has been getting, and also enhance the value of this recycling center.

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Welles Fitzpatrick, Johnson Rice & Company - Analyst [10]

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As the recounts ramped up, and as water has become a little more of a bottleneck, have you, would you, describe the level of inquiries coming to you all as having been growing over the past quarter or so? Or is it generally just putting out feelers?

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Qingming Yang, Approach Resources Inc - President & COO [11]

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I think in our specific area, because we have water sourcing wells, we also have the recycling capabilities, obviously the water issues, we have ways to resolve them. But we do receive a lot of inquiries about our recycling facility, about our water system, and a lot of those inquiries saying a lot of value is in the system and that they would like to partner with us to realize those values. We're in discussion with them and obviously the question is when is the best time to maximize the value of that system.

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Welles Fitzpatrick, Johnson Rice & Company - Analyst [12]

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That's great, I appreciate it, really interesting. Just a quick one on NGL hedging, it looks like you guys are up to 50% that's great, with the rebound in NGL -- can you talk about the depth of that market? Can you guys hedge into 2018? Can you hedge more than 50%, or is it a little bit too thin to be able to go that far out?

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Ross Craft, Approach Resources Inc - Chairman & CEO [13]

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Well, the problem with NGL hedging is since we are not in control of the processing facility, we don't want to get too far ahead of ourselves. So there's still room in 2017 to add some beneficial NGL hedges. If you look at the hedges that we did add, and just look at them on a composite mix of our mix, it equates to around $26 a barrel gross before TF&S.

Obviously those numbers are similar into the end of 2014 numbers we were seeing on NGL product mix. So we felt like it was important because have a balanced mix of products that here, oil, NGLs and gas. As far as 2018, we can increase our hedge positions, we can go as high as 80%, if you want to, on NGL.

But you also have to keep in the back of your head that if for some unknown reason, unplanned reason, the plant has an issue you don't want to get behind on those NGLs. So I doubt if we'll ever get much more than 65% to 70% in front of ourself.

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Welles Fitzpatrick, Johnson Rice & Company - Analyst [14]

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That make sense, thanks so much guys.

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Ross Craft, Approach Resources Inc - Chairman & CEO [15]

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Thank you.

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Operator [16]

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Irene Haas, Wunderlich

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Irene Haas, Wunderlich Securities, Inc. - Analyst [17]

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Along the line of your hedging situation, is there any reason why you didn't hedge your oil?

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Ross Craft, Approach Resources Inc - Chairman & CEO [18]

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Irene, if you look at the oil prices for 2016, since about September 2016, oil prices have been rocking anywhere between the high $40s and the low $50s -- $53, $54 at one point. We don't see -- we think we have a built-in floor out there on oil prices. It could temporally drop down, but we want to leave ourselves plenty of flexibility.

If you look at our economics and what we feel we need to really get this machine back up and running, we want to see oil prices up north of the $55 mark. So what we're trying to do, is since we think we have a semi-floor on oil prices, we think there could be some upside potential at midyear to lock in some oil hedges and some attractive numbers.

We are just kind of looking at it from the standpoint of risk and reward. We didn't feel like locking in oil right now was the proper thing to do just yet. We felt like natural gas was an area that was very attractive, so we locked in.

We felt like NGLs being close to the end of 2014 levels was very attractive as well. But, we will keep a close eye on the oil and once we see a position we like, we'll layer in some oil as well.

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Irene Haas, Wunderlich Securities, Inc. - Analyst [19]

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Great, thank you.

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Operator [20]

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(Operator Instructions)

We do have a question from Patrick Fitzgerald from R.W. Baird.

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Ross Craft, Approach Resources Inc - Chairman & CEO [21]

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Hi, Patrick.

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Patrick Fitzgerald, Robert W. Baird & Co. - Analyst [22]

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Hi, why is LOE expected to be up $1 per barrel next year, from where we're currently operating?

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Sergei Krylov, Approach Resources Inc - CFO [23]

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Our LOE for the full-year was $4.25, so the guidance for next year is $4 to $5. On a year-over-year basis, it is in line with historical.

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Patrick Fitzgerald, Robert W. Baird & Co. - Analyst [24]

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But versus the fourth quarter and the third quarter, it is up $1. So I'm just trying to understand, is that just mostly conservative, or --?

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Ross Craft, Approach Resources Inc - Chairman & CEO [25]

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There's a couple components. Number one, during 2016 obviously with the prices being where they are, we scaled back any workovers we were doing to conserve. Not that we did a lot of workovers, but we put everything on the back burner.

We plan on putting, as prices improve, we plan on putting some workovers on some of these horizontal wells just to do gas leak repair and a few things like that. We want to give ourselves plenty of room. Plus as you said, it's also a conservative approach that we took, and so that's kind of why we went midpoint around $4.50.

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Patrick Fitzgerald, Robert W. Baird & Co. - Analyst [26]

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And could you give an update on the existing bond exchange for the $100 million that's outstanding right now?

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Sergei Krylov, Approach Resources Inc - CFO [27]

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Given the [tenders are] still currently outstanding, we can't comment on that process or expectations.

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Patrick Fitzgerald, Robert W. Baird & Co. - Analyst [28]

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Okay. So you guys think, with your current commodity prices, you think you'll be able -- I think you said you expect to be able to pay down the revolver somewhat, in 2017 -- is that true?

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Sergei Krylov, Approach Resources Inc - CFO [29]

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Well, really it's a function of capital spending and the cash flow that we generate. The good thing is that with the regional exchange with Wilks, which has already closed, we feel like we have right-sized the balance sheet for the current commodity price environment. And what I mean by right-sized, we effectually can grow our production out of our operating cash flow in the current market price environment, which is really good.

So we will have free cash flow, quite a bit of free cash flow coming our way, and we will be making decisions as to what to do with it. At this point in time, we plan to increase our capital budget and grow our production with that cash flow

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Patrick Fitzgerald, Robert W. Baird & Co. - Analyst [30]

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Right, and the banks are looking more at your PV-10 forward [deck], versus the SEC pricing? So they don't have any concerns at this point, right?

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Sergei Krylov, Approach Resources Inc - CFO [31]

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That's right, as you see in our presentation, PV-10 using NYMEX prices is close to $730 million. And that compares to our current base -- boring base of $325 million, so there's quite a bit of value in excess of boring base.

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Patrick Fitzgerald, Robert W. Baird & Co. - Analyst [32]

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All right, thanks a lot guys.

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Sergei Krylov, Approach Resources Inc - CFO [33]

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Thank you.

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Operator [34]

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I'm showing no further questions at this time. I would now like to turn the call back over to Mr. Ross Craft for closing remarks

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Ross Craft, Approach Resources Inc - Chairman & CEO [35]

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Hey guys, we appreciate you taking time to listen to the story. Obviously we've made some substantial advancements toward right-sizing our balance sheet during 2016. We continue to stay focused on doing the same through 2017, with a combination of starting the drilling machine back at a reduced schedule but still starting it back up.

Also, we will continue to look at ways to further strengthen the balance sheet. We feel like we've made sufficient steps and it looks like we are well underway to getting back to do what we do best and that is find oil and gas. Thank you for the time, we appreciate it.

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Operator [36]

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