Q2 2021 Earthstone Energy Inc Earnings Call

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Good morning, and welcome to Earth's Stone Energy Conference call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation.

If anyone should require operator assistance during the conference call. Please press star zero on your telephone keypad.

As a reminder, this conference call is being recorded.

Joining us today from Archstone are Robert Anderson, President and Chief Executive Officer, Mark Lumpkin, Executive Vice President and Chief Financial Officer.

Steve Collins Executive Vice President of operations and Scott the lender Vice President of Finance Mr. <unk> you may begin.

Thank you and welcome to our second quarter Conference call before we get started I would like to remind you that today's call will contain forward looking statements within the meaning of section 27 day.

Of the Securities Act of $19.33, as amended and section 21 E of the Securities Exchange Act of 1930 for as amended.

Management believes these statements are based on reasonable expectations. They can give no assurance that they will prove to be correct. These statements are subject to certain risks uncertainties and assumptions as described in the earnings announcement, we released yesterday and our form 10-Q for the second quarter that we file.

As of yesterday and in our annual report on form 10-K for the year ended December 31.2020. These.

These documents can be found in the investors section of our website www dot or stone energy Dot com.

Should 1 or more of these risks materialize or should underlying assumptions prove incorrect actual results may vary materially.

This conference call also includes references to certain non-GAAP financial measures reconciliations of these non-GAAP financial measures to the most directly comparable measure under GAAP are contained in our earnings announcement released yesterday.

Also please note information recorded on this call speaks only as of today August 5.2021, thus any time sensitive information may no longer be accurate at the time of any replay or transcript reading.

A replay of today's call will be available via webcast by going to the investors section on <unk> website and also by telephone replay you can find information about how to access those in our earnings announcement released yesterday.

Today's call will begin with comments from Robert Anderson, Our CEO, followed by remarks from Steve Collins, Our executive Vice President of operations.

And Mark Lumpkin, our CFO and then we will have some closing comments from Robert ill now turn the call over to Robert.

Thank you Scott and good morning, everyone. I know, it's been a busy couple of days and we appreciate your time today, while you join us for our second quarter 2021 conference call.

Our strong second quarter results reflect our continued positive momentum and the impact of our ongoing consolidation strategy. We have now closed 3 meaningful acquisitions. This year for a total of $360 million and resumed our drilling and completion program, even adding a second drilling rig and all of this activity.

Adding only minimal G&A, while these acquisitions closed with these acquisitions closed in our drilling program well underway, we enter the second half of the year expecting to hit a daily production rate by year end it should be nearly double our 2020 daily average production rate, while only increasing our outstanding share count.

By 30% and with a minimal impact on debt to trailing EBITDAX.

We have also generated over $100 million of free cash flow in the past 12 months was $60 million of it coming this year.

We continue our efforts to increase per share value with our financial results, which we expect will continue to be recognized in our stock price.

Through these acquisitions, we have added complementary assets that have helped us to increase our operating scale continue our operating efficiency improvements at economic upside from high quality drilling locations, while maintaining strong liquidity and low leverage all of these enhance our primary mission of increasing per share Val.

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Efficiency and cost management continues to be a key focus for our team. For example, we recently drilled our initial wells on the IRS assets acquired in January of this year and we are pleased that they came in ahead of schedule and below our cost estimates.

This adds to our confidence in our ability to efficiently integrate these acquisitions and effectively develop our growing drilling inventory.

As you know with now having closed 3 acquisitions this year and with the combined assets, bringing significant cash flow. We recently increased our 2021 capital budget by $40 million in conjunction with the addition of a second full time rig which is now drilling away.

We don't expect to see much if any production impact on 2020 volumes from the second rig yet with the increased cash flow. We are achieving we do expect to continue to generate significant free positive free cash flow and look forward to production and cash flow impact of the second rig in 2022.

After completing an internal review of our mid year reserves and adjusting for the tracker acquisition proved.

Proved developed reserves at strip prices as of July 1 have a PV 10 value of approximately $1.1 billion.

And $83.6 million Boe or barrels of oil equivalent.

Considering the total proved reserves consisting of proved developed and proved undeveloped while giving no credit for the tracker drilling locations. At this point, we have a PV 10 value of approximately $1.7 billion and $133.6 million Boe.

Compare these numbers to our market cap today of approximately $750 million.

Proved developed reserves compared to the end of 2020 have more than doubled with the acquisitions and our drilling activity. This year.

And the end of 2020, we had 40 million barrels of oil equivalent using 50 barrel per barrel flat oil prices. So quite an achievement in the first half of this year, we generated almost $54 million of adjusted adjusted EBITDAX in the second quarter up approximately $10 million from the first quarter due to.

Higher commodity prices and higher production volumes, resulting in almost $100 million of adjusted EBIT ex in the first half of the year.

We estimate that production in the second half of 2021 will be between 25000.527000 Boe per day.

From 21, 525 Boe per day in the first half and.

And we intend to continue to work to add additional scale that will further enhance our cost efficiencies and lower our per unit cost structure now I will turn the call over to Steve to provide an update on operations.

Thanks, Robert and good morning, everyone. During the second quarter, we completed a 3 well pad in Midland County comprised of short laterals for which we have a 70% working interest. We also drilled 4 wells on our Pearl Jam pad in Midland County, where we have a 95% working interest.

Pearl Jam Wells also short laterals on the Companys first wells drilled on the recently acquired IRI on acreage as Robert mentioned, we're very pleased with how smoothly. These operations.

That rig is now drilling at a 4 well pad in Western Reagan County on our West Hartgrove unit, where we have 87%.

Working interest.

Having picked up a rig in March after nearly a 1 year hiatus, our team has hit the ground running and we are excited to be back to drilling and completing wells as Robert mentioned, we just deployed a second rig which we replace in Upton County on a 5 well pad we're.

We're excited about having a full drilling and completion schedule going forward, particularly once we begin completing the wells drilled for the second rig, which we expect to do late in the year.

So far we're very pleased on our drilling and completions operations and are particularly pleased to have the IRA assets fully integrating having recently drilled our first pad on those assets. We begin completion operations on those wells this week.

We have taken over operations on the tracker assets I was out in Midland. This week to start the process of implementing the archstone culture that the tracker properties as well as initiating completion operations on the Pearl Jam packed.

Due to a combination of factors our completion schedule. This year is heavily weighted towards short laterals. The 20 gross wells or expect we expect to bring on this year will have an average completed lateral length of around 5200 feet.

While these wells are in really good rock with attractive economics. There is no doubt that capital efficiency has decreased with a shorter lateral weighted program.

30 wells, we expect to spud. This year, we'll have averaged 6800 foot laterals the longer laterals are more weighted to the back half of the year. This debt.

The sub oil for next year, when we expect the average lateral length to be much more heavily weighted to longer laterals with expected average completed lateral length closer to 9000 feet.

Let me take just a moment to address cost inflation.

We have some upward pressure on all areas of operations like steel prices for casing.

Frac cost increases and increases in items, such as chemicals and trucking.

We had some of these items included in our range of capital cost for the updated guidance. We are working hard to offset these increases with efficiency gains from less days on locations, while drilling and completing.

Steel prices are up approximately 20% on our frac cost per stage is up 14% since the beginning of the year. We expect these costs to level out here and only expect minor increases in other areas as oil prices have stabilized in the $70 range.

We are seeing some savings and lease operating expenses as we implement our procedures based on our experience of best practices from our existing operations. However, we do continue to see increases in trucking and fuel prices.

Again, we will target additional efficiencies in these new assets in order to offset higher costs.

With that I'll turn it over to Mark.

Thank you Steve as usual, we will start on the financial side with a recap of the balance sheet and liquidity position and then we'll go into some other financial details for the quarter.

As you know maintaining strong liquidity continues to be a key focus for us, especially as we further increase the scale of operations and remain poised to take advantage of new opportunities in the A&D world.

With the closing of the tracker acquisition on July 20th for borrowing base of our revolving credit facility increased from 475 million to $550 million.

Looking at the quarter end cash balance and debt balance as of June 30, we had a cash balance of zero point $5 million and a debt balance of $241.4 million outstanding on our credit facility borrowing base of $475 million.

Adjusting for the closing of the track for acquisition in July we would've had an estimated <unk> 5 million in cash and 301.0 million of long term debt outstanding under our credit.

<unk> with a borrowing base of $550 million on that adjusted basis looked at $249 million of Undrawn borrowing base capacity and about half a million dollars in cash we had total liquidity of near $250 million, which is just a little below 50% availability under the new borrowing base.

For the second can you share any quarter, we generated $28.4 million of free cash flow, which when combined with the $31.8 million, we generate in the first quarter brings us to a little over $60 million of free cash flow in the first half for the year.

We expect to continue generating free cash flow in the second half of the year and will continue to utilize free cash flow to pay down debt.

Through the first half of the year, which was prior to the impact of tracker or total debt to annualized adjusted EBITDAX was 1.2 times. We believe we are well on our way to achieve our targeted goal of having leverage below 2.5 times at year end 2000, 22021, including adjustments for all of our acquisitions for.

Further with the expectation that we will see significant production growth in 2022, while utilizing free cash flow to reduce debt levels, we fully expect to be below 1 times leverage by year end 2022.

Excluding acquisitions, our accrued capital expenditures totaled $22.8 million in the second quarter, bringing year to date capital expenditures to $32.6 million based on running 2 rigs for the balance of the year and turning 20 gross operated wells to sales. Our recently revised 2021 capital budget sits at a range of $130 million.

$2.140 million.

As Steve mentioned, we do have some room for cost inflation embedded in the implied $102 million of second half capex at the midpoint.

I assure you that our operating team is laser focused on maximizing cost efficiencies.

Now looking at the second quarter 2021 financial metrics and starting with the top line revenues for the quarter were $89.7 million with oil contributing 79 per cent of the revenues for <unk>.

<unk> standpoint in the second quarter, we achieved record sales volumes of 2000.22716 barrels of oil equivalent per day, which was comprised of approximately 52% oil, 24% natural gas and 24% natural gas liquids.

Now moving over to commodity prices for the second quarter, our realized prices for oil were $65.47 per barrel of oil before hedges and $52.39 per barrel after hedges for natural gas, we realized $2.29 per Mcf before hedges and $2.19 after hedges and for.

Natural gas liquids, we realized $24.31 per barrel and we don't have any hedges on our natural gas liquids, the same realized price pre and post hedge.

That brings us to a total Boe equivalent up $43.38, since before hedges or $36.38 since after hedges of course, we've not enjoyed writing hedge settlement checks this year, but our consistent discipline on hedging is the key part of our risk management strategy and Washington painful on a rising commodity price environment, our hedging strategy greatly benefit.

For this in 2020, and it was really critical and position us to be able to make the <unk> acquisition, we have in 2021.

On the expense side on a per unit basis, our all in cash costs, which includes low.

Gathering processing and transportation costs production and severance tax cash G&A and interest expense came in at $11.65 per barrel of oil equivalent for the second quarter, which was down from $12.66 per barrel of oil equivalent in the first quarter, our lease operating expense was $5 <unk>.

68 per barrel oil equivalent compared to $5.93 per.

The barrel of oil equivalent in the first quarter and as you've seen we have revised our guidance range for LOE in the second half downward to a range of $5 and steady cash to $6 per Boe.

Which is significantly lower on a range of guidance than we previously had provided on.

On the general administrative expense side, our adjusted cash G&A expense was $4.8 million or $2.30 per barrel of oil equivalent in the second quarter, which compares to 2 hours 76 cents per barrel oil equivalent in the first quarter.

Our continued growth in production, while maintaining relatively flat cash G&A, which came in just under $10 million for the first half has allowed us to continually improve our cost structure.

It was not that long ago that we are seeking to achieve combined low.

Plus cash G&A cost of below $2 per Boe.

And we just came in under $8 per Boe in the second quarter.

From an income standpoint, we reported a GAAP net loss in the second quarter of <unk> 58 to $15.8 million or a loss of <unk> <unk> per share, which included unrealized losses of $36.7 million on on derivative contracts are adjusted net income, which excludes the impact of unrealized derivatives.

Was a profit of $23 million or 26 cents per diluted share in the second quarter and as Robert said, we reported a very strong EBITDAX of $53.7 million on the second quarter, which was up approximately 22% from the first quarter with that I'll turn it back over to Robert for closing comments.

Hey, Thanks, Mark are having closed on $360 million of highly attractive deals. So far this year is representative of our ability to execute on our growth strategy by using our strong financial position to increase our scale with high quality accretive acquisitions.

<unk> meaningful value for our shareholders remains our number 1 priority and as can be seen by these deals our operating statistics through the first half of the year and our conservatively managed balance sheet.

We are continually seeking additional attractive consolidation targets and are confident in our ability to effectively integrate further asset acquisitions. We have worked hard to maintain the strength of our balance sheet through throughout these recent acquisitions and we will continue to pursue accretive consolidation opportunities that add valuable scale to our.

<unk>, while maintaining our strong cost structure and clean balance sheet.

Now with all of that operator will be glad to take a few questions.

Thank you at this time, we'll be conducting a question and answer session. Thank you would like to ask a question. Please press star 1 on your telephone keypad, a confirmation tone will indicate your line is on the question queue.

Press Star 2 if he would like to remove your questions on the queue for participants using speaker equipment and may be necessary to pick up your handset before pressing the star keys.

Our first question comes from Jeffrey Campbell with Alliance Global Partners. Please proceed with your question.

Thank you and good afternoon.

My first question is regarding cost inflation your forecast at all and for our costs on slide 12.

Actually I haven't changed since guidance provided on <unk> 521, so even though you highlighted some cost inflation today. It appears that it's still within your prior forecasted range is that correct.

Yep that all stays the same Jeffrey.

We had a little bit of cushion in there from the beginning of the year and things have stabilized. So we hope that we.

We don't see any major increases between now and the end of the year.

Okay, great. Thank you.

I was wondering if you could add a little bit of color regarding the location.

Of the wells Youre evolutions.

Youre currently generating with the second rig.

It's in Upton County, sitting right next to some other wells that we completed earlier in the year offsetting the ratliff and been a day area. So it's right at the County line between Upton and Reagan County line. So it's really.

A really good high quality rock area.

And that's where the second rigs running right now.

Okay.

Last 1 that I'll ask is.

You noted that unit.

To add additional scale I just wondered if you could expand on what your options on that regard.

Well, it's a pretty active.

A&D market currently for lots of reasons oil prices are up so sellers are feeling pretty good although forget about what's happened maybe in the last week, but.

And I think people are trying to take advantage of where the market is right now and so there is lots of deals on the market.

So our deal flow is pretty high on our teams are really busy and I think it just gives us optionality of.

Future opportunities to look at and kind of pick and choose what makes sense for us. So.

We feel like we are.

We've proven we can integrate assets, Steve and our team have done this a lot through long number of years and a lot of different deals. So each one's a little different each deal, but we think we can continue to integrate assets effectively.

And manage more under this management team. So we're going to continue to keep beating the bushes and try and find opportunities to grow because I think thats what.

What will make us attractive to investors as we continue to build a really nice business.

And just as a quick follow up to that so on us on the whole thing here.

You recently did a deal on the Eagle Ford and Theres been some more consolidation there recently.

As the Eagle Ford are places that you would still look for opportunities or are you really focused on them on at this point.

Midland is our first focus area, we'll call it but having a footprint in the Eagle Ford and having a great operating team there makes it easier for us to look at deals versus if we werent in that basin, we love the play.

There has been some consolidation and I think similar to the Midland Basin, there's still a lot of.

Private companies, who are looking to monetize as well as public or larger cap excuse me larger companies, who are looking to sell assets. So we want to we want to participate if it makes sense.

Okay, great. Thanks, Thanks for that on all the color on I appreciate it.

Net.

Thank you. Our next question comes from Neal Dingmann with share list. Please proceed with your question.

Good morning, guys and I mentioned that I'm going to ask about M&A because by now I'd. Just assume you guys are going to keep cranking out a few accretive deals a year or so Robert let installed let me turn things over to capital discipline I'm. Just wondering given next year, you've talked about the 2 rig program low cost I think you'll see obviously the hedges.

Drop off a bit and if we have the solid prices that could continue by my math you guys could start cranking out I don't know if he would potentially over $25 million quarterly free cash flow could you speak to your thoughts on redeploying this capital weather.

Does it make sense to.

For more growth to generate even more free cash flow or debt.

I might even say share buyback, while not always a fan.

Your share does seem incredibly cheap bruce or asset value. So again I'm just wondering once you get to that potentially.

Next year, if things go into as such.

Is your thoughts.

Yes, and we consider all of this Neil as you know, whether we should consider some kind of shareholder return or use cash flow to continue to build scale and I think first and foremost for us outside of paying down debt and getting leverage well below 1 time.

Is.

Continuing to build scale I think sub I don't know what the right number is 2% or 5 billion dollar market cap.

You have limited options for investors and getting bigger and if we can build the same kind of profile of the company at $2 billion, plus having low leverage lots of liquidity and.

And a good business with low cost structure, I think that will continue to attract new investors into our stock and create shareholder value, which is what it's all about so I think next year.

We would consider it but that's not the first place, where we would consider putting excess free cash flow.

Yes, absolutely. It makes total sense and then my second maybe Robert maybe even for Mark.

Just more on your hedging plus the kind of again back to what I was thinking about for next year, if things continue to go as such.

Balance sheet continues to be of course, very very conservative. So I'm just wondering again with some of the hedges roll off next year would you consider.

Just leaving less hedges would you go to more call it or maybe even consider puts like I know some larger companies are doing or would you stay as highly hedged as you've had in the past.

Well, let me, let me take the first gas well.

Well, let me take the first stab on and Mark you can chime in a little bit.

First of all we're going to be disciplined and we're going to have some regular <unk>.

<unk> program that we're going to do we're just not doing it to forecast prices right, we're protecting balance sheet capital obligations or our capital program and our overhead and we're going to have some level and that number could be less than 80% like we've historically had.

With a bullish view on oil prices, but also lower debt and a good environment.

But at the same time.

We're all about risk mitigation, so around hedges I mean, sorry around acquisitions, we're definitely going to want to hedge some PDP value.

Mark I'll, let you expand.

I think you got it thats looks for.

Right.

Yeah.

Glad to hear I think that for what it's worth that's the way to handle going forward. Thank you all guys nice quarter.

Thanks Neil.

Thank you. Our next question comes from Scott Hanold with RBC capital markets. Please proceed with your question.

So if we could pivot back to that second rig and I think you said there was on a 5 well pad could you give us a little bit more color or.

When do you expect to turn those wells in is it going to be like all at ones or will it be staggered and could you remind us the working interest on those wells.

That'll be all at once well staggered over a couple of days how about that Scott.

This is a 5 well pad we typically.

Welcome.

Well frac them all at 1 time and bring them all on and when I say at 1 time, it's over continuous operations and bring them on all at 1 time or continuously until they come online.

But I think our plan right now is they don't get started fracking until the.

Late this year so they wouldnt come on till early next year and it is it is a 5 well pad like you mentioned.

And John just on lateral lengths on those.

Yes, Scott Bob Adams.

Go ahead Mark.

Those are 10000 foot laterals and that is the 100% working interest and I would say just looking at our program <unk>.

Generally speaking our average pad sizes for 4 wells, we just brought on something late in June that was 3 wells.

I think the rest of the completions. We have this year are actually all 4 well pads.

As Robert mentioned those are all from the existing on the first rig we deployed.

And those are actually all short laterals. So we've got 12 short laterals that we should bring on line in the second half for the year really for.

Probably mid to late September into December.

And then once we get into next year.

As we've outlined we get to a lot longer on average lateral length. I think we're more like 9000 foot average lateral length next year versus this year with the heavy weighting towards the short laterals were not much higher than 5000 feet. So we're looking forward to that and certainly for me capital efficiency standpoint.

It'll be nice to see the impact of that.

And so presumably I mean, obviously with some of the those for pads coming in September December this year and the net 10000 per lateral 100% working interest pad 5 well pad coming on early next year, I mean that should probably present, a pretty good opportunity to see a big uplift in production in <unk> 2022 is that a fair.

A way to think about it.

I think that's fair Scott.

I'll just add obviously just put out updated guidance a couple of weeks ago, when we announced the close of the trial for deal and for the second half, it's a bit of a stair step in terms of.

We are a bit over 22000 BOE a day in the second quarter.

If you wanted to take what our second half guidance as you know.

The third quarter doesn't have a full quarter of tracker and there is share.

<unk>.

Not really much in the way of completion activity that will hit in the third quarter if at all.

So you get a bit of a stair step for them.

<unk> Q2 to 3 key to <unk>.

Fair to say.

Next year, particularly as we start bringing on some longer laterals you would see you maybe in other sections upward and <unk>.

Yes, I mean its on it.

It feels like it's going to.

Probably a push in excess of 30, a day is that.

And my thinking.

Thinking about that right.

Yes, Lisa.

Ballpark I would also say just for me oil content standpoint on our guidance is a little below 50% for the second half for the year.

That's probably even.

Well.

Is that different between <unk> and <unk>, but as we bring on wells and <unk>. It does get <unk>. So we do expect to kind of get back over 50% oil content when we start getting.

Multiple pads come on line, especially into next year.

Okay. Okay no that's on.

Good day nice start for next year.

And then.

I'll ask a little bit on M&A and what are you generally seeing in the conversations I mean, obviously, it's been a robust market out there, but do you find that.

Sellers are trying to push price a little bit more can you could you be purely accretive with transactions out there right now.

We hope so.

I think youre seeing with improved prices and kind of moderated service cost inflation now.

Net.

Certain.

Instances upside as being.

Ascribed value and so to be competitive in a in a process, we're going to have to look at the upside and figure out whether it fits into our inventory and how soon and whether it makes sense to have to pay something for that upside but I.

I think thats, where you see certain deals in certain sellers, having the ability to you know.

Pushed the prices they've got really good inventory.

And we've got good inventory and if we can find.

Areas that will compete for capital then.

That makes sense and we push our price a little bit based on inventory.

Yes.

Thank you.

Thank you. Our next question is a follow up from Jeffrey Campbell with Alliance Global Partners. Please proceed with your question.

Yes, thanks for letting me back on kind of following up on some other things as Scott was asking on this.

On an obvious but should ask anyway are you planning to continue a 2 rig program in 2022 and is there any comparability when I get a third rig at some point during the year. If we continue to have the supportive commodity environment, we have now.

We are definitely planning for a 2 rig program.

We've contemplated what does the 3 rig program look like and you can imagine we've run sensitivities on all of that but at this point.

Steve will probably kill me, if I said, Hey, I want to go to a third rig we just got the second rig running so just like we did with 1 going to 2 rigs will probably get 2 rigs running.

We'll see how our program is working out and efficiency in getting the rust out on the second rig and then consider it based on circumstances next year.

Okay, that's fair.

Thank you.

As a reminder, if you'd like to ask a question. Please press star 1 on your telephone keypad 1 moment, please while we poll for questions.

Ladies and gentlemen, we have reached the end of the question and answer session and I will now turn the call over to Robert Anderson for closing remarks.

I appreciate everybody joining us today, and we look forward to continuing the discussion with you next quarter have a good day.

This concludes today's conference and you may disconnect. Your lines at this time. Thank you for your participation and have a wonderful day.