It is recommended that this article be read in conjunction with the prior report on Miller Energy Resources (NYSE:MILL).
Cash Concerns And Timeliness Of Annual Meetings
Miller's cash is running low at $4.3MM as of 10/31/12. Following FY11 (4/30/11), the CEO, Scott Boruff, took (pg. 35) a $1.1MM cash performance bonus (25% of 10/31/12 cash) and presumably will hope to receive a similar bonus for performance this year which will further drag down the company's cash.
The most recent annual meeting took place on April 12, 2012; however, this meeting was for the year ended 4/30/11. Miller holds its annual meeting for the prior year, less than 20 days prior to the end of the NEXT year. Typically companies host annual meeting 4 or 5 months after year end with the typical calendar year filer hosting meetings in April or May. Miller waits more than 11 months.
By delaying the filing of the proxy and annual meeting till the last possible opportunity for last year Miller management is able to delay disclosure of compensation arrangements for its executives as well as updated options awards and any related party transactions. This allows Miller management to prognosticate about the future and things to come while quietly sweeping their poor execution for the year before under the rug. Imagine if you turned in your expense report for 2011 in December 2012; your boss would laugh at you and tell you not to expect to get paid back. By failing to file a proxy with any urgency, Miller CEO is able to defer disclosing amounts related to his personal use of the corporate jet to fly to vacation destinations in Florida which should be disclosed under "other compensation" in the proxy.
In the 10Q, MILL reported oil and gas operating expenses of $4.871 million for the quarter ending 10/31/2012, on production of 78,145 boe (barrels of oil equivalent) for production costs of $60 / barrel. This is obviously a much higher cost than the company's reserve report assumes to calculate MILL's PV-10 value, which some investors are using to justify Miller's valuation. However, if the cost assumptions underlying the report prove to be optimistic, any valuation derived from the PV-10 calculated in the report will prove to be too high. As detailed in my last article on the company, Miller's reserve report assumes that operating costs / barrel for the company's developed but non-producing assets will be under $15/boe and operating costs on undeveloped assets will be less than $6/boe.
This is a convenient time to point out that much of the work Miller is currently performing on the Osprey platform over the next year, if successful, will go towards restoring production to levels that had already been achieved by Pacific Energy when they controlled these assets. In the most recent quarter, Miller's average net production was less than 900 barrels of oil equivalent per day. The bull thesis for Miller assumes that this higher production will lower production costs per barrel to what is assumed in the reserve report. However, this does not appear to be a reasonable assumption, since Pacific Energy had Alaskan production over 6,000 barrels boe per day (more than four times higher than Miller's current production rate) yet still experienced operating expenses over $40 per boe (more than double the cost assumed in Miller's reserve report) in 2009.
This is before considering the fact that for the PV-10 to be an accurate representation of the value for Miller's assets, the reserves need to be developed in a timely fashion, with capital available to finance this development. In the case of Miller, both of these assumptions appear to be tenuous at best.
Miller has nearly run their current credit facility up to the limit, and has had to place the proceeds from their recent preferred stock sales into an escrow account with their lenders who then allow disbursements from the account for approved capital expenditures. In addition to this, Miller has been unable to meet the covenants of their debt facility, and is at the mercy of their lenders to obtain waivers in order to avoid default.
Miller sticking to a development schedule has proven to be a bad bet historically.
- Miller's CEO stated on their most recent earnings call (12/10/2012) that 10 days was a conservative estimate for completion and testing of the RU-3 well. However, 11 days later, the company released an update stating the well had still not been completed, again promising another update as soon as well testing is complete. This update itself was over 2 weeks ago, and includes what appears to now be another missed deadline, when the company stated they expected to complete RU-3 and move to RU-4 "in the first week of January 2013".
- In the same earnings call estimating a 10 day completion time for the RU-3 well, Miller also noted that drilling of their Olsen Creek prospect which they had planned to begin drilling by the end of 2012 would be pushed into summer 2013.
- Before receiving a waiver from their lender, the minimum level of production acceptable for Miller to remain in compliance with the production covenant of their credit facility was 1,500 bbls per day for 10/31/2012, when actual production averaged less than 1,000 bbls per day for the quarter.
- Finally, for further demonstration of Miller managements' poor long term ability to meet production plans, one can go back to the Q3 2012 earnings call, from 3/12/2012. When asked about where he saw total company production by calendar year end 2012, Miller's CFO responded, "We think that the total company view by the end of the calendar year should be in the 4,500 to5,000 barrel-a-day range." In the most recent 10Q, filed on 12/10/2012 Miller noted that the first production measurement date for the Apollo Credit Facility will be 1/31/31, when the required level will be 1,700 barrels per day, and based on current production levels, they would not be in compliance.
Cook Inlet Energy:
When discussing opportunities, Forensic Accounter reminds shareholders that when David Hall mentions the failures of "previous operators", he is in fact talking about his team and their employment with the prior owners of these assets.
Cook Inlet Energy is the corporate subsidiary of MILL through which the company acquired their Alaskan properties. Cook Inlet Energy was formed by former employees of the bankrupted owner of the acquired assets, Pacific Energy. In fact, David Hall (the current CEO of the Cook Inlet Energy subsidiary and MILL director), has been involved in the operation of these same assets since 2000 (when they were owned by Forest Oil).
Keeping The Lights On
It is critical that Miller get the RU-3 well completed successfully in a timely manner since the company is a net buyer of natural gas while operating in a region where XTO, an Exxon (NYSE:XOM), subsidiary recently had to shut down two of their production platforms in the Cook Inlet due to a natural gas supply shortage in the region.
Miller filed plans for approval of a pipeline which is expected to cost $50MM and begin in 2014. Given the company's cash of $4.3MM as of 10/3/12 and declining production, funding this large capital commitment would be incredibly difficult. Common shareholders should expect either a secondary or the slow trickle of dilution as Miller makes use of its at-the-market offering. Keep in mind that the lower the stock price goes, the worse the dilution gets for each dollar raised in such a fashion.
Forensic Accounter continues to believe that Miller management paints a rosy outlook for the company and makes use of side projects such as the pipeline and horizontal drilling program to create talking points for use in finding additional sources of capital to supplement the languishing pace of progress being exhibited in Alaska.
Disclaimer: Use of the opinion produced by the author is at your own risk. This is a short-biased report and you should assume the author of this report holds a short position and/or derivatives tied to the security of Miller Energy Resources that will benefit from a decline in the price of the common stock. Following publication of the report, the author (including members, partners, affiliates, employees, and/or consultants) may transact in the securities of the companies covered herein. The author of this report has obtained all information used to form opinions and draw conclusions contained herein from sources believed to be accurate and reliable and has included references where available and practical. However, such information is presented "as is," without warranty of any kind- whether express or implied. The author of this report makes no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. Forward looking statement and projections are inherently susceptible to uncertainty and involve many risks (known and unknown) that could cause actual results to differ materially from expected results. All expressions of opinion are subject to change without notice, and the author does not undertake to update or supplement this report or any of the information contained herein. The author is not a broker/dealer or financial advisor and nothing contained herein should be construed as an offer or solicitation to buy or sell any investment or security mentioned in this report. You should do your own research and due diligence before making any investment decision with respect to securities covered herein.