Constellation Energy Partners LLC Management Discusses Q1 2013 Results - Earnings Call Transcript

May.17.13 | About: Sanchez Production (SPP)

Constellation Energy Partners LLC (CEP) Q1 2013 Earnings Call May 17, 2013 9:30 AM ET

Executives

Stephen R. Brunner - Chief Executive Officer, President and Chief Operating Officer

Charles C. Ward - Chief Financial Officer and Treasurer

Analysts

Michael D. Peterson - MLV & Co LLC, Research Division

Frank J. Abella - Investment Partners Group, Inc.

Operator

Good morning, and welcome to Constellation Energy Partners' First Quarter 2013 Earnings Call. [Operator Instructions] The conference is being recorded. I will now turn the call over to Stephen R. Brunner, President and Chief Executive Officer of Constellation Energy Partners.

Stephen R. Brunner

Hello, everyone. This is Steve Brunner. Chuck Ward and I would like to thank you for taking the time to join us this morning as we review our first quarter 2013 results.

Before we get started, I'd like to remind our listeners that this morning's presentation is being webcast and slides are available on our website, which is constellationenergypartners.com. I'd also like to remind everyone that our slides and discussion this morning include forward-looking statements, which are subject to certain risks and uncertainties, which are described more fully in our documents on file with the SEC.

As we normally do, we'll use GAAP financial measures in this morning's presentation to help our unitholders and investment community to better understand our operating performance. The presentation available on our website includes an appendix that reconciles these non-GAAP financial measures to GAAP measures.

And finally, those of you who have followed us for a while know that we've historically communicated with the investment communities in metric stated in cubic feet equivalents. Given our current focus on growing oil production and the meaningful results that focus -- that continues to produce, we've decided with today's report to initiate a dialogue based on barrels of oil equivalent, or BOE, as we think this lends itself to a more focused discussion on our results, cost structure and plans for the future. Note that our Form 10-Q, which was filed with the SEC earlier this week, will continue to present our results in terms of cubic feet equivalents. So that data is still available for anyone that may find it useful in their analysis of our company.

If you'll turn with me to Slide 3 of our presentation, I'll begin with some updates since our last call. As you can see on Slide 3, oil accounted for about 50% of our total sales revenue in the first quarter. Our total average net production was 3,722 BOE per day during the first quarter, which is a little better than our forecast for the full year. Included in this total net, oil production of 531 barrels per day, which was up about 34% over fourth quarter 2012 and up 64% over the first quarter 2012. As we've previously discussed, the increase on net oil production is attributable to the continuing success of our Mid-Continent drilling program, with the higher level of oil production during the first quarter of this year resulting primarily from our 2012 drilling efforts.

During the first quarter of 2013, we completed 17 net wells and recompletions in the Mid-Continent on $2.5 million in capital spending, and we ended the quarter with 4 additional net wells and recompletions in progress. As you'll recall, our full year capital spending is forecast to range between $19 million and $21 million in 2013, so we anticipate our drilling activity and capital spending will accelerate as we progress through the remainder of this spring and into the summer.

Our operating costs, which include lease operating expenses, production taxes and general and administrative expenses, excluding certain noncash items and a onetime employee severance charge, came in at $23.98 per BOE during the first quarter, which was also right on target relative to our forecast for 2013. Our adjusted EBITDA, excluding the onetime employee severance cost, was $6 million in the first quarter. This is down slightly relative to what we reported for the fourth quarter 2012, but up about 40% relative to what we realized in adjusted EBITDA during the first quarter from our Mid-Continent asset base, which makes up our continuing operations after the sale of the Robinson's Bend Field assets. Chuck will provide some more details on how the quarter stacked up against prior quarters in terms of continuing operations in just a second.

But before he does, I'd like to mention that we're working to complete an amendment to our reverse -- reserve-based credit facility and expect to share more details later this quarter. In anticipation of that amendment, we layered on additional NYMEX hedges with one of the existing lenders that cover approximately 3.7 Bcfe of our natural gas production in the 2015 and 2016 time frame. Our updated hedge positions are summarized in the appendix today, slides and our Form 10-Q filed earlier this week.

I'd also like to mention that we remain focused on identifying and pursuing opportunities to grow the company through acquisitions and/or consolidation, with our primary focus on these opportunities that allow us to leverage our Mid-Continent footprint. We hope to share more details on how our efforts in this area are progressing in the months to come.

With those updates, I'll turn things over to Chuck, who'll begin on Slide 4.

Charles C. Ward

Thanks, Steve. Slide 4 compares our first quarter 2013 results to the first quarter -- fourth quarter 2012 and the first quarter 2012. For purposes of this presentation, we're showing first quarter 2013 begins the prior quarter's continuing operations, which is to say that we've excluded the Robinson's Bend out of the prior quarter's reported results.

You can see from this presentation that our total production during the quarter, at 335 MBOE, was essentially flat relative to the fourth quarter 2012. However, looking at our revenue components, our oil production was up about 31% quarter-on-quarter and natural gas production was down about 5%. First quarter of 2013 oil and gas sales revenue of $14.4 million compares to $13.7 million in the prior quarter and $14 million in the first quarter 2012. This increase in sales revenue in the first quarter of this year was helped along by our higher level of oil production during the quarter and shows the impact our oil production is having on our results.

It's also worth mentioning, as we've seen some rebound in natural gas prices over the last several months, that we still maintain a pretty sizable gas option with the Osage Concesssion, and our oil drilling helps us maintain that option. This gas option is something we can act upon pretty quickly with gas prices to show some resiliency in the future. Note that the balance of our revenue was impacted by a loss from mark-to-market activities, this was, again, a function of commodity price movements during the quarter, which impacted the value of our hedge portfolio and flowed through our financials as a noncash item.

Operating expenses, even with the onetime employee severance costs that Steve mentioned earlier, were down about 3% in the first quarter 2013 as compared to both fourth quarter 2012 and the first quarter 2012. Taken together, our adjusted EBITDA, excluding the onetime employee severance cost, was $6 million. You can see that on Slide 4, that this is a quite a bit better than the results we showed for continuing operations in the fourth quarter 2012 and first quarter 2012. We attribute this generally to the increase in our oil production, which has more value to us in the current commodity price environment and our continuing efforts to manage operating costs.

Further, to Steve's comments on our hedge positions, I'd like to note that for the remainder of 2013, we've hedged approximately 5.1 Bcfe of our natural gas production and an effective NYMEX fixed price of $6.17 per Mcfe, with basis hedges on 3.8 Bcfe of this amount at an average differential of $0.39 per Bcfe. We also have hedges in place on approximately 107,000 barrels for our oil production, at a fixed price of $96.31 per barrel.

On Slide 5. Here, we show our net asset value of earned reserves [ph] that exist after the sale of the Robinson's Bend assets based on the forward prices observed at the end of the first quarter. We continue to look for ways to positively impact our NAV. As we've discussed previously, key among these are our efforts to increase oil production while managing our operating costs. Additionally, with the refinancing of our credit facility anticipated shortly, we look to use our liquidity to accelerate growth through acquisitions primarily focused on consolidation in the Cherokee Basin.

With that, I'll turn the presentation back to Steve for some closing remarks.

Stephen R. Brunner

Thanks, Chuck. I'll wrap up this morning's presentation with a few key takeaways. We're seeing meaningful contributions from our focus on the oil opportunities in our Mid-Continent asset base, with our first quarter results on target relative to our forecast for 2013. Our net oil production increased by 34% in the first quarter 2013 and now accounts for approximately 50% of our revenue from sales. As we look to grow the company, we intend to maintain a focus on oil while working to identify and pursue acquisitions and/or consolidation opportunities primarily focused around our Mid-Continent footprint.

I'd like now to turn the call back to our moderator for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Michael Peterson.

Michael D. Peterson - MLV & Co LLC, Research Division

First question, if you could frame your development activities in historical context, excluding your divestitures. Put differently, how did the 17 net wells and recompletions that you had during the first quarter compare to a similar asset base in prior periods? Was this an acceleration? Was the development activity flat? How would you characterize that?

Stephen R. Brunner

Well, actually, it's a little lower than we would normally expect to carry out on a quarter and some of that's related to weather, some of it's just related to timing as we prepare our budgets in our technical program going forward. Our historical capital spend in Q1 has always kind of lagged behind. If you just took our expected capital spend for the year and divided it by 4, we're always a little slow getting it out the first quarter. We intend to accelerate through the next couple of quarters while we have the best weather months and, hopefully, are able to execute as efficiently as possible. We have the technical program in place. We have the wherewithal to execute it, and we will accelerate, in fact, over the next couple of quarters.

Charles C. Ward

And, Mike, what I'd add is also, remember, in the first 2 quarters we were working on the Robinson's Bend sale. We were pretty heavy invested in that process, in that timeline and to really, what we'd say, finish off rightsizing the balance sheet. So that was another factor that affected the timing and execution there.

Michael D. Peterson - MLV & Co LLC, Research Division

Okay, that's helpful. If I can do a follow-up, Stephen noted that you expect a successful amendment of your credit facility sometime this quarter. Question is, upon completion, would it be fair to expect that your cash carry would reduce once you've got a functional revolver in place?

Charles C. Ward

Yes, absolutely.

Operator

Our next question comes from Jay Abella.

Frank J. Abella - Investment Partners Group, Inc.

I wanted to ask you quickly, I guess from the 2013 forecast standpoint and the capital expenditures that you guys are thinking about, what would you say, after the sale of the Robinson's Bend, we can look forward to with respect to an exit rate of production for the end of the year? You're at about 3,700 BOE now. And so does that number stay around 3,700, or does that go higher? And I guess the second question is, what can I put down for your 2P reserves now?

Charles C. Ward

Yes. I think the first -- on the first exit rate, what I would think is that it will be at that or higher. We, obviously, aim to be higher, and we continue to grow it. It depends upon, of course, getting the capital out in the right time frame. Then I think that we're -- for the first quarter, sticking with our forecast range, so I think, obviously, we're nearing the quarter -- the way along with the capital that we've had out so far. 2P number, I don't think we have actually a -- and I don't -- I guess you can calculate the value from the NAV slide, but I don't think we have a 2P BOE or MBOE or equivalents that we have that's in a publishable format. Are you asking for value perspective, or are you asking from a volumetric measurement?

Frank J. Abella - Investment Partners Group, Inc.

It's just an update from a reserve calculation standpoint, just total. Trying to figure out what the reserve life index is.

Charles C. Ward

From a volume perspective?

Frank J. Abella - Investment Partners Group, Inc.

Yes. Trying to figure out what reserve life index is at this point.

Charles C. Ward

We don't have a publishable volume perspective. What we can -- we can look at whether we can sort a way to update that in our next filing, but we don't have that actually in a way that's prepared to go. We did the NAV, which gives, obviously, a -- you can calculate a 2P value on a forward curve. But that's all we have that's -- in the way we currently generate our IR material.

Frank J. Abella - Investment Partners Group, Inc.

Okay. And then I guess going back to the production, would you anticipate if the production were the same or better by the end of the year that, that would indicate more oil? And if so, what can we maybe look for on a range?

Stephen R. Brunner

Jay, I think a good way to think about this is if you look at our kind of historical perspective. From 2010 to kind of current, we've managed with limited capital spending, quite frankly, because simply the challenge is to triple our daily oil production and our reserves, quite frankly. This year's capital program hasn't changed. Our focus is on our oil opportunity that are available. So with an effective capital program, which we intend to accelerate drilling over the next 2 quarters or summer months, where we do it as efficiently as we can, we can't promise, but we certainly hope to continue improving both production and reserves on the books.

Charles C. Ward

And maybe perhaps -- we did the midyear drilling update last summer, and maybe that's a good refresh and a chance for us to get that data out there for you guys, too.

Operator

Our next question comes from Joseph Acursa [ph].

Unknown Analyst

Most prospective retail investors like to invest in companies that have distributions that give them a bond equivalent yield and they're growing their top and bottom lines. According to my calculations, a small $0.02 per quarter distribution would amount to less than $0.5 million per quarter and would give unit owners a 5% bond equivalent yield. Well, where prices are today, that seems to be a very small fraction of free cash flow. Is this something that you're considering in doing in the coming quarters? Also, you mentioned in the last conference call small opportunistic acquisitions as a plan to rightsize the company, and this would likely improve the top line definitely. For the bottom line, have you considered anything like approaching PostRock to purchase the Constellation units that they own or possibly putting in a unit repurchase program that I've seen some other LLCs do? I know it's more of an exception than a rule.

Charles C. Ward

Sure. So I'd clump 2 of the things that you asked together, which is distribution and a repurchase, since both of those would be a return of capital to unitholders. And though you would know and agree that they have a different nature and applicability to them. From a cash flow NAV perspective, they may seem similar. And probably from with respect to us recommending it to the board, we feel a little similar as well. But your point on a retail investor has been something that's not been lost on Steve and I since '09, when we had to cease the distribution to really begin the sequestered debt reduction schedule. The operative thing, therefore, for considering a distribution and for us recommending to the board and then the board taking that into effect is -- number one, is finishing the credit facility. That's an important first step. The second one, though, is actually having the capital spend rate out, so that the company is kind of has a flat multiyear forecast on cash flow, such that the excess cash falls out the bottom and is able to be distributed to unitholders. And all the things that we're doing are things that are headed towards being in that position. To us, growing the top line and the oil is all aimed at heading towards that, to be that. That's embedded in our LLC agreement. It's an important part of who we are as a company and how we were formed. And there's -- I'm really kind of no-changing that by wishing things were some other way. So we continue to work to try to grow the top line. We continue to work to try to increase the adjusted EBITDA, so that ultimately a distributable cash flow number could yield a distribution. And the math has to work that way more so than us hoping to be able to make a small distribution to kind of kickstart a different relationship with our retail investors. We desire a different relationship with our retail investors, I think, as both unitholders as management is as much as anybody. But we had -- the math has to work first.

Stephen R. Brunner

And I can tell you that we have a significant discussion with our board every quarter. We're well aware that we've -- we had some significant challenges, and it looks like we're overcoming or getting to the point where we've cured many of them. Chuck and I and the board has significant discussion every quarter about how can we start returning value to our unitholders. Chuck and I happen to be significant unitholders, and we are interested, as you are, in having that happen. But like Chuck said, we have to get through the credit facility and make sure it's refinanced, make sure that's in place. We expect to be able to get back to you soon on that issue. And then our total focus, quite frankly, is how do we return value to unitholders. We have a gap in our net asset value as to where we -- as we trade, and we're an MLP that's not making a distribution. So as we can, we're going to address both of those issues.

Unknown Analyst

All right. I guess on a final question, I guess noting how much of the Alabama assets did sell for over $60 million, I guess, I'm pretty reluctant to ask the question, but has it ever crossed anyone's mind that a sale of the remaining assets would probably fetch more than twice that in a fire sale? Do you expect...

Charles C. Ward

So here's the great thing is, I think if you look at NAV slide, which is not to meant to say that the assets sell for what the NAV is, some assets sell for below PV10 and some assets sell for a higher than a PV10, Steve and I and the board thought it was the thing to do, or Steve and I thought it was the thing to do and recommended it to the board and said, "You know what we should do? We should just shut down the G&A. We should sell these assets and all go home." There's provisions in the operating agreement that give a veto of that to, number one, the A unitholders. And then there's provisions in the operating agreement that also make that 2/3 shareholder vote necessary for approval. And before back, when we had Tudor, Pickering with us and we kind of brought up these concepts, the risk was do you -- how do you run a data room process with participants in the process knowing that their deal is subject to 2/3 shareholder approval, which is kind of like selling an asset with a ROFR [ph]. You just don't drill and expect to see as much activity on that sales process. So it does occur to us. We watch now very closely what's happening in deals in Oklahoma, mainly we watch because we're in that market; looked at a handful of deals last quarter and as part of kind of our looking to expand our footprint in Cherokee basin. And we can certainly think, anecdotally, what do we see from results. If we saw something that I think would make compelling, that we think we could make the case that could convince PostRock and then subsequently, of course, pass a unitholder vote, then it's okay, how do you define a mechanism? It's not like, we could say, "Unitholders, hey, go ahead and approve selling the asset, and we'll let you know what the results were." That'd be a pretty tough vote, I think, to go out and get. At the same time, it's how do you actually put the company for sale if you decide you want to liquidate the assets as they currently stand, knowing that anybody who bids is going to have to sit back and wait to kind of the 60- to 90-day time window for approval from unitholders and/or PostRock, who would then has kind of a binary veto. Then that makes it really tough to figure out how do you effect that.

Stephen R. Brunner

It certainly is a little more difficult for us to consider that option. But I can tell you with great certainty that Chuck and I and the board are looking for every possible way to return value to unitholders.

Unknown Analyst

I guess on the last topic, has there ever been any discussion of potentially trying to get the Constellation units from PostRock? It seems that their balance sheet could probably use quite a bit of cash.

Charles C. Ward

We have to be no comment on that.

Stephen R. Brunner

Sorry.

Operator

Our next question comes from Michael Peterson.

Michael D. Peterson - MLV & Co LLC, Research Division

I'd like to follow up on the strategic discussion. Certainly, with your hedge revenues through 2014, you've got a window to restructure the portfolio. And if we kind of step away from the wholesale liquidation of the portfolio to look at what you might do on an additive or augmentive kind of a basis, how are you thinking about how you move forward with the portfolio? What types of assets are you considering? What kind of capacity do you have to screen deals once you turn the corner on your credit facility in terms of the staff that you have and your ability to start to look at what might complement the current portfolio?

Charles C. Ward

Sure. Well, it's -- well, I love that question. So what we've been doing is we go through kind of a quick screen process here, probably got about 5 or 6 people currently looking. We get together, we talk about those assets and the opportunities on those. We make sure that we don't think they're prospectively too large. But the good thing is that we're looking, where drilling's looking in Mid-Con. We're looking at Oklahoma, Kansas. We're looking for operated predominantly. And since we're looking below $100 million kind of assets, it's kind of a strange box -- sized box. There's a lot of people who -- they want to buy operated assets. They want larger. They want more to put the capital to work. We're not looking for high pud. We're looking for some good solid PDP with the ability to turn our existing development team and our geology and our technical team loose to actually have new eyes and go in and look at those assets. There's been a handful that had come through in the last quarter. There's 2 more kind of prospectively on the horizon right now, which we're working on that we're very excited about. They're exactly the right size. They're operated. They're predominantly oil. They've got some good development potential. One of the things we look for is a place that has a different rate of return horizon to the current assets. So that if I can go from, say, a 20% rate of return for capital on a risk-adjusted format for the puds to a 30% rate of return and a slightly different risk horizon, then we can blend the capital across that and, by virtue of that, be able to grow the top line differently for the same capital. At the same time, we're not probably looking to buy land with something that we don't know. I think we fought hard to get the balance sheet to where it's at to turn around and kind of be, "I'm going to buy land. I'm going to drill 3 wells. I'm going to look at the reserve report that says it's all incredible and then turn around and sell it." That doesn't seem something that, number one, we've been able to do and that we just don't have the technology team just built to do that. We have a technology team that's built to exploit existing production areas by looking at new horizons and new ways to drill and execute there. So we aim to keep on doing that. Very fortunately, in Mid-Con, there's a handful. There's a couple of assets out there right now that are going into the market. They look just right.

Stephen R. Brunner

And I guess to just add a thought there, one of our challenges, of course, has been to get our cost down. We're really small to be in the public space, and it takes a certain amount of G&A to run a public company. And one of the things that we tried to do is hit the right balance, and this is always a concern. We can't have too much technical staff because of the challenges we've had, but I can't tell you the -- that we've pointedly held on to what we think the right balance of engineers, geologists and operations folks that can help us not only execute our current capital program, which I think if you look at the increase in oil production reserves tells you we do have a technical team that's functioning well. But they have a little more capacity than that. I think we could easily, with our team, get out twice the capital if we had the capital to get out and good projects to do it on. And also, I can tell you that we have the experience, significant experience. There's a lot of gray hair sitting around the table to screen deals. So we can screen easily a dozen deals a quarter and do it really well and get our capital program out. So I just want you to rest assured that although we have significantly cut G&A, we haven't cut it to the point that now that we finally turned the corner, we can make a difference, because our total focus now is to turn that corner and make a difference for our unitholders.

Charles C. Ward

And, Mike, one of the things I talked about is if a new -- if you think about a range of 170 to 450 for a new well and let's say that an average new well looks like something like 250 or so, the -- us getting our capital out is as much a logistic exercise as it is anything else. And to me, the thing that I kind of always think about when we're looking at new deals is even if the prospective rate of return, let's say, a push to the rate return we have on our existing portfolio for new plays, if the well cost is double or triple that, then I think that lowers the logistics hurdles that sometimes get in the way of small-basin development and be assured that not only can we get out the capital that we'd forecast, but perhaps have the opportunity to go back to the board and ask for more.

Michael D. Peterson - MLV & Co LLC, Research Division

That color is definitely helpful, and I appreciate that. If I can follow up on some of what you said, which was your operation currently would benefit from incremental scale to the portfolio. You have the capacity to digest that. How do you manage that against what I would expect -- you put in a range of up to $100 million. I would think the digestibility would be easier if you're less than $50 million and maybe less than $25 million. How do you reconcile what would be probably a material change in terms of economies of scale if you added a bigger piece, something on the higher end of that range, $50 million to $100 million, versus something that's probably more manageable and digestible from a financial standpoint, $25 million to $50 million?

Stephen R. Brunner

Well, I'll take a crack at it and then Chuck can follow up. If you think of $25 million to $50 million, we wouldn't expect to add G&A or technical G&A in the office. Of course, you'd have field people and you'd have more folks out there in trucks pumping and that kind of thing. When you start thinking about approaching a $100 million kind of asset, that's probably going to come with more than just field operations people. There -- that's probably more -- for us, it would be more considered a merger or consolidation of another company out there, in which case, we would have to go through the exercise of, well, okay, what does this mean in terms of our capital spend going forward, who are the technical people and the assets that are available and, again, going through that rigorous process of trying to make sure we keep the right staff on board so that we can actually digest and then benefit from a larger acquisition as versus the smaller acquisition. I'm not sure if that's what you're asking. But, Chuck, what do you think?

Charles C. Ward

Yes, I think that we can -- you're right that the kind of the $25 million to $50 million is an easy add for us. We've pulled all the accounting, the well accounting internal. We no longer do that external. That's very easily scalable. With our new auditor and with our new -- with the way we're set up internally now, we can add things from a home market perspective pretty easily. We've -- we have consolidated operations in some of the offices in Oklahoma a little bit to -- a little bit of an inconvenience for some folks there, but getting everybody in the same building in the same -- or in the same series of buildings in the same place, that would help them, I think, and that they feel a little bit of scalability if we had something in their neighborhood. If it's something not in their neighborhood, we would probably have to ramp that up a little bit. But a lot of those do flow through as LOE rather than G&A. And then also I think about -- when we think about asset acquisition, if you kind of use the rule of thumb of somewhere between 45% to 60% of an acquisition price is probably easily financeable in the current market and adding on to our existing debt facility. And then it's -- everything above that is using up incremental capacity, so we can do the back-of-the-envelope math on kind of what the maximum sizing could be. We always start with what people think they're going to sell stuff for, and then we start whittling it down to what we think we'll pay.

Stephen R. Brunner

Lots of emphasis on -- we're really focused on trying to make a difference for our unitholders. So the easy adds are $25 million to $50 million. The harder ones are larger. But we're not going back off from a larger opportunity if it makes sense and we can finally get some value back to our unitholders.

Charles C. Ward

We just kind of use it -- if it looks like it's above $100,000, we don't lift, unless it looks like it's something you can carve out and we think that they'd be receptive to piecing it up. But generally speaking, those are not.

Operator

At this time, there are no other questions.

Stephen R. Brunner

Well, thanks, again, for joining us this morning. We look forward to speaking to you in August, when we review our second quarter results.

Operator

Thank you for joining today's conference call. All parties may disconnect at this time.

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