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Diamondback Energy, Inc. (NASDAQ:FANG)

Q3 2013 Earnings Call

November 5, 2013 9:00 AM ET

Executives

Adam Lawlis – IR

Travis Stice – President and CEO

Tracy Dick – SVP and CFO

Analysts

Ryan Oatman – SunTrust

Eli Kantor – IBERIA Capital

Jeb Bachmann – Howard Weil

Mark Lear – Credit Suisse

Operator

Good day, ladies and gentlemen and welcome to Diamondback Energy Third Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct the question-and-answer session and instructions will follow at that time. (Operator Instructions)

I would now like to introduce your host for today’s conference Mr. Adam Lawlis, Investor Relations. Mr. Lawlis please begin.

Adam Lawlis

Thanks, Janine. Good morning and welcome to Diamondback Energy’s third quarter conference call. We have prepared PowerPoint slides to supplement our call today and they accessed on our website at www.diamondbackenergy.com. Representing Diamondback today are Travis Stice, CEO, Tracy Dick, CFO and Russell Pantermuehl, Vice President of Reservoir Engineering. We also have Paul Molnar our VP of Geosciences.

During this conference call today the participants may make certain forward-looking statements relating to the company’s financial condition, results of operations, plans, objectives, future performance, and businesses. We caution you that actual results could differ materially from those that are indicated in these forward-looking statements due to a variety of factors. Information concerning these factors can we found in the company’s filings with the SEC.

During our call today, we will reference certain non-GAAP financial measures, which we believe provide useful information for investors. We include reconciliations of those measures to GAAP in our earnings release.

I will now turn the call over to Travis Stice.

Travis Stice

Thank you, Adam. Welcome everyone and thank you all for listening into Diamondback’s third quarter 2013 conference call. Since our last call we’ve issued several press releases highlighting our one year anniversary as a public company surpassing the 10,000 barrel a day production milestone and our first Clearfork test in Andrews County and our guidance for 2014. As Adam mentioned we’ve updated the company presentation on our website and I’ll refer to a couple of those slides during my comments this morning.

The third quarter again marks improvements across essentially all aspects of Diamondback’s performance as we continue to make significant progress on lowering, drilling and completion costs reducing our operating expenses and testing additional horizontal benches while continuingly to rapidly increase production. We’ve now drilled over 38 miles or 200,000 feet of horizontal lateral section since the beginning of our horizontal development program a little over a year ago and our execution continues to improve to what I feel as a leadership position within the Midland Basin. Also the cash margin per Boe down that generates is best among our peers due to the more oily nature of our production mix and the dramatic reduction we’ve made in our operating expenses.

While it was just a few weeks ago when I was offering my last operating update discussing our Clearfork test today I’ll provide an update on more of our drilling activities in addition to discussing our strong quarter.

First of all I’m very excited about the early performance from the 5,000 foot lateral Middle Spraberry Shale test in Midland County that we participated in as a non-operator partner. The well had a peak 24 hour initial production rate of 733 Boes a day of which 90% was oil from electric submersible pump out of the Middle Spraberry Shale. This is the second significant test in the Spraberry interval following the original test in the Lower Spraberry completed several months ago.

The Spraberry interval not only is one of the more continuously deposited shales across the Midland Basin but also contains among the highest measured oil in place compared to the other shale members. If you refer to the slide in our company presentation on page 7, you can see how both of these Spraberry wells are exceeding our 600,000 Boe Wolfcamp B type curve from Midland Country and that’s why we’re excited.

On slide 5 and again on slide 16 encouraged by this Middle Spraberry test we’ve now added a 180 horizontal locations to reflect this new bench in the Middle Spraberry substantial increase in the resource base our shareholders are exposed to and further validating our recent purchase of the underlying mineral rights exposed to in this area. This early test furthers our belief that multiple benches will ultimately develop across our acreage.

Lastly to help clarify any confusion on the Spraberry [indiscernible] we have included a cross section on slide 6 which shows both the Middle and Lower Spraberry Shale and how the Spraberry thickens as you move east across our acreage.

Staying in Midland County we’ve completed the Spanish Trial 501H our longest lateral to-date in this county at approximately 900,000 feet for less than $8.5 million. This is one of the best wells we’ve completed and now at 38 days has flown to naturally longer in any other horizontal well that we’ve put on production. The Spanish Trail 501 had a peak naturally flowing rate of 1,033 Boes a day and has produced for the last 30 days over 24,000 barrels equivalent flowing in excess of 800 Boes a day. We will not kill a well but put it on our official lift that continues to flow back so nicely just to generate a higher 24 hour IP rate. However when we do put the well on artificial lift we typically expect a significant uplift in the well’s peak flowing rate. On slide 8, we’re going to take this uplift as an artificial lift effect.

Finally in Midland County we have two other wells to highlight that are producing favorably. The Spanish Trail 362H at a 24 hour IP over 1069 Boes a day from a short lateral and the Spanish Trail 363H well had a 24 hour IP of 934 barrels a day also from the short lateral. These wells were 94% and 89% respectively in our bolt-on gas lift. As a reminder Diamondback owns the mineral interest on all of these wells significantly enhancing returns and cash flows.

Shifting further north in Andrews County our first horizontal Wolfcamp B well remains encouraging now reflecting a 30 day peak rate of 440 Boes a day from our previously reported peak 24 hour rate of 613 Boes a day. This well was drilled with a short 4,000 foot lateral due to lease geometry. When normalized to 7,500 foot lateral the peak 24 rate would have been approximately 1,100 barrels a day and the 30 day rate would have been approximately 815 barrels per day.

Referring to slide 8, you can see that the production from this well is above the 600,000 barrel Wolfcamp B type curve as well as – all most after 90 days. We also remain encouraged by our initial horizontal Clearfork test which had a peak 24 IP rate of 611 barrels a day. This well was drilled and completed for $6.8 million for a 7,500 foot lateral and looking ahead at additional development drilling we feel we could decrease development cost immediately especially in multi well pad development mode in utilizing a fit-for-purpose fueling drilling rig. We will wait several more months to gain additional production date to generate our investment type curve before drilling and offset well.

Once we’re comfortable with predicting reserves for the Clearfork I’ll communicate accordingly. When we evaluate our performance using preliminary data for all of our horizontal wells across all counties we remain at or above our average type curve projections. As a reminder we’ve guided towards 550 to 650,000 barrels for 7500 foot lateral.

We’re currently four horizontal rigs one in Upton and two in Midland County with the fourth horizontal rig set to begin testing our recently acquired acreage in Martin County this month with results expected during the first quarter of 2014. As recently outlined we envision a fifth coming in – in the second quarter of 2014 and based on these results may consider adding the sixth rig later in the year.

Turning to our your quarterly results 3Q 2013 production average 7.4000 Boes a day almost doubled last year’s levels and do not reflect any of our recent acquisitions. The production ramp we expected from horizontal wells and [continue] and we entered the fourth quarter producing over 10,000 barrels a day. Current production is about 10.5000 barrels a day and we envision exiting the year possibly close to 12,000 Boes a day but have offered no official guidance. Instead we’ve introduced 2014 production guidance of between 15,000 and 16,000 Boes a day trying to stay away from quarterly guidance. Our focus is on sequential growth with a clear eye on operational efficiency as shown by our performance during this year. Our operation team continues to improve performance to a level we believe is among the best in the Midland Basin.

Our 7,500 foot laterals averaged approximately $7.2 million down from $7.6 million in the previous quarter. For the three 7,500 foot lateral wells that were drilled during the quarter, total debt was reached on average in 14 days. We’ve drilled our first test well where we used a cheaper, smaller and faster moving vertical rig to drill and set deep intermediate casing to roughly 9,000 feet before the bigger horizontal rig arise to drill the curve and lateral portion of the well. We estimate this sale is between $150,000 and $200,000 per well and will reduce our cycle time by seven days. While this is still in the testing phase we estimate we could apply this strategy to roughly 25% of our wells helping to further reduce costs and drilling more wells with fewer rigs in 2014. Our first two well pad location has been drilled and completed with to approximately 5,000 foot wells for a combined total cost of $10.5 million to $11 million.

We’re still finalizing cost and allowing our county system to catch-up with these costs and have a few operations left to perform, but early cost results certainly look encouraging with per well cost below $5.5 million. We also used the zipper frac technique where we conducted simultaneous operations on both wells which not only improves efficiency and operations, but we think also improves fracture stimulation effectiveness. We are currently drilling our second well on our second two well pad and we anticipate drilling over 50% of our wells next year on multi-well pads and will soon shift to three well pads. With these impressive cost results we’ve decreased our well cost guidance for 2014 for 7,500 foot lateral to a range of $6.9 million to $7.4 million in 2014 and from $7.5 million that’s down from $7.5 million to $8.5 million in 2013 as we previously announced in our 2014 guidance conference call.

Now looking at expenses. We’ve changed the method used to report our LOE to be more consistent with our peers including ad valorem taxes as part of production taxes. Previously we had included ad valorem taxes as part of lease operating expense. We made this reclassification and we’ll report this way going forward and we’ll restate historicals over time. Corporate overhead previously reported as indirect LOEs now included as part of lease operating expenses. 2013 guidance has been adjusted to reflect this reclassification. If you have any questions on this please call Adam Lawlis following the call and we could help out.

Our third quarter total LOE per Boe decreased 21% to $7.27 per barrel down from $9.16 in the second quarter of 2013 after given effect to the reclassification. We’ve now achieved four consecutive quarters of double-digit declines in LOE which are now down over 50% from this same period last year. The quarterly details of this dramatic reduction in LOE are laid out on Slide 14. Additionally this reduction in LOE is yet to benefit from our recent purchase of the Midland County Minerals which is we’ve explained have no associated LOE with the production.

Combined with a much higher price realization due to our high oil content Diamondback’s cash margin per Boe is now among the highest of our peers and we expect to raise further in the fourth quarter as the minerals acquisition is fully incorporated. Again please see our updated guidance and results which breaks out the contribution from these Minerals as we don’t think everyone understands our mechanics here. It’s safe to say though that it’s making our good results even better. With these comments complete allow me to turn the call over to Tracy.

Tracy Dick

Thank you, Travis. Our net income for the quarter was $14.6 million or $0.33 per diluted share. Net income for the period included a non-cash loss on commodity derivatives of $1.7 million. Excluding the non-cash loss and the related income tax effects our adjusted net income was $15.6 million or $0.35 per diluted share. Revenues for the third quarter totaled $57.8 million, a 27% increase as compared to second quarter 2013 of $45.4 million.

Our average realized prices before the effective hedges was $84.67 per Boe, an improvement of approximately 12% when compared to $75.70 per Boe for the prior quarter. Our average realized price including the effective hedges was $79.96 per Boe compared to $74.27 per Boe for the prior quarter. EBITDA for the quarter was $47.7 million or $69.82 per Boe. Our EBITDA growth over the prior quarter was driven by increased production, strong realized pricing, and decreasing operating cost during the quarter.

Turning to our cost, lease operating expense was $7.27 per Boe as compared to $9.16 per Boe in the second quarter of 2013, a 21% decrease. As Travis mentioned earlier these metrics have been adjusted reclassifying ad valorem tax out of LOE and into our production in ad valorem tax line on our income statement for all periods presented. Our general and administrative cost came in at $3.11 per Boe. This is at the low end of our guidance of $3 to $5 per Boe.

Our current hedge position through 2014 have been laid out in our earnings release. We continually effect our hedging opportunities and we will continue to layer on additional hedges as our production growth. In the third quarter of 2013 we generated $42 million of cash flow or $0.94 of diluted share. We spent approximately $84.9 million; this is excluding the previously announced minerals and Martin and Dawson County acquisitions. This spend includes approximately $78 million for drilling and completion, $3.5 million for leasehold acquisitions and the remainder for infrastructure and facilities.

Our accumulated spend for our drilling and completion, infrastructure and facility for the nine months ended September 30, 2013 is approximately $193 million. This excludes acquisition spend. We are on track to be in line with our annual capital guidance of between $290 million and $320 million. During the quarter we raised total net proceeds from debt and equity offerings of approximately $618 million. This includes $450 million aggregate principal amount, 7.625% senior notes which are due in 2021. Our liquidity position remains strong with approximately $53 million of cash on hand at September 30, 2013 and an undrawn revolver with $225 million of availability.

With that I’ll now turn the call back over to Travis for his closing remarks.

Travis Stice

Thank you, Tracy. To summarize I’m proud of the third quarter results as we again demonstrated our ability to reduce total well cost, reduce drilling cycle time, reduce our operating expenses and to continue to ramp our production. We’re extremely excited about the early results from a test in the Middle Spraberry Zone in the Midland County and we’ve increased our inventory accordingly. Our cash margins during the third quarter were almost $70 a barrel and I believe we are delivering results and returns to our stockholders that are among the best in the Midland Basin. On behalf of the Board and employees of Diamondback Energy I would like to thank you for your participation today. This concludes our prepared comments. Operator, please open the call to questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And the first question is from Ryan Oatman of SunTrust. Please go ahead.

Ryan Oatman – SunTrust

Hi, good morning guys.

Travis Stice

Good morning, Ryan.

Ryan Oatman – SunTrust

Obviously a solid first rate from this Middle Spraberry Shale. Can you discuss the prospectivity that you see of that interval across your acreage and what you see it working across the leasehold that you got there?

Travis Stice

Yes, Ryan as I mentioned in my prepared comments this Spraberry interval is one of the more continuous shale deposits across the Midland Basin. But specifically to our acreage certainly everything in Midland County looks extremely good. Also, similarly the assets we recently acquired in Martin and Southern Dawson also look very perspective in the Spraberry intervals as well as our – about half of our acreage in Andrews County in the Northeast piece. So, really excited about that in those 139 net locations we’ve added are predominantly located in those three counties.

Ryan Oatman – SunTrust

Okay. Thank you, for that. And what’s the depth difference between the middle and lower Spraberry and do you feel like the two are definitely separate zones.

Travis Stice

It’s about 400 feet between and the question is all these separate zones we think they are certainly they’ve been deposited separately. I think it’s well we as an industry we still need to prove out that the fracture between more and doesn’t interfere with the other but at this point we’re really confident that they’re separate in this stacked intervals.

Ryan Oatman – SunTrust

Okay. Thank you, for that. And then one more from me and hop back in the queue. You talked about a $70 barrel cash margin, what would that number look like on your acreage where you own the minerals?

Travis Stice

Ryan, I don’t have that in front of me, I’m going to have to get back with you on that if we can – if we handle it during the call, we can come up with you during the call, I’ll circle back with you.

Ryan Oatman – SunTrust

Sure. Thank you.

Operator

(Operator Instructions) The next question is from Eli Kantor of IBERIA Capital. Please go ahead.

Eli Kantor – IBERIA Capital

Hey, good morning guys.

Travis Stice

Hey, Eli, how are you this morning?

Eli Kantor – IBERIA Capital

I’m doing well. I just have a question on down spacing prospectivity within your acreage position a couple of your peers Pioneer and [Laredo] have had success testing higher densities and what was previously guided to. Curious, if you have any plans to test densities higher than 106 acre spacing within your footprint in the near future?

Travis Stice

Yeah, most of our development well all of our development today has been it’s kind of that inter lateral space is about 850 feet. We’re in a process here in the next quarter of tightening that down space into inter lateral space and then we’ll also look at 650 feet.

Unidentified Company Speaker

About 660 feet.

Travis Stice

Yeah.

Unidentified Company Speaker

This point of wells the test we’re doing our fast drilled acreage in Midland County, those wells will be drilled in the fourth quarter so probably have results in 1Q of next year.

Eli Kantor – IBERIA Capital

Okay, thanks. That’s all I have.

Operator

And the next question is from Jeb Bachmann of Howard Weil. Please go ahead.

Jeb Bachmann – Howard Weil

Good morning everyone. Just a quick question from me on stack laterals, I know as you talked about testing stacked laterals in middle and lower Spraberry next year. Any idea if you’re going to try that in some of the Wolfcamp zones next year on your acreage?

Travis Stice

Yeah, our next stacked lateral paste is going to be in Section 42 where we own about 47%. We’ve participated in a stacked lateral that’s already been drilled it’s the lower lateral in the Wolfcamp B and the upper lateral is in the lower Spraberry and even also offset about 300 feet. And those wells are scheduled to be fraced at the end of this month and then we’ll probably have results on that in 1Q of next year. As it pertains to testing and the stacking in other intervals we just need to really assess what our inventory looks like in these other intervals especially with the addition of these successful lower Spraberry and middle Spraberry test as we go into 2014 and look for us to provide additional color on that as we accursed a lot of plans.

Jeb Bachmann – Howard Weil

Okay, great. And one last one from me. I know Pioneer you talked about Wolfcamp B wells and they’re released yesterday, just wonder if you guys had any plans to try and drill that target on your acreage or the folks on the other intervals at this point?

Travis Stice

Well, certainly we remain focused on the intervals where we put the drill bid but it’s hard to ignore a well that’s 20 miles from either test is over 3000 barrels a day. So, I’m looking at a cross section now that Paul provided me last night that has that same plan interval across our acreage base there in Midland County. So, pretty exciting information.

Jeb Bachmann – Howard Weil

Great. Thanks for the color Travis.

Operator

(Operator Instructions) The next question is from Mark Lear of Credit Suisse. Please go ahead.

Mark Lear – Credit Suisse

Good morning. Just want an update on the timing of the testing in Martin and Dawson and what you guys will be targeting out there.

Travis Stice

Yeah, good question. As I mentioned this quarter very good arriving, we’ll be testing the Wolfcamp B in Martin County next month actually we support that well not support this month. And that’s where our initial focus will be is both in Martin and Dawson County we’ll test the Wolfcamp B. And then of course we’ll adjust plans as we go forward and understand different horizons because we’ll always put the drill bid in the intervals that we think generates the highest rate of return for stockholders.

Mark Lear – Credit Suisse

And then I guess just ask you’re thinking about bringing in 6 rig late in 2014. How does that rig count look in the minerals rights or how many rigs will be operating there in Midland?

Travis Stice

Yeah, we’ll initially – in the initial guidance that are offered was two horizontal rigs on our operated piece and the non operated piece we’re going to have one horizontal rig. Our intent will be to always try to maximize the minerals because it generates such exceptional returns. So, we’ll look for opportunities to drop a third rig and whether it stays in there continuously or just goes in there and when we have a window where we think we can accumulate enough frac water to accelerate, we’ll look to doing that as well. Mark, I also want to remind even I said that possibility of a 6 rig arriving late next year there is really two ways to accelerate activity, one is to accelerate by just adding more rigs. And the second is to accelerate by drilling more wells with the same rigs. And I think you’ve seen us historically demonstrate continued reduction in cycle terms and if this first test that we did where we’re bringing typically a vertical rig and to drill the deep intermediate section that could materially change our cycle term as well. So, we’re going to look at accelerating both ways but I think there is a distinction there when you look at the amount that we can increase our cycle terms.

Mark Lear – Credit Suisse

Great. And I guess, is there an opportunity to pick up the working interest on that – on those mineral acreage that you don’t have right now?

Travis Stice

We look at all kinds of opportunities Mark, here in the Permian and obviously where we own the minerals it makes a great story to have the working interest as well too but I don’t comment on any acquisitions that are currently in progress. So, more analysis there in progress.

Mark Lear – Credit Suisse

Got it. Thanks a lot.

Operator

I would now like to turn the conference back for any further remarks to Mr. Travis Stice, Chief Executive Officer.

Travis Stice

Well, again thanks to everyone participating in today’s call. I know it was early and I know I talked to some of you guys late last night and saw some releases really earlier this morning. So, now right here on the calls at late night and early morning. So, appreciate your continued interest in Diamondback Energy story. And if you got any questions, please reach out to us using the contact information we provided. So, you guys have a great day. And we’ll talk again soon. Thank you, very much.

Operator

Ladies and gentlemen, thank you for your participation in today’s program. This does conclude the presentation. And you may all disconnect. Everyone have a good day.

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