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Evolution Petroleum Corporation (NYSEMKT:EPM)

Q3 2014 Earnings Conference Call

May 08, 2014 11:00 AM ET

Executives

Randy Keys - CFO

Robert Herlin - CEO

Analysts

Chris McCampbell - Southwest Securities

Joel Musante - Euro Pacific Capital

Bruce Brown - Brown Capital Management

Operator

Hello, and welcome to the Evolution Petroleum Corporation Third Quarter 2014 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Mr. Randy Keys, CFO. Please go ahead, sir.

Randy Keys

Good morning. I’d like to welcome you to Evolution Petroleum's conference call to discuss results for the quarter ended March 31, 2014. This is our third quarter of our fiscal 2014 year. I am Randy Keys, CFO of the company. With me today is Robert Herlin, our CEO; and Daryl Mazzanti, who is VP of Operations and Executive of VP of our wholly owned sub NGS Technologies, which has our GARP services technology.

Before we begin, let me cover a couple of basics. If you'd like to be on the company's e-mail distribution list to receive future news releases, please see the contact info in our news release. If you wish to listen to a replay of today's call it will be available shortly by going to the company's website at evolutionpetroleum.com, or via recorded telephone replay until May 23. The necessary information can be found in the earnings release. Please note that any statements and information provided here-in are time-sensitive and may not be accurate at a later date.

Our discussion today may contain forward-looking statements that are based on management's beliefs and assumptions that are based on currently available information. We can give no assurance that such forward-looking statements will prove to be correct, as they are subject to risks and uncertainties that are listed and described in our filings with the SEC. Actual results may differ materially from those expected. Our discussion also may include discussions of probable, possible or potential reserves or potential recovery. Such non-proven estimates are more speculative than proven reserves.

We will begin with comments about our results for the year and quarter and then go to questions. Bob?

Robert Herlin

Thanks, Randy. Since detailed numbers are readily available to everyone in the news release yesterday evening, I will focus my remarks on key operating results and our nonrecurring items. Randy will provide some additional commentary, particularly focused on our GARP business and then we’ll take your questions.

I am pleased to report that we returned to profitability this quarter with earnings of approximately $800,000 compared to $600,000 loss last quarter. Our current earnings were impacted by the restructuring process began in second quarter and was completed in the third quarter with the retirement of our previous CFO. As a consequence current results were reduced by related one-time charge of $600,000. Now that should be the end of these non-recurring one-time charges that are related to restructuring.

Our results continued to be impacted by the fluids release event that occurred last summer in the South West tip of the Delhi field and the resulting remediation work. Delhi daily production was essentially flat compared to last quarter, as purchase volumes of CO2 did not appear to increase until late in the quarter, we expect that an increase in CO2 injection volumes and a continued response to the previous year’s development expenditures should increase oil production this calendar year, so we really can't reliably predict when or by how much at this point.

Current quarter revenues were 4.3 million on net production of 487 barrels of oil equivalent per day at an average price of $99 per BOE. And that reflects our 96% oil content in our production. Really not much change in the volume of revenues but as a temporary increase in lease operating cost to the work overs on two GARP wells and production testing to Mississippi lime wells in Oklahoma.

Now that the testing of those two wells is done LOE should be materially lower in our fourth quarter. Overhead cost (begin) [ph] to reflect the benefit as the restructuring began last quarter by decreasing by some $300,000 despite $600,000 one-time charge and continued litigation expense.

Now let’s go to some specific projects. The operator of Delhi, which is a subsidiary of Denbury, announced that the field is back to normal operations with remediation completed. The data that we get suggests that any incremental CO2 injections during the quarter were modest until late in the quarter thus any products response will likely not occur for several months.

The operator further stated that the development plan now includes installing a recycled gas processing plant to recover methane in all NGOs in 2015. And that’s about a year earlier than we had originally projected and it also incorporates a full recovery of natural gas liquids than we projected in our last summer's reserve report.

We also believe that additional changes in reordering into development plan are likely, but we really don’t have enough information since we’re a non-working interest holder to accurately project the impact at this time. Gross production averaged 6,173 barrels of oil per day for the quarter compared to 6,254last quarter and the oil price at Delhi averaged almost $102 a barrel which is about $5 improvement over the last quarter.

Now I just speak with the operator as to several breaches of our 2006 agreement including applicability of their 2006 indemnity for environmental liability has not been resolved and our loss rate is moving forward. We believe that the primary factors for litigation however is to determine just when in 2014 our working interest reversion will occur.

As far as GARP I am going to let Randy cover that with his remarks with you shortly. And Mississippi Lime project up in Oklahoma we were conducting a production test of our Sneath well but that test is neither approved nor disproved or hypothesis for drilling results to date are the remaining opportunity. Since the lateral of the Sneath well begins at a low point in reservoir and runs up structure, we isolated the lower or the first two thirds of this lateral and kept open the last third that’s higher in structure to show the potential for structural recovery. Unfortunately it appears that we were not able to shut off water production therefore we weren’t able to generate enough oil and gas production to prove significant amount of reserves. So at this point in time we got those wells shut in and we too expect to invest our assets on that project.

Looking forward we are in excellent financial health, we’ve got 25 million in cash, we have no debt and we have substantial free cash flow from operations and we have our pending working interest diversion at Delhi which will more than triple our revenue interest in that project.

At this time we do not expect significant capital expenditures during the balance of our fiscal 2014 other than a million or so to fund the first 10 GARP installations under the contract we entered into in February. We do expect substantial CapEx in fiscal 2015 primarily related to our Delhi assets but working capital that we have plus our projected cash flows from operations should be more than adequate to meet those needs as well as continue providing our very attractive dividend to shareholders. We will continue to retain considerable flexibility and liquidity to meet our needs at Delhi and to grow our GARP business.

We remain very excited about the opportunities in front of us and our ability to continue providing share value growth and to our shareholders. Randy will now give you some additional background.

Randy Keys

Okay. Pleased to report that last week we moved work over rig in to begin the first of five consecutive GARP installations under our previously announced contract. We are scheduled to complete all five installations back to back with the same rig with completion sometime in early June. Our current staff capacity is about four installations per month, we can do approximately one a week and we are nearing completion on the first of those five installations.

As was previously disclosed, the operator is providing the lease the wellbore and most of the down hole and surface pumping equipment. We are providing certain incremental hardware and funding the installation cost the total of which we estimate to be approximately 100,000 per well. In exchange for this investment and the use of our technology, we will receive 25% of the net profits from each well. This particular customer has a large portfolio of good candidates for GARP and we expect that the results from this initial 10 well package will be a strong inducement to a much larger opportunity. Our current marketing efforts are focused on identifying specific targets for GARP through industry databases and then contacting operators directly to show how our enhanced recovery system can increase production and profitability and allow them to maintain their leases for an extended period of years.

We were honored to receive the Special Meritorious Award for Engineering Innovation from Hart Energy which was presented to us at the offshore technology conference this week. We are also presenting at an artificial lift symposium and workshop in Houston next week. The technology continues to get positive feedback from the industry as we continue with our marketing efforts which include industry tradeshows and other media channels.

As Bob mentioned, the company has an excellent liquidity position with no debt, approximately $25 million in cash and 5 million of undrawn capacity on our line of credit. This balance strength is a key part of our strategy as we transition from a royalty position at Delhi to a 23.9% working interest after reversion.

Robert Herlin

Thanks Randy. As you can see our strong value proposition for shareholders remains in place with that 25 million in cash, with no debt, with the pending reversion at Delhi that will triple our revenue stream. We look forward to executing our strategy to maximize share value for our shareholders.

And with that we’re ready to take questions. Operator, you can please open the lines for the questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions). And our first question comes from Chris McCampbell of Southwest Securities. Please go ahead.

Chris McCampbell - Southwest Securities

Would there be a share price at which repurchase would be attractive or do you expect the majority of cash and cash flow to go towards dividends?

Robert Herlin

There is clearly an attractive point at which we would start buying back stock. We’re not planning on doing anything with that though until after reversion has occurred. We want to make sure that we retain full flexibility to meet any CapEx demand from our partner on that project. And this possibility of some sort of a cash call whatever, we just want to make sure that we don’t forgo any opportunities there, once that is resolved which is something that will happen right around the reversion day, we would then be in a position to reconsider how we deploy our available capital in our revolver that we’re expecting to probably expand by quite a bit as well if the share price were to be at a level that we think is far below where it should.

Operator

Our next question comes from Joel Musante of Euro Pacific Capital. Please go ahead.

Joel Musante - Euro Pacific Capital

I just had a question about the recycling gas plant, just trying to get a better handle on what that -- what kind of an impact that will have on your peers and costs?

Robert Herlin

[Indiscernible] first of all, what we know is probably not a whole lot different than what the general public knows because as we're not a working interest partner, we’re not entitled to a lot of detail information, but what we do know is that in our reserve report a year ago, we had to assume basically the worst case scenario for processing. So it was the least recovery for the most money in the shortest period of time which is the most inefficient use of capital and that particular, in our reserves then we only were able to include as proved reserves recovery of our C5 plus with a natural gas link.

Recovery of methane was a probable part of our reserves, than we weren't recovering anything in the C2 to C4 ranges where the bulk of the liquids are. Subsequent to that we have found and determined and heard and so forth that Denbury has announced a smaller plan that has a broader recovery on a smaller slipstream, therefore they are going to be recovering the full suite of natural gas liquids which is much greater volumes.

As part of project that ought to move all those reserves until approved category and it’s a much more capital efficient way of doing it. Our understanding is that the capital cost of that plant is substantially less than what was in our reserve report.

Again what they have announced that they are going to start on in 2014 with expectations of it been up and running in 2015 and then as about a year earlier than what we have projected in our reserve reports as well, it will be processing a smaller slipstream of the recycled gas as a result of probing operation for a lot longer time, that’s led to much more efficient operation. [Indiscernible] that will allow the recycle stream to have a lower content of methane which makes it easier to pressurize and cool off and therefore make the overall CO2 flood a more efficient project in process. It will also allow I think a little lower operating pressure in the field, which should also be helpful. So that’s all we know, probably more than we know.

Joel Musante - Euro Pacific Capital

Okay. All right. Does it reduce your operating cost because you’re cycling your CO2 or I assume that that’s part of what it does?

Robert Herlin

Well, there’s going to be a lot of benefits and obviously it’s a more efficient process that’s -- if that means that you’re now that all the recycled gas is helpful for creating a mixable flood as opposed to some of the gas which is not helpful. So obviously that’s better for you, so on an effective basis, yes, would it drive down your operating cost, it should. I think one of the benefits is, one of the big benefits is by recovering the methane you can use that to fuel your plant, instead of buying natural gas. So that’s a really nice benefit and because instead of selling gas and paying all of our transport cost and the marketing cost to get the market you’re getting the full value at the plant itself and you’re not having to buy natural gas at the regulated rate there in the stake, so that’s very helpful. So there’s a lot of benefits to this that are probably more extensive than are obvious on the surface.

Operator

(Operator Instructions) And our next question comes from Bruce Brown of Brown Capital Management. Please go ahead.

Bruce Brown - Brown Capital Management

Thank you. Hi Bob and Randy. On that topic I tuned in late, I missed the first 10 minutes, I apologize for that on the recycling gas processing facility, what do you think you -- are you will be -- are you obligated for a certain percentage of that assuming the reversion kicks in I would assume that 23.9% or whatever the cost is would be born by Evolution is that right?

Robert Herlin

That is our expectation, Denbury has stated from time to time that they really don’t want to spend a significant amount of capital at Delhi this year until reversion occurs which makes a lot of sense from their perspective, obviously we will love to have to spend their money for our benefit and not have to pay for it but that is not our expectation, we really don’t expect to see much capital to be spent out there until reversion occurs later this year and at that point in time we will be paying our full 23.9% share of those costs.

Bruce Brown - Brown Capital Management

All right. Now does your royalty interest continue after the reversion?

Robert Herlin

Yes, it does. The royalty interest is totally independent and separate from our reversion working interest, so today we collect 7.4% off the top on the revenues and we don’t pay any OpEx and frankly we’re not even paying severance tax because we’re on a severance tax holiday with the State of Louisiana which is going on for a number of years. After pay out -- after reversion occurs, we will continue to get that 7.4% but we will also be getting an additional 19.1% revenue interest to give us a total of 26.5% of the revenues and then we’ll be paying a 23.9% of all the operating cost to CapEx.

Bruce Brown - Brown Capital Management

Okay, that’s good. And the Denbury slides on their latest presentation which I think was last week, indicates that the proven and the 2P I guess it’s the 2P and 3P reserves are some 40 million barrels for the field as a whole.

Robert Herlin

There is two errors in that statement, number one Denbury then recognized 3P reserves the best as far as know, so there is just a 2P number, second that 40 million is their net reserves, it’s not the gross, it’s their net.

Bruce Brown - Brown Capital Management

After reversion?

Robert Herlin

(Periods) [ph], I mean it’s the total reserves 4.5 to a reversion and so as a result, if you back calculate that I believe it works out to a number closer to 80 million gross barrels for the whole project of which I think 5 is being collateral produced today.

Bruce Brown - Brown Capital Management

So is that 75 million barrels left to produce over time assuming everything continues to work according to plan?

Robert Herlin

Right, that would be a gross number and that be barrels of oil equivalent I believe.

Bruce Brown - Brown Capital Management

Okay, and that would include the gas that would be serving to the -- putting through the gas recycling plant?

Robert Herlin

Correct, that would be the recovered methane and the natural gas liquids and so forth. Remember this is -- I am just using the same numbers you are using, that you are seeing but we know what their interests are and so forth and we can back calculate what that means on a gross level.

Bruce Brown - Brown Capital Management

Yes, what percentage of the 75 million barrels would be oil, roughly?

Robert Herlin

Oh, boy you got me there.

Randy Keys

It’s a very high percentage, its north of 90%.

Robert Herlin

No, no, it’s 68 maybe, 68 of the 80 or 60 of the 80, it’s on the order of -- you asked me a quick question I can’t off the top of my head tell you.

Bruce Brown - Brown Capital Management

All right, so 68 million barrels of oil and another 12 of BOEs coming from [Multiple Speakers] and liquids.

Robert Herlin

It’s 31 Bcf of gas and then -- which is 5 million equivalent in gas and then there is gas liquids, makes up the difference, so these are all just rough numbers that I would hate to be held to, they’re just off the top of my head here.

Randy Keys

In that case it would be about 85%.

Robert Herlin

Yes

Bruce Brown - Brown Capital Management

Yes, well. Bob I must say the top of your head is probably not that inaccurate.

Robert Herlin

No, no there is not much hair up there so…

Bruce Brown - Brown Capital Management

Neither have I.

Robert Herlin

Great, very shiny up there…

Bruce Brown - Brown Capital Management

Yes, but not enough room for a solar panel…

Robert Herlin

Although I have been accused of that.

Bruce Brown - Brown Capital Management

All right fellows thanks so much.

Robert Herlin

Yes, thank you.

Operator

(Operator Instructions) And I am showing no more questions at this time. This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Robert Herlin for any closing remarks.

Robert Herlin

Sure. Thanks again to everyone for participating. As you can see that -- I think we’ve got a decent quarter and things are looking for substantial improvement, (swap) [ph] improvement for the balance of this calendar year. And a conversion coming up we expect to see a several fold increase in revenues and cash flow and so forth. So we’re very excited about the opportunity with GARP starting to take off better and better. We’re very pleased with our -- where we are and hopefully the shareholders in the market will come to agree with us. Thank you again and feel free to call us if you have any questions.

Operator

The conference is now concluded. Thank you for attending today’s conference. You may now disconnect.

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