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Evolution Petroleum (NYSEMKT:EPM)

Q1 2012 Earnings Call

November 09, 2011 11:00 am ET

Executives

Lisa Elliott - Vice President

Robert S. Herlin - Co-Founder, Chairman, Chief Executive Officer and President

Sterling H. McDonald - Chief Financial Officer, Vice President and Treasurer

Analysts

Mark Aydin - McNicoll, Lewis & Vlak LLC, Research Division

Unknown Analyst -

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Evolution Petroleum First Quarter of Fiscal 2012 Conference Call. [Operator Instructions] This conference is being recorded today, Wednesday, November 9, 2011. I would now like to turn the conference over to Lisa Elliott of DRG&L. Please go ahead.

Lisa Elliott

Thank you and good morning, everyone. We appreciate you joining us for Evolution Petroleum's conference call to discuss results for the first quarter of fiscal 2012, which ended September 30. In a moment, I'll turn the call over to management, but first I have a couple of items to cover.

If you'd like to be on the company's email distribution list to receive future news releases, please feel free to let me know. My contact information is in the earnings release we sent out this morning.

If you wish to listen to a replay of today's call, it will be available in a few hours and archived for one year via webcast by going to the company's website at www.evolutionpetroleum.com or via recorded telephone replay until November 16, 2011, and the dial-in number and passcode can also be found in the earnings release. Information recorded on the call today is valid only as of today, November 9, 2011, and therefore, time-sensitive information may no longer be accurate as of the date of any reply.

Today, management is going to discuss certain topics that may contain forward-looking information which are based on management's beliefs as well as assumptions made by management and information currently available to them. Forward-looking information include statements regarding expected future drilling results, productions and expenses. Although management believes that these expectations reflected in such forward-looking statements are reasonable, they can give no assurance that such expectations will prove to be correct. Such statements are subject to certain risks and uncertainties and assumptions, which are described and listed in the company's filings with the Securities and Exchange Commission. If one or more of these risks materialize or should underlying assumptions prove incorrect, actual results may differ materially from those expected.

Also, today's call may include discussions of probable or possible reserves or use terms like volume, reserve potential or recoverable reserve. Please note that these estimates are of non-proved reserves or resources that are, by their very nature, more speculative than estimates of proved resources and reserve and accordingly are subject to substantially greater risks.

Now with that, I'd like to turn the call over to Bob Herlin, Evolution's Chief Executive Officer. Bob?

Robert S. Herlin

Thanks, Lisa, and good morning to everyone. We certainly appreciate you joining us for this fiscal first quarter call. I'll briefly review some key operating results and provide an update on our future plans, then Sterling McDonald, our CFO, will go over some select financial information. And then, we'll be able to take your question.

As you may have read in the earnings release we put out this morning, we had a solid first quarter with an increased net earning of some 89% over the previous quarter in a diluted basis and in June 30, which is our fiscal fourth quarter of 2011. This growth was driven by 48% increase in daily oil production at the Delhi Field to a gross quarterly average of some 4,400 barrels per day. It's great to see this project ramping up at a time when price at which we sell Delhi oil or the Louisiana Light Sweet prices continue to see -- receive a premium averaging almost $106 a barrel for the quarter.

Delhi production during the quarter was primarily from development work through calendar 2010 and are what we have referred to as Phases 1 and 2 of the CO2 enhanced oil recovery project that's being developed by Denbury Resources. It's important to note, however, that our Q1 oil production already includes a small contribution from ongoing development work during calendar 2011. As already noted by Denbury in their recent earnings call, the Delhi reservoirs are performing at the higher end of expectations due in part to a more efficient CO2 floods than expected. Unit EOR performance is a function of reservoir quality and for main economic reserves, and we have, in the past, stated our belief that Delhi has reserves upside due to more original oil in place than originally estimated and potentially higher recovery rate. The operator has also previously stated that the peak production rate net to their interest was expected to be between 5,000 and 10,000 barrels a day, and that corresponds to a peak post-payout production rate net to Evolution of between 2,300 and 4,600 barrels a day.

We continue to expect the operator to complete rolling out of the project over the next 3 years or so, so we're still in early production growth stage of the field. For now, our net production comes from our 7.4% royalty interest that doesn't bear any operating cost or severance tax. We also don't bear any capital expenditures until our deemed payout occurs at which time we gain a 24% working interest and an additional 19% revenue interest. Now these revenue interest or venturing [ph] interest are in addition to our royalty interest that we have today.

Based on our independent SEC reserves report at June 30 of this year, payout is projected to occur in late calendar 2013, about 2 years from now. By that point, Delhi production is projected to be much higher than today's level. It's still growing to a peak gross level in excess of 10,000 barrels a day, and we'll be netting over 26% of that production.

Actually, we're generating a fair amount of cash now. We reported $2 million in income from operations in our first fiscal quarter, which is up about from $1.2 million in the prior quarter and from a loss of $650,000 in the first quarter of last year. The combination of cash flows from operations and current working capital are well in excess of the expected high end of our capital expenditures during the fiscal 2012 plan.

Now that we have a better visibility of the revenue generation capability of the Delhi fields, our focus is to step up the pace of identifying and developing attractive low-risk projects into which we can invest our growing cash flow. As you may know, over the last couple of years, we've focused on testing 2 projects targeted to provide opportunities for the long-term development. One is a mid-depth Woodford shale gas project in Oklahoma, and the other is an infill drilling project in an established oil field in South Texas or the Lopez Field.

Continued low natural gas prices have diminished the projected return from the Woodford shale project so many other operators were moving much more deliberately there. On the other hand, our oil project in South Texas appears potentially attractive both for reserves addition and some value creation.

During the fourth quarter of 2011, we installed a larger downhole pump in our Lopez Field test well and determined that we could produce a much higher fluid rate and still maintain the same percentage of oil. These wells typically produce a low grade of oil and a higher rate of water. Consequently, we recently began drilling a 4-well program of 2 producers and 2 water injection wells designed for high fluid rates. If these wells confirm our expectations, we expect to ramp up our development activity in the area, as we believe that our finding and development costs there will be less than $20 per net barrel oil and the production is 100% crude oil.

Our activity in the Giddings Field in Central Texas was limited during the quarter. Normal production decline and no recent drilling resulted in production declining net to us at about 172 fields -- barrels of oil equivalent per day. Giddings wells included about 50% natural gas component on average and a high flush production. So we have not been aggressive in drilling new wells today. We are retaining leases that hold proved undeveloped reserves and continue to consider opportunities to best realize our value in Giddings. While watching the activity of other operators, we are testing some of the potentially oilier zones in the area. We entered into agreement that contribute leases, covering one of our less attractive proved undeveloped locations to a joint venture, in exchange for minority work and interest in what we believe will be a much larger and more economic well. Additional drillings of our proved undeveloped portfolio, frankly, will be through new industry joint ventures, and our 2012 plan includes drilling of up to 2 wells at a reduced working interest.

Also during the quarter, the U.S. Patent Office formally granted us a patent covering our gas-assisted rod pump technology that we have trademarked as GARP or G-A-R-P. We've also filed a continuation in part to cover further improvements in broader applications in the technology.

Subsequently, we signed 2 commercial GARP demonstration agreements with industry partners. Each agreement allows us to install our technology at our sole expense in a fully equipped and currently producing horizontal well contributed by the partnering company. In return, we earn a 50% net profits interest in one agreement and a 76.5% working interest in the second after payout in the installation costs. The wells are both located in the Giddings Field of Central Texas and were selected to demonstrate the benefit of GARP in a [indiscernible] target well provided by a third party. Additional installations of the technology with either of the 2 partnering companies would be subject to further negotiation. We are operating the wells and we expect to have the GARP technology installed in both prior to year-end calendar year [indiscernible].

Overall, we are steadily improving our financial results while generating substantial liquidity to redeploy into new projects and other opportunities that may arise.

Now with that, I'm going to turn it over to Sterling.

Sterling H. McDonald

Thanks, Bob, and good morning, everyone. Before we get started on my section, I see that, for some reason, our press release is not showing up on Yahoo! but I do see it on some other sites. I think Zacks has it. I haven't got a chance to check for all that has been sent it. I don't know what the problem is, but we'll get it addressed.

So, well, for those of you who have seen the press release and have found it on a service, I guess you can imagine that we're pleased with the significantly higher results we reported. I'll visit the high points here and before we discuss some additional color to our financing and business strategy going forward.

On the numbers, Q1 '12 basic net income more than doubled, while diluted income to shareholders increased 89% sequentially over the prior quarter and improved by $1.6 million from the $0.5 million loss in the comparable prior-year period. Limited product prices per BOE and revenues were up across the current, appreciating in the prior year's quarter, although oil prices were 8% significant -- sequentially lower over the prior quarter.

Expenses per BOE were down in every category across all 3 comparable periods, except for a minor increase in our depletion rate due to an acceleration of our expected payout today at the Delhi.

While some expenses dropped absolutely, such as LOE and internal operating expenses, absolute DD&A increased proportionally to our increased sales volumes across all periods compared. At the field level, these improvements produced pretax margins of $73 per BOE in Q1 '12, $65 per BOE in the prior sequential quarter and $26 per BOE in Q1 of fiscal 2011.

Moving to the balance sheet and cash flow statements, our financial position remains solid with no debt. We tripled our working capital sequentially to $12.2 million, $2.6 million of which was from cash flow from operations before changes in working capital and $6.1 million of which was from net proceeds from our preferred stock sales during the quarter.

Our capital budget for fiscal '12 was a base case of $4 million and expandable up to $12 million, subject to results of our early drilling and other opportunities that may arise. Today, our working capital on hand is sufficient to meet any level of expenditures within that range.

As to our preferred stock issuance, we chose this additional vehicle add to our options in financing going forward, should they become necessary. We believe this offers our shareholders several advantages, as follow: By its perpetual nature, there is new due date nor is it redeemable by the holder when combined with its preference price, this allows us to classify the issue as permanent equity.

Secondly, the preferred stock is not convertible into our common shares so it does not dilute our common stockholders ownership in our net assets. Third, minimal covenants and no due date allows us to maintain control of our assets and operations.

Fourth, we may redeem the preferred shares for any reason after June 2014 at $25 per share plus accrued dividends or earlier at a slight premium in the event of a change in control.

Next, the issue is listed on the New York Stock Exchange AMEX, offering liquidity to its holders. And today, our Board of Directors has authorized up to 400,000 shares of the 1 million shares legally authorized for our Series A -- 8.5% Series A Cumulative Preferred Stock, I kind of messed that one up.

In Q1 '12, we began issuances that totaled 282,255 shares through an initial underwritten public offering and subsequent sales at the market. Our average offering size through September 30 was $23.56 per share, netting us approximately $6.1 million after all underwriting discounts, legal and accounting fees, printing and other fees and expenses in the offering.

So to sum this financing strategy up, we've passed all the hurdles of SEC registrations, underwriting due diligence and fixed cost expenditures necessary to put this additional financing tool on the shelf to be used, as the markets permit, when necessary. When combined with our expected increase in cash flows coming off at Delhi, our unlevered balance sheet, we are positioned, as Bob said, to take advantage of EMP investment opportunities as they may arise in these volatile markets.

I'll now turn it back over to Bob.

Robert S. Herlin

Thanks, Sterling. Please note that Sterling's going to be presenting on Thursday at the New York Society of Security Analysts' Conference at 3:25 Eastern time at the offices of the society. This is going to be webcast and accessible through our website tomorrow, as will be our latest presentation.

We are encouraged that the Delhi reservoir continues to respond well to the CO2 injection, in fact, better than expected. We're also pleased that Denbury is moving steadily forward in installation of their main good project in eastern half of the field. The higher production rates there, combined with the premium Louisiana Light Sweet pricing, is providing a great uplift to our results.

While our current projects are sufficient to redeploy the current level of cash flows, the projected ramp-up in cash flows from Delhi over the next couple of years provides us with the opportunity to consider other development project opportunities that meet our very stringent criteria of location, required expertise, oily products and appropriate risk-reward ratio. As employees and major shareholders, our focus here remains clearly on protecting and building share value. That's a key issue for us everyday.

Now with that, we're ready to take questions, then operator, please open the line. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from the line of Mark Aydin with MLV and Company.

Mark Aydin - McNicoll, Lewis & Vlak LLC, Research Division

Just a couple of questions for you guys. On the cost side, is this a level that we should expect them to stay at going forward, or is there going to be some variability?

Robert S. Herlin

Which cost?

Mark Aydin - McNicoll, Lewis & Vlak LLC, Research Division

Just on -- yes, operating costs.

Robert S. Herlin

The LOE cost, you may notice, on a quarter-to-quarter basis are actually quite flat, and the reason is that we don't bear any operating cost on any of the productions at Delhi. So as that goes up, there is no increase in our operating cost. Those are really tied to our operations primarily in the Giddings Field and starting to be, a greater extent, a large extent, I should say, in South Texas. And as we add more wells in South Texas, that number will go up accordingly but not a very big number.

Mark Aydin - McNicoll, Lewis & Vlak LLC, Research Division

Okay. And my only other question was the development plans for the expansion into eastern half of the Delhi Field. Has that already begun? Or is that sometime in the near future?

Robert S. Herlin

Well, in the past, what we talked about is Delhi being done in phases, and actually, the operator has kind of gone away from that concept. We are, as we say, we -- they are still in the process of completing the installation of the project in the western half of the field. It just so happens that, the way they did it this year, they were able to begin CO2 injection and generate oil production at an earlier phase of that development. So while we realized production from activities out there this year, they're still in the process of completing that installation on the western half. Starting next year, we expect them to move into installation in the eastern half. And that will be likely over by a 3-year period.

Operator

[Operator Instructions] And we do have a question from the line of Dick Feldman [ph] with Axiom Capital.

Unknown Analyst -

I've got a question about GARP. What will those installations cost you in terms of capital?

Robert S. Herlin

That's been really varied depending on the nature of the well that we get. Right now, our focus is in, you want to install it in wells that are already currently operating, producing, they already have the rod pump, the drive and so forth so we don't have to put a lot of money into the installation of a non-GARP equipment. So in that case, we're actually going to be spending on the order of about $100,000 or so for those kind of application for a typical full installation of the GARP. If we have to actually include the installation of the rod pump and the rods and so forth, then that could easily add another $150,000 to $200,000. On the other hand, you typically get additional reserves associated with just that the rod pumps of installation on its own because that is typically a more efficient artificial lift than, say, a gas pump.

Unknown Analyst -

Okay. How long do you think it will take for you to know whether these 2 tests are living up to expectations?

Robert S. Herlin

Well, it'll take anywhere from -- we would expect to see fairly rapid response, but then you also want to see it hold up for a number of months, so I suspect that we'll make some disclosure of the results in the third quarter or at the third quarter results earnings call, sometime in that period of time.

Unknown Analyst -

Your fiscal...

Sterling H. McDonald

[indiscernible] third fiscal [indiscernible]. We will make sure we have adequate information so that we have a reliable answer.

Operator

[Operator Instructions] And I am currently showing that there are no further questions at this time. I will turn it back over to Mr. Herlin for any closing remarks.

Robert S. Herlin

Again, I'd like to thank everyone for joining us. We're very pleased with the results this quarter, and we have every reason to believe that we're going to continue to see these kinds of results going forward.

So if you have any other questions, feel free to give us a call. Otherwise, I would encourage you to listen into the full presentation by Sterling tomorrow or to review the presentation, it will be online tomorrow. Thank you.

Operator

Ladies and gentlemen, this does conclude the conference call. If you'd like to listen to a replay of today's conference, please dial (303) 590-3030 and enter an access code of 448565 (sic) u. Thank you for your participation. You may now disconnect.

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