Evolution Petroleum's (EPM) CEO Randall Keys on Q2 2017 Results - Earnings Call Transcript

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Evolution Petroleum Corporation (NYSEMKT:EPM) Q2 2017 Earnings Conference Call February 8, 2017 11:00 AM ET

Executives

David Joe - Chief Financial Officer and Senior Vice President

Randall Keys - Chief Executive Officer and President

Analysts

Jeff Grampp - Northland Capital Markets

Brian Corales - Scotcia Howard Weil

John White - Roth Capital Partners

Christopher Vaughn Mccampbell - Hilltop Securities

Jim Collins - The Portfolio Guru

Harshit Gupta - Euro Pacific Capital

Operator

Welcome to the Evolution Petroleum Corporation Second Quarter Fiscal 2017 Earnings Release Conference Call. As a reminder, all participants are in listen-only mode, and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]

I would now like to turn the conference over to David Joe, Chief Financial Officer. Please go ahead.

David Joe

Hello, and thank you for listening to Evolution Petroleum’s conference call to discuss financial and operating results for our fiscal 2017 second quarter ended December 31, 2016. I am David Joe, Chief Financial Officer for Evolution Petroleum. On the call with me today is Randy Keys, our President and CEO.

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 www.evolutionpetroleum.com, via recorded replay until February 15, 2017. Please note that any statements and information provided today are time-sensitive and may not be accurate at a later date.

Our discussion today will contain forward-looking statements of management’s beliefs and assumptions based on currently available information. These forward-looking statements 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. Since detailed numbers are readily available to everyone in yesterday’s news release, this call will focus on key overall results, operations and an update on our capital plans for the remainder of fiscal 2017.

I’m now going to turn the call over to Randy Keys, President and CEO.

Randall Keys

Thank you, David. Evolution reported very strong results for the quarter ended December 31, 2016. Our net income was $2.3 million on total revenues of $8.5 million, which gave us earnings of $0.07 per common share.

Based on these positive results and a favorable outlook for the company, the Board of Directors of Evolution voted to increase the quarterly common stock dividend to $0.07 per share. This is an increase of 8% from the previous level of $0.065 per share. On an annual basis, the new dividend amounts to $0.28 per share, which provides a yield of almost 3.5% at current price levels for the stock.

Production in the Delhi field has continued to increase, adding over 200 barrels of oil per day on a gross basis, and our net share during the quarter was just shy of 2000 barrels of oil per day. In November, we completed the previously announced redemption of all of our preferred stock outstanding, with the total redemption amount of $7.9 million.

The redemption was funded with internal working capital and we remain debt free. And the redemption further simplifies our capital structure, which consists of 33 million common shares outstanding, virtually no dilutive securities and no security senior to our common stock. We will talk more about the NGL plant later in the quarterly review.

During the quarter, we’ve recorded revenues of $8.5 million and our total costs were $4.9 million, resulting in income from operations of $3.7 million. Of these costs our noncash DD&A expense was $1.3 million, and our noncash stock based compensation was $0.3 million, so our EBITDA was over $5 million.

Our tax expense for the quarter was $1.4 million based on an expected combined state and federal tax rate for the year of 35%. However, with bonus depreciation from the NGL plant in the current year, we expect our combined cash income taxes to be approximately 5% of taxable income. That means we expect to defer the other 30% of our book tax expense in the current fiscal year. Our net earnings were $0.07 per common share.

I would point out that the other income reported in the September and December quarters of last year consisted primarily of our hedging gains which are reported as other income and not part of revenues as well as an insurance settlement related to periods prior to the reversion of our working interest. The large other income in the June 2016 quarter resulted from the litigation settlement, as more fully described in our Form 10-K.

Gross production in the Delhi field averaged 7,580 barrels of oil per day during the December quarter. Based on our 26.2% net revenue interest, our net production was 1,987 barrels of oil per day for the quarter. We have shown a very positive trend of increasing production over the last two years. At reversion of our working interest in November of 2014, production in the field was around 5,800 barrels of oil per day. This quarter, it averaged over 7,500 barrels of oil per day, an increase of over 30% in two years.

Most of the increase has resulted from conformance projects to increase the efficiency of the CO2 flood through selectively sending the CO2 to the most productive sub-zones within the formation. Our net capital investment in these conformance projects over the past two years has been around $6 million. So the return on investment has been outstanding.

Our average price for the quarter was $46.66 per barrel, an increase of almost 10% from $42.66 in the prior quarter, and it’s our highest average price over the past five quarters. The chart at the bottom of the page shows how our net realized pricing in the Delhi field compares to average WTI prices as quoted on the NYMEX.

The LLS price premium has narrowed significantly over the past two years and our pricing has gone from near parity or a small premium to WTI to around $2.50 per barrel discount to average WTI prices. Since the oil from Delhi is moved by pipeline and not by truck, this discount is still relatively small, compared to the differentials experienced by many other oil producers.

One of the most significant accomplishments in the conformance process is that production has increased, at the same time that volumes of purchased CO2 have declined dramatically. In the span of two years, purchased CO2 volumes have dropped from over 100 million cubic feet per day in early 2015, to the current level of around 70 million cubic feet per day.

Part of the conformance process is shutting off zones that produce high volumes of CO2 with relatively small volumes of oil. This improves the overall efficiency of the flood and allows for similar or even higher rates of production with less purchased CO2. This has been a key driver of the drop in our total production costs per barrel, from nearly $20 per barrel to current levels of around $13 per barrel.

In the current price environment, these lower lifting costs are very important to maintaining profitability. Purchased CO2 is our largest component of total operating costs, accounting for up to 50% or more of total costs. We are fortunate that under our contract, CO2 costs are tied directly to the realized price of oil in the field. So our largest cost is variable with revenues. Along with reduced volumes of purchased CO2, this pricing is another key factor to maintaining profitability in a challenging oil price environment.

Other production costs at Delhi have been fairly stable in the aggregate, totaling around $1.2 million per quarter. Our G&A expenses have come down dramatically over the past two quarters, now that the litigation settlement has been result. As you can see, our litigation costs were very high, exceeding $1 million in the March quarter of last year. Our normalized cash G&A is now below $1 million per quarter, which is our target.

Our G&A was higher in the June quarter even without litigation costs. This was driven primarily by the vesting of performance based stock compensation and other incentive payments resulting from our net income of over $20 million in the prior fiscal year.

Evolution began paying a quarterly cash dividend on common stock in December of 2013, and has now paid 13 consecutive quarterly dividends. Our cumulative return to shareholders now totals almost $30 million, or $0.915 per common share.

As the chart shows, we were forced to cut the dividend based on the significant drop in crude oil prices beginning in late 2014. There are many factors in addition to oil prices that way into the decision on the amount of the dividend. But an improving oil price recovery is certainly a foundation to increasing distributions. Management in the board remained committed to returning cash to shareholders in the form of a common stock dividend.

The photo on Slide 11 shows an aerial view of the Delhi Central CO2 processing facility, with the NGL plant in the background at the top of the photo. This facility handles the compression and reinjection of almost 200 million cubic feet of CO2 per day, while also processing the oil and water produced from the field.

The photo on Slide 12 shows the NGL plant in the final stage of completion in October of last year. The plant is designed to process up to 155 million cubic feet of CO2 per day from the recycle stream. It separates the methane and natural gas liquids from the recycle stream, and significantly increases the purity of CO2 for reinjection into the field.

The photo on slide 13 shows the four storage tanks for produced NGL, totaling over 8,000 barrels of storage capacity. The NGLs leave the field by truck and are processed at a fractionation plant in Texas. The plant has been ramping up throughput this month and we sold our first loads of NGLs during January. We expect to reach full production capacity during the current quarter. We do not have sufficient data to project actual production volumes at this time.

A significant part of the NGL plant complex is the 25 megawatt GE turbine to generate electricity from the methane and ethane produced by the NGL plant. This electricity will supply the needs of the NGL plant, and will also provide part of the power requirements for the central processing facility. The turbine has been operating since late December using purchased natural gas for testing and commissioning purposes.

Last week the turbine was switched over to internally produced gas. And we have ceased purchases of outside natural gas. The turbine is currently operating at very close to full capacity, which is 22 to 23 megawatts of continuous power generation.

This concludes our review of financial results and operations for the December 2016 quarter. In summary, we reported positive net income of $0.07 per common share, an increase in cash dividends on our common stock to $0.28 per share on an annual basis, very strong performance from the Delhi field, the redemption of all of our preferred stock, and the completion and start-up of the NGL plant.

Thank you very much for your interest in Evolution Petroleum.

David Joe

Okay, thank you very much. For those of you who are not aware, this quarter we did a pre-prepared conference call, and there are slides accompanying the conference call, and this is available on our website. It is on the front page of the website, you can click it under webcast, and you can see the slide, and the audio, if you want to review some of the audio did refer back to slides in that presentation.

So I think we are now ready for Q&A. Thank you very much.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Jeff Grampp with Northland Capital Markets. Please go ahead.

Jeff Grampp

Good morning, guys. I appreciate the extra details in the slide presentation there.

Randall Keys

Thank you.

Jeff Grampp

I guess, first just maybe to start on the CapEx program and potential growth opportunities, you guys kind of talked about in the release. Randy, do you guys have a sense for maybe the CapEx associated with the infill drilling that’s slatted for the second half of this year?

And then maybe just have a - second part to that question is that, do you guys have kind of a sense of what kind of reserve categorization? I mean, are those reserves that are in the probable category, are those PUDs or just kind of thinking about potential changes to your reserve base with that project?

Randall Keys

Certainly, first off, the information we provided was kind of on an early notification basis. The capital budget has not been approved by the operator at this point. So we do see some opportunities. We think these reserves or this spending would result in both a higher production rate and greater recoveries. Those recoveries are probably technically within the proved category, but we would expect to have these projects result in additional probable reserves being ultimately produced, which is our overall view of the field, is that the field is outperforming the proved curve and we do see recoveries that are going to include some of the probable reserves in our opinion and based on our expectations.

As to the capital amount this is also has not been completely budgeted yet. We would expect it to be somewhere in the $7 million to $8 million in total for all of the projects net to us. And like I said, it is still preliminary at this point as to both timing and amount.

Jeff Grampp

Got you, okay. And I guess maybe that kind of dovetails into my next question, which is more on the dividend side of things. I’m assuming that a lot of any potential reassessment back down the road is going to be partially driven by what ultimately the CapEx needs are. But do you have a sense of kind of how the Board is thinking about dividend increases as far as - should we think about it as far as a percentage of free cash flow or EBITDA or any kind of metrics or payout ratio that you guys think about, or is it a little bit more complex of a process than they’re right now?

Randall Keys

Well, it is a factor - a function of those things. It’s certainly not a formula. And the reason is because we don’t know what prices are likely to be in the future. This CapEx program would not impact the dividend program in any meaningful way. It would certainly be one of the factors we would consider. But at present, we view that we got plenty of free cash flow to make this investment and still maintain a similar or increasing dividend.

So I don’t think we are going to see this impact, the dividend, like I said in any meaningful way based on the numbers that we are seeing. And we are - we do look at our free cash flow as the primary determinant of the amount of the dividend. And we are looking for a dividend that’s sustainable over time that we can continue to pay for the long run.

Jeff Grampp

Okay. I appreciate the color. I’ll let someone else hop on. Thanks, guys.

Randall Keys

Thank you.

Operator

The next question is from Brian Corales with Howard Weil. Please go ahead.

Brian Corales

Hey, guys. Just kind of dovetailed on that same topic, I mean, you have $20 million cash, nothing is on a revolver, I mean if oil prices are in these range or we assume there is no acquisition that you’re all targeting, and can we just assume that the dividend inches higher or would you consider the share buybacks, what are your thoughts there?

Randall Keys

Well, we are not active with our share buybacks at the current time. We do still have a program authorized. I think we would look to reevaluate that dividend, particularly when we see the additional revenues from the NGL plant and as we continue to monitor results from the field. But we are not - I’m not sure that we have a clear view, we look at it based - I think the biggest question mark is just oil prices, and making sure that we got sufficient free cash flow.

As to the cash balance, that’s not really a factor in the equation. I mean, we want to see that cash balance basically increase. That gives us an opportunity to evaluate future growth opportunities. But we would not - we don’t envision subsidizing the dividend from our working capital, is the simplest way to say that.

Brian Corales

Got you. Now, that makes sense. And then on the M&A front, have you seen - I mean, it seems like industry-wide we’ve seen a lot more M&A. Have you seen, I guess, opportunities increase over the past six months or so?

Randall Keys

We have. We’ve seen two things. We’ve seen pricing become more rationale in our view, after a long period in 2015 and early 2016, where it was not rationale in our view. And we have seen a greater number of opportunities in projects, divestitures primarily. We see an opportunity for primarily producing property acquisitions that may be divestitures from larger companies that are rotating into the more active shale plays, the SCOOP, the West Texas and others.

We think there is an opportunity for them to redeploy that capital. And we may be able to find opportunities there.

Brian Corales

All right, guys. Thank you.

Randall Keys

Appreciate it, Brian. Thanks.

Operator

The next question is from John White with Roth Capital. Please go ahead.

John White

Good morning, guys. Can you hear me okay?

Randall Keys

You bet, John. How are you?

John White

I’m good. Maybe you’ve - I think you’ve addressed this already, but I’m going to try. You want to give us any of just even the recess [ph] comment on current NGL volumes from the plant?

Randall Keys

We will provide additional disclosure on that, when we have reliable consistent data. We are still in the ramp-up process, and we really don’t have numbers to report at this time. Wish we did. The plant is making good progress. It is operating as intended, but we just don’t have stabilized numbers that we consider meaningful to disclose.

John White

Okay. Well, congratulations on all the good numbers. And I thought I’d give it a shot. Thanks for taking the call.

Randall Keys

You bet, John. Thanks a lot.

Operator

The next question is from Chris Mccampbell with Hilltop Securities. Please go ahead.

Christopher Vaughn Mccampbell

Hey, Randy and David. Most of my questions have been answered. I guess that’s what happens when you’re fourth in line. But you’ve mentioned tax benefit for the remainder of the year. And I just wondered whether or not that was for fiscal year since we’re now in Q3, or whether or not you’re talking about the next 12 months?

Randall Keys

Well, that’s a fiscal year calculation, because that’s how we pay our taxes. But, yeah, we do see a fairly low cash tax rate in fiscal 2017. We will see that cash, the percentage of cash taxes move up. And as we roll into 2018 fiscal year that partly a function of the fact that we’ve utilized a lot of our NOL with the settlement last year with the litigation settlement. But, yeah, we still got a very favorable cash tax rate this current fiscal year.

Christopher Vaughn Mccampbell

Okay. And maybe just to piggyback on the last question, I know that it’s de minimis at this point. But are you seeing any P&L impact even with the relatively volumes you’re talking about with the plant or, I guess, maybe just a little more color on how we would look at that going forward, in terms of…?

Randall Keys

Yeah, I wish I could give a clear picture at this point. But we have not seen January numbers. January, we’re just few days into February. We will get January numbers in about a week to 10 days. And so we just don’t - we don’t have those production numbers or the - most of the costs through the end of the year were still capital costs, because it was in the commissioning phase, so we haven’ really seen operating costs either.

So it’s just - frankly, it’s a little too soon and we are waiting on actual. Rather than trying to guess, we’re just going to wait on actuals and report those as we get better clear information.

Christopher Vaughn Mccampbell

Okay. And in regards to a share buyback, you mentioned there are still some shares available for purchase, would you consider - well, I guess, I’d ask, what would you say would be your primary focus with cash? Would it be more share buyback or would it be having your powder dry for M&A?

Randall Keys

Well, I would say in the current environment, meaning for the next - so here we are in February - for the next six to nine months, we believe that we got some opportunities to add producing properties to the mix. And we think that is the best answer for our shareholders. And so the answer is, we want to keep that capital available. And we might consider an opportunistic buyback if the situation arose. But I don’t see us making a big push for repurchasing stock, while we are in this mode where we think we got some opportunities ahead of us.

Christopher Vaughn Mccampbell

Okay, great. Thank you, all.

Randall Keys

Thank you.

Operator

The next question is from Jim Collins with Portfolio Guru. Please go ahead, sir.

Jim Collins

Thank you. Good morning, Randy.

Randall Keys

Hey, Jim. How are you?

Jim Collins

I’m doing fine. Thank you. A big picture question on Delhi, I mean, each quarter or the last several anyway, you come in ahead of my expectations for net reduction. And you mentioned the conformance work-over projects quite a few times in the press release and the slides.

So from a big picture perspective, how much more upside is there on a quarterly production run rate run that field, given that you have some more CapEx coming in the second-half of this calendar year, and also given that the field is obviously been in production for decades?

Randall Keys

Yeah, it’s actually been in - well, the field itself has been in production for decades. The flood begin in 2010, so it’s…

Jim Collins

Yes, yes.

Randall Keys

…about six-years-old. So very good big picture question. I’m going to exclude the CapEx part of it and the NGL plant, and just focus on the conformance project. The operator identified a number of those projects during 2016 calendar year. We did about - I don’t know, almost 11 of those projects in the second-half of the year, maybe few more than that.

And so, I think they’ve identified lot of the low-hanging fruit. And there are still some projects yet to come. They’ll probably slow down a little bit. They’ll be a little more selective. But we do see continuing opportunities for improvement. And we do see positive growth over the next 12 months just from the base, what I would call the base production in the field.

Now, if we are going to spend this additional CapEx, we are obviously going to want to see a meaningful increase in production. We don’t have a clear view of that. That’s part of the reason I didn’t want - don’t want to get into that discussion of how much CapEx is. The next question that follows is what do you expect to get for it.

And we don’t yet - we are still doing the analysis on that, I think is the simplest way to put it. And the operator is also doing their analysis. And that cost justification and that benefit is also something that we are working on right now. But we would see - we’d have to see a meaningful positive benefit from that in production, and then of course, that we do have the NGL volumes coming on line this quarter.

Jim Collins

And what is the…

Randall Keys

So I think it’s still positive. Go ahead.

Jim Collins

Sure. And what is the timeframe for completing the analysis that both [you and Denver] [ph] you’re doing on what the CapEx needs would be for the second half of the calendar year or first-half of fiscal 2018 for EPM?

Randall Keys

I mean, it’s a couple of months. It’s not something that - it’s a very complex - the field itself is complex. There is a 100 well. There are 10 different zones within the field. You got to determine oil in place for each one of those zones, and try to calculate what you think the recoveries, the incremental recoveries are from these projects. So, no, it’s not something that is going to be over night. It’s something that we are working on. It’s part of a larger process of analyzing and understanding the field.

We are going through that right now for our reserve update for our year-end in June. So there is quite a bit of analysis that goes into that process.

Jim Collins

Okay. Thanks a lot for answering my question, Randy.

Randall Keys

You bet. Thank you, Jim.

Operator

[Operator Instructions] The next question is from Harshit Gupta with Euro Pacific Capital. Please go ahead, sir.

Harshit Gupta

Hey, good morning, guys. This is Harshit on behalf of Joel Musante. In somewhat related question, I was looking at the production trend you have shown in your latest presentation from the Delhi field. And it shows production - oil production on a consistent upward trend into 2020. So is that an accurate depiction of the expected production from the field?

Randall Keys

It certainly is in the aggregate. Now, that’s just a generalized view. But I mean I don’t know is 2020 is the right exact endpoint for that. But we do see production. We’ve seen production grow over the last two years. We do see positive growth in the next year to two. And beyond that, it’s somewhat dependent on when we do Phase Five, because Phase Five is the next major development project in the field. It’s in our proved reserves. It’s proved undeveloped at this point.

The net cost to us is about $11 million, which means the net cost to the operator is a little over $30 million in round numbers. So that project we think - that’s in the press release we talk about that or maybe in the call we talk about that being in fiscal - or sorry, calendar 2018. It is not yet - the timing is not yet determined on that. But that project should add significant new production in the field we think within the next two years.

Harshit Gupta

Okay. And in the past, you have talked about acquiring some properties and becoming an operator. I was wondering how that fits into your current business model as a dividend payer. Is the goal to remain a dividend payer or to become a more like traditional E&P company?

Randall Keys

Well, that’s a great question. I would say, we are looking for the path that will yield the best opportunity for our shareholders and the best return. We think right now that there is a very promising opportunity to add production and continue with the yield model. And whether we’re an operator or not is not really the key factor there. The key factor there is how much capital the field require - whatever properties you own, how much capital they require to continue to develop.

When you say a traditional E&P company, I think of company that’s primary goal is the successful and profitable investment of capital. And that’s the key function. And generally, those companies consume all of - much, or if not all or even more than their cash flow on any given year. We don’t want to be in that mode. We want to be in a situation, where we got excess cash flow that we can return to shareholders. And part of that cash flow that we can use to maintain or add to reserves to offset the decline in those, in that production.

Harshit Gupta

All right, yeah, thanks. Thanks for the detail.

Randall Keys

You bet. Nice to talk you. I look forward to meeting you at some point. And give my regards to Joel.

Harshit Gupta

Definitely. Thanks.

Operator

This concludes the question-and-answer session. I would like to turn the conference back over to the management for any closing remarks.

David Joe

Thanks everybody for participating on the call. Good questions, any further questions feel free to contact us here in our Houston office. We’ll be participating in a number of conferences starting in March. We’ll be out on the roads in the near-term. Thank you again, all.

Operator

This concludes today’s conference call. You may disconnect your line. Thank you for your participation and have a good day.

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