EP Energy's (EPE) CEO Brent Smolik on Q3 2017 Results - Earnings Call Transcript

EP Energy Corporation (EPE) Q3 2017 Earnings Conference Call November 2, 2017 11:00 AM ET

Executives

Bill Baerg - Director, IR

Brent Smolik - Chairman, President and CEO

Clay Carrell - COO

Kyle McCuen - Interim CFO, VP and Treasurer

Russell Parker - President and CEO

Analysts

Scott Hanold - RBC Capital Markets

Asit Sen - Bank of America Merrill Lynch

Sean Sneeden - Guggenheim Securities

Operator

Good morning, and welcome to the EP Energy Third Quarter 2017 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation there will be opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to Bill Baerg. Please go ahead.

Bill Baerg

Good morning, and thank you for joining our third quarter 2017 investor update. Our speakers for today's call will be Brent Smolik, President and Chief Executive Officer of EP Energy. Along with him will be Clay Carrell, Chief Operating Officer of our company; and Kyle McCuen, our interim Chief Financial Officer. Also joining the company and our call today is Russell Parker.

Hopefully, you saw yesterday we filed our third quarter press release announcing our quarterly results. This morning, we posted slides to our website, epenergy.com, which we'll be referring to on this call. Also on our website, in the Investor Center section, you'll find our third quarter financial and operating reporting package that includes non-GAAP reconciliations and other relevant information. This is a helpful resource, which we hope you'll download and review.

During today's conference call, we'll make a number of forward-looking statements and projections. We've made every reasonable effort to ensure that the information and assumptions on which these statements and projections are based are current, reasonable and complete. However, there are a variety of factors that could cause actual results to differ materially from the statements and projections expressed during this call. You'll find those factors listed under the cautionary statement regarding forward-looking statements on slide two of this morning's presentation as well as in other SEC filings. Please take the time to review them.

Finally, EP Energy does not assume any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Thank you. And it's now my pleasure to turn the call over to Brent.

Brent Smolik

Thanks, Bill. Good morning, everyone, and thank you for joining our call today. We've got a couple of key topics to discuss this morning. First the quarter, where we continued to execute on each capital program and met our goals despite dealing with the challenges of cost inflation and Hurricane Harvey. In addition to the third quarter results, we've also announced that I'll be retiring on November 15th and Russell Parker will become the new President and CEO. As Bill mentioned, Russell has joined us on the call and he'll also be available for Q&A this morning.

As outlined in the release and the 8-K yesterday, four additional leaders will also be joining the company. And in addition to me, several other officers including Clay Carrell, Marguerite Woung-Chapman and Joan Gallagher, will be departing the company. Over the next couple of weeks, we'll be executing on a transition plan and process of on-boarding the new leaders and we expect the transition to be completed by November 15th.

Additionally, on November 1st, the Board announced the appointment of Alan Crain, who currently serves on the Board, as Chairman of the Board to succeed me effective today. And these changes are all initial steps in moving from an asset-based organization to a functionally based organization. The new structure will create a flat organization and will enable greater flexibility in allocating capital and resources to specific assets, while maintaining the focus on reducing costs.

I'll now turn the call over to Russell for his remarks.

Russell Parker

Thank you, Brent, and good morning, everyone. As Brent mentioned, my name is Russell Parker, and I'll be transitioning into the role of President and CEO with Brent's retirement. I'm very excited about our people, our assets and the EPE platform. In addition to the existing team, we have some new members joining the EP Energy over the next couple of weeks, who will be heading up the operations and engineering team as we complete this transition. We are very - all very excited to be a part of the team and see opportunities for continued enhancements and growth as we move towards a functional organizational structure.

I believe in strong capital discipline and have a returns-based strategy when allocating investment dollars. We are currently and will always remain focused on improving all of our key metrics, while protecting cash flow and improving liquidity. EP Energy has a great set of assets as well as a talented and dedicated group of professionals.

We look forward to our future success as a company. I expect to communicate with you more in the near-term to provide further insight into my views and into the path forward. My immediate focus is working with Brent and his team on an orderly transition and to set the course for the opportunities that lay ahead.

With that, I'll hand it back over to Brent.

Brent Smolik

Thank you, Russell. Welcome to EP Energy. Let's now turn back to the quarter, beginning on Slide 4 with our operational and financial highlights. In the quarter, we continue to make progress on our 2017 goals with the results either in line or ahead of expectations. Our technical teams continue to find new ways to improve operations and increase efficiencies, primarily by increasing the speed of execution.

Our production teams continued to improve our base production volumes in all three asset areas. In 3Q, we increased Wolfcamp completion activities and we produced the highest quarterly oil and equivalent volumes since the inception of the program. We also completed several bolt-on acquisitions in the Permian Basin and Upton County, which added production and near-term drilling locations to the Wolfcamp.

For the quarter, we generated $159 million of adjusted EBITDA, in line with our expectations. Our operating costs continue to trend lower in the quarter, setting us up well to come in at the lower end of guidance ranges for the full year 2017 unit cost. And we benefited from higher realized pricing in 3Q versus the comparable period in 2016. And we ended the quarter with more than $930 million of liquidity. And finally, we recently completed our semiannual RBL redetermination and maintained a $1.4 billion borrowing base.

Slide five is a summary of our 3Q results and capital by program. Total equivalent volumes were 81,000 barrels a day in the quarter, including 45,000 barrels of oil production per day. We completed a total of 40 wells in 3Q with the largest percentage being in the Wolfcamp with 32 out of the 40 total completions.

Recall that we front-end loaded the Eagle Ford activities in the first half of the year and had no planned completions in the third quarter. And we still expect to have a busy fourth quarter in that program and expect to hit our annual completion targets. Eagle Ford remains our largest program by volume with total equivalent production of nearly 33,000 barrels per day in the quarter.

In the Altamont, we produced 12,500 barrels of oil per day while spending about $23 million of capital. Total capital in the quarter was $162 million, the majority of which was allocated to our Wolfcamp program, which was consistent with our planned increase in Wolfcamp completion activities. Also note that the Wolfcamp total included $27 million of acquisition capital in the quarter, which we reallocated from planned D&C capital.

Kyle will reconcile the full year Wolfcamp capital and completion activity later in our guidance discussion.

And with that overview, I'll turn to Clay to go through more specifics on each program. Clay?

Clay Carrell

Thanks, Brent, and good morning. Operationally, we had another good quarter in 3Q with solid execution across all programs. I'll start with the Eagle Ford program on slide seven. The big news for this asset during the quarter was the minimal impact of Hurricane Harvey in late August. Our operations team did a great job of preparing for the hurricane and minimizing impacts to both equipment and production.

We ended up with no impact to our production infrastructure and our drilling activities were unaffected. However, as we mentioned in a release a few weeks ago, we did see a short-term reduction in our sales volumes due to temporary losses of downstream infrastructure and markets. The production impact of 3Q was approximately 900 barrels of oil equivalent per day, including 300 barrels of oil per day. By mid-September, everything was back to normal, both operationally and in the downstream markets.

During the quarter, we averaged one drilling rig and no frac crews. We maintained our focus on maximizing base production performance and mitigating cost inflation, and we exceeded expectations in both areas. As we discussed in the 2Q call, we slowed down completion activities at the end of 2Q due to lower oil prices that started in June. We kept the drilling rig running to build up our DUC inventory so that we would be ready to ramp up this asset if oil prices improved.

As you can see from the production chart on the lower left of the slide, production volumes increased in the first two quarters of 2017 as a result of the accelerated completion activity in 1Q. In 3Q, we did not have any completions, and as expected production declined to approximately 20,000 barrels of oil per day.

As we have previously discussed, the Eagle Ford asset is our most capital and EBITDA efficient asset and is our highest return program when oil prices are above $50 a barrel. Additionally, we have not seen as much cost inflation pressure in this asset and we've been able to mitigate the moderate inflation we have seen with operational efficiencies.

As we moved into the fourth quarter, we have seen oil prices and LLS basis improve, which results in a nice increase in our realized prices. As a result, we moved two frac crews back and added a second drilling rig to the asset in October. We moved the rig from the Wolfcamp asset in order to quickly capitalize on the improved pricing in the area and to put an efficient drilling rig in place.

Going forward, we expect to have increasing completion activities and growing production volumes in the fourth quarter and as we move into 2018. Like always, timing of completions matter. And as we restarted the completion activity in October, we experienced some delays. But like we showed in 1Q, when we have increased completion activities in this asset, we have seen a quick production response.

Slide eight highlights our Wolfcamp program. Throughout the year, we have increased the value of our Wolfcamp asset. We increased the type curve to 750 MBoe. We advanced our subsurface knowledge through the expanded use of our earth model. We expanded our development across the acreage and recently added bolt-on acquisitions. In the quarter, we had two drilling rigs running and two to three frac crews, which significantly increased our completion activities.

As a result, quarterly production volumes grew as expected and we achieved the highest quarterly oil and equivalent production volumes for the asset since its inception. The production chart on the upper left of the slide highlights our quarterly net oil volumes and gross and net well completions, which were all up significantly in 3Q. We completed 32 gross wells and 19.5 net wells in the quarter, which is almost double the 2Q net completion count.

We produced 12,600 barrels of oil per day, which is approximately 27% higher than 2Q. We continued to improve base production volumes and reduced our LOE unit cost to approximately $4.50 of Boe. As Brent mentioned, we also added 3 bolt-on acquisitions in our Upton County acreage, totaling $27 million in 3Q and $29 million year-to-date.

The map on the lower left of the slide shows our westernmost acreage position, which is mainly in Upton County. Our existing acreage is shown in yellow and the acquired acreage in green. As you can see, the acquired acreage filled in the gaps in our Upton County position like puzzle pieces. In total, we added approximately 3,600 net acres and 300 barrels of oil per day of gross production.

The acquired acreage included approximately 60 future drilling locations and allowed us to extend approximately 20 short laterals that were in our existing inventory to long laterals. We funded the $29 million of acquisition capital by reducing development capital in the asset in order to maintain our annual capital guidance. While we have continued to benefit from efficient operations, like many Permian operators, we've seen increasing pressure on services and cost inflation. As a result, we shifted one of our drilling rigs from the Wolfcamp to the Eagle Ford as I mentioned in the Eagle Ford update.

As we have previously discussed, this is one of the many benefits of having a multi-basin portfolio. It allows us to capitalize on cost and commodity price advantages without being captive to one asset and gives us the opportunity to quickly make capital allocation shifts to improve returns and increase the value of the company.

We currently have one drilling rig running and going forward, we should continue to benefit from the 32 completions that were done in 3Q, along with the planned 4Q completions. We recently submitted 17 new IP24s as part of our regulatory reporting process, which were all part of our third quarter completion activities. These wells are performing in line with our type curve forecast with IP24s averaging over 700 barrels of oil per day. As a result, we expect to modestly grow production in the fourth quarter.

On slide nine, our Altamont program continues to deliver quality results quarter after quarter. In 3Q, we averaged two joint venture drilling rigs and had eight gross and three net completions. We also performed 11 recompletions. The capital and EBITDA efficiency associated with the combination of our drilling JV program and the recompletion program has elevated our program returns and maintained quarterly production while spending less than $25 million in the quarter.

The quarterly production chart on the lower left of the slide shows the stable production profile we have been able to achieve in this asset. In 3Q, we maintained net oil production at approximately 12,500 barrels of oil per day. Base production exceeded expectations here as well and we were able to continue to offset cost inflation on both the capital and expense side of our business. And we also benefited from improved realized prices.

Going forward, we expect to continue to run two joint venture drilling rigs and maintain our recompletion program activities. This should keep 4Q production levels flat to slightly down from 3Q levels.

I'll now turn it over to Kyle to review our financial highlights. Kyle?

Kyle McCuen

Thanks, Clay. Good morning. Before I start, I'd like to remind you that in addition to the materials we posted for this call, we expect to file our third quarter Form 10-Q by end of week.

I'll start on slide 11, which provide some financial highlights for the quarter. In line with Clay's earlier comments on our operations, our financial performance was in line with expectations despite storm and inflationary pressures. We generated $159 million of adjusted EBITDAX in line with expectations, driven by higher oil and equivalent volumes compared to third quarter 2016, and improved physical oil price realizations relative to WTI year-over-year, which is driven by improved contractual terms and pricing differentials.

Our adjusted EPS was a net loss of $0.12. We also continued to maintain strong financial flexibility, which is an important priority as we work through the oil price recovery. Executing on open market debt repurchases of $101 million in July at a discounted face value and reducing interest costs, maintaining a strong liquidity position of over $930 million and successfully completing our semiannual borrowing base redetermination, the value of the facility was renewed at $1.4 billion through April 2018, which is essentially in line with our previous value. I'd like to thank our banks, which continue to support us in this facility, hedging and capital markets.

Slide 12 includes our third quarter adjusted cash operating costs. Due to our continued focus on cost control and efficiencies, we are on track to deliver on the low end of our August 2017 guidance range. The bar chart on the left shows a favorable trend from our guidance. Managing cost is a critical - is critical in this phase of the cycle and we've driven unit cost - cash cost down 10% from our original estimates.

Note that in the third quarter cost, it includes a $0.43 per Boe accrual related to a historical contractual matter and a small termination fee. So, if you exclude this item we are favorable to the third quarter of last year. And we continue to improve operating efficiencies and mitigating inflation by lowering costs like water disposal and securing products at better prices. And we're also getting things done quicker, which reduces cost and correction downtime.

And our G&A continues to trend lower with reduced labor costs and lower negotiated non-labor costs such as rent and insurance premiums. And just to reiterate Brent and Clay's comments, we are continuing to see the success of improved efficiencies flowing through to our bottom-line.

Slide 13 summarizes our current hedge position. Using the 2017 midpoint of our production guidance, we are meaningfully hedged through 2018 with over half of our expected oil and gas production at prices higher than strip. Importantly, our oil volumes are floored at $60 in 2017 and 2018 with upside to $70 next year. Hedging our commodity exposure remains an important strategy to protect enterprise cash flows, and we will continue to monitor markets to opportunistically lag in the fixed price and basis positions on oil, gas and NGL products.

Slide 14 includes our current outlook. With our success we've had this year on all the areas on which we provide guidance, we are maintaining our full year production capital and cost ranges. The only update is in our Wolfcamp program where we expect to reduce gross completions by approximately 20 gross wells. This is due to the substitution of development capital for approximately $30 million of acquisition capital, also moving a rig to the Eagle Ford while we work to offset inflationary pressures and as a result of completing a slightly higher mix of non-JV wells.

In the quarter, we continue to improve our cost guidance and still expect all categories to be at the low end of the range. And we will continue to focus on operational efficiencies and lowering operating and general costs. Our business is performing well, and with another quarter of success, we remain on track with our goals.

To end my prepared remarks, I want to thank Brent and Clay for their leadership and many contributions to the company. It has been an honor and a privilege working with you both.

With that, we'll open the call for the questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Scott Hanold with RBC Capital Markets. Please go ahead.

Scott Hanold

Thanks, appreciate it. Brent and team, I'd say congrats on a job well done during your tenure. From my seat, I think there's been a tremendous amount of technological and operational improvements across your asset base. And obviously, the Permian has been a tremendous evolution from where it was several years ago. So, kudos to you and your team and hope you enjoy your retirement at least for a little bit before you think about what's next.

Brent Smolik

Thanks, Scott.

Scott Hanold

So, my first question. If I step back and look at this discussion around the strategy shift to more of a functional based organization and I don't know if Russell is the best person to maybe address this, but can you clarify for me exactly how this changes the strategy or what EPE is looking at doing going forward?

Russell Parker

You bet. So, putting us together as a functional organization basically means we treat all three of our assets as 1 asset. So rather than the technical professionals and land professionals being grouped by region, they're grouped together, and each project will now compete for capital against any other project across the entire portfolio.

Scott Hanold

Okay, okay. So, in a sense should we expect, based on commodity prices or improvements, a much quicker shift between capital and regions, sort of like what we saw with Wolfcamp activity moving to the Eagle Ford this - here recently?

Russell Parker

That's correct.

Scott Hanold

Okay. And then my follow-up question is you did take, obviously some activity out of the Wolfcamp and moved it to the Eagle Ford. Yet, you made an acquisition in the Wolfcamp and I'm just trying to figure out like what the messaging is here. Certainly, the Eagle Ford, obviously, has a lighter inventory but better returns right now. The Wolfcamp has deeper inventory, maybe not as strong of returns at today's prices of Eagle Ford, but you're buying more inventory there. Is it looking at the Eagle Ford in terms of bolt-ons there, is something you'd value going forward? And why add more to the Wolfcamp when you really have a lot to begin with?

Brent Smolik

Yes, Scott. This is Brent. I think your first part of your question was kind of two different questions that we can't always control when acquisition opportunities come to us. But we should take advantage of the ones where we have competitive advantages and that - if you look at the map, I think it's pretty self-explanatory how well those - that acreage fit with our Wolfcamp program.

The Eagle Ford rig moving to Eagle Ford, I think, is much a reflection of we've had higher inflation in the Permian than in Eagle Ford and we've been able to offset what inflation we've seen in Eagle Ford with better efficiencies. We've seen good performance out of the program this year and netback pricing is better because LLS has been advantaged to TI for the last few months and we think that will persist.

So that's some of that capital flexibility that Russell is pointing to between assets. And then I think in terms of future acquisitions, I think that's more appropriate for Russell to take.

Russell Parker

Sure, Brent. Thank you. So, I'll take that one. Scott, as we're moving forward, absolutely, we're going to consider bolt-on acquisitions or strategic acquisitions within each of the three basins where we believe we have a competitive advantage.

Scott Hanold

Okay, understood. Thanks.

Operator

Your next question comes from Asit Sen with Bank of America Merrill Lynch. Please go ahead.

Asit Sen

Thanks, good morning. Russell, a question for you. I know these are early days, but - and understand the functional organization and benefits of it, but just wondering if you could outline some of the levers you think are available with respect to optimization beyond what the prior management team was considering?

Russell Parker

Well, good question, but I wouldn't say beyond what the prior management team has done. We're looking to extend what the prior management team has been doing. And those are levers such as landing, lateral lengths, completion design, refrac, IOR. We're going to look to extend that work and push it - continue to push it forward.

Asit Sen

Okay. And the second question, again, these are early days, but a key pushback on the story, EPE has been limited free float? What are your thoughts or early thoughts on this issue?

Russell Parker

Sorry, can you repeat that question?

Asit Sen

Free float stock.

Kyle McCuen

Yes, this is Kyle. I can take that question. So obviously, 15% of our company is in the public hands and we would - we'd like to ultimately look at transactions and market windows and that will ultimately improve our leverage and capital markets is one of those levers. So, we will look at transactions that help the balance sheet that have potentially improvement in terms of our float dynamics as well. So, I think that's on the table given, again, what market windows may be available in the future.

Asit Sen

Great, thanks. And lastly on the bolt-on acquisition. I know it's small, but what's the strategy behind it? Is it just longer lateral or bulking up? Any color would be appreciated.

Brent Smolik

Yes, I think both. They come with about 20 wells that we can extend laterals and make them more efficient in the development and about 60 new wells that come into the inventory and an area that we think is very prospective.

Asit Sen

Okay, thank you.

Operator

And our last question will come from Sean Sneeden with Guggenheim. Please go ahead.

Sean Sneeden

Hi, thank you for taking the questions. Maybe just one on the kind of strategy shift. Can you talk about just corporate priorities and how we should think about it holistically as we head into '18? And so maybe this is more for Russell, but institutionally is there going to be, I guess, a greater focus on achieving cash flow neutrality? And how are you kind of thinking about that construct as you kind of move forward with the plan?

Russell Parker

So good question. And obviously, as another - as mentioned earlier, this is early days. So, it's premature to talk very deeply about strategy, but we're certainly going to be and are returns focused. So, return on capital is number one. Margin is number two. So, we're looking to improve our margin where we can. Accretive acquisitions is number three. And then, obviously, the longer-term drive is to directionally move us towards free cash flow neutrality. But in the near-term we're going to be focused on the prior topics.

Sean Sneeden

Okay, that's helpful. And I guess, with the new team joining, is there any kind of propensity from some of the existing equity holders or perhaps new ones to help fund some of the growth initiatives that you have in place? Or is it really kind of should we think about what we have today is really how you're supposed to be growing into the structure?

Brent Smolik

Sean, this is Brent. Maybe I should take that one. I think the best way to answer that question is that the Board's deliberated what we've done here hard and made the decision to go forward the way we're going forward. And so, I think that suggests to you that the Board is supportive of the new management team and that's probably about as far as we should go with it at this point.

Sean Sneeden

Okay, that's fair enough. And just one last one, if I can. I guess, Brent, I think you had mentioned a decent amount of cost inflation within the Wolfcamp. What's the order of magnitude there? Or how should we kind of think about what the impact of kind of D&C looks like today?

Clay Carrell

Yes, this is Clay. We've seen about a 10% net inflation in our Wolfcamp program. As Brent mentioned elsewhere, we've been able to mitigate that. And so, on our total capital program, we're more in the 3% to 5% net inflation, but Wolfcamp's been where we've seen the most pressure.

Sean Sneeden

Okay. And that's 10% off of like the '16 average or just to kind of make sure I have apples-to-apples?

Clay Carrell

Yes, approximately that.

Sean Sneeden

Okay, great. Thank you very much.

Operator

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

Brent Smolik

Thank you, operator. So, no doubt the last few years of low oil prices have been a challenging environment for the industry and for EPE, but while I still have the microphone, I just want to take a moment to say that Clay and I are really grateful for the opportunity to work with our investors and with the research community. And as we did for the World Series Champion Astros, we'll be rooting for Russell and the new combined team to take EP Energy to the next level. Thanks, everybody.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.