Magnolia Oil & Gas Corp

NYSE:MGY

Earnings Call Transcript 2019-Q3

[Operator]

Good day, and welcome to the Magnolia Oil & Gas Third Quarter 2019 Earnings Release and Conference Call. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Brian Corales, Vice President of Investor Relations. Please go ahead.

[Brian Corales, executive]

Thank you, Sean, and good morning everyone. Welcome to Magnolia Oil & Gas Third Quarter 2019 Earnings Conference Call. Participating on the call today are Steve Chazen, Magnolia's Chairman, President and Chief Executive Officer; and Chris Stavros, Executive Vice President and Chief Financial Officer.

As a reminder, today's conference call contains certain projections and other forward-looking statements within the meaning of the federal securities laws. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those expressed or implied in these statements. Additional information on risk factors that could cause results to differ is available in the company's annual report on Form 10-K filed with the SEC. A full safe harbor can be found on Slide 2 of the conference call slide presentation with the supplemental data on our website. You can download Magnolia's third quarter 2019 earnings press release as well as the conference call slides from the investor section of the company's website at www.magnoliaoilgas.com.

I will now turn the call over to Mr. Steve Chazen.

[Stephen Chazen, executive]

Thank you. Good morning, and thank you for joining us today. I'll provide an update on our business and some comments about Giddings. And Chris will go into some of the details and financials and provide some additional guidance for the year before we take your questions.

Strategy and business model we laid out over a year ago has served us relatively well despite the poor sentiment around the energy sector. Magnolia's most recent quarterly results were clear-cut and continued to demonstrate our ability to deliver on our model, generating moderate production growth while spending within 60% of our cash flow for drilling completing wells and maintaining low financial leverage. This overall strategy remains unchanged.

Operationally, we executed well during the third quarter as our production grew roughly 10% sequentially, nearly all of which were generated from organic drilling program. The same time, our capital spend on drilling completing wells declined 24%, comprising less than half of the EBITDAX generated during the period. We essentially grew our production with less capital.

Our model continues to generate significant free cash flow. We built $68 million of cash during the quarter after our D&C capital, and after spending $10 million repurchasing our own shares. Our total capital spending level are expected to decline modestly in the fourth quarter, which would lead to a further building cash through year-end.

Most of the free cash we've generated during the past year has been allocated towards small bolt-on acquisitions, oil and gas properties that have similar financial characteristics as our underlying asset base. While we continue to pursue these types of opportunities, activity has been more temperate in the second half of this year. We remain confident and disciplined in our process towards assessing asset acquisition opportunities, anticipate the pace of activity could pick up into early next year.

In getting to continue to make progress towards our -- through our exploration appraisal program in order to better define our large position in this field. As we noted in our press release, we brought 2 wells on in Giddings late in the third quarter and using our current -- our current methodology, which is refining process for targeting drilling locations based on what we've learned. Combined, these two more recent wells produce more than 2,700 BOE per day in their first 30 days online, which included 1,700 barrels of oil per day and 6,400 Mcf per day gas. These 2 -- the 2 wells which are 15 miles apart are currently producing about 2,900 barrels of oil equivalent a day. Approximately 62% of this is black oil. Our investment and activity in Giddings to-date has already yielded data improving our understanding of the field, providing us with greater confidence, we expect -- that we expect will lead to true development of this asset over time.

We plan to complete 3 additional wells in Giddings later in the fourth quarter as part of our ongoing appraisal program. Just for clarity, these are by no stretch of the imagination development wells. All of these wells are -- wouldn't even be classified as field extensions. They're pretty far away from current production and resigned to guide our leasing program as we go forward.

I'll now turn the call over to Chris.

[Christopher Stavros, executive]

Thank you, Steve. And good morning, everyone. I'll go through a few of the details around the third quarter results, provide some additional guidance and then summarize what we've accomplished since the company's inception before turning it over for questions.

Looking at Slide 4 of the presentation that's posted on our website, we reported total adjusted net income for the period of $16 million or $0.06 per diluted share, which excludes a noncash special item associated with our earlier warrant exchange.

As shown on Slide 5, our cash flow from operations excluding changes in working capital for the third quarter was $173 million and $495 million for the first 9 months of 2019. Our total cash outlays for drilling, completions, facilities and the acquisition of oil and gas properties were $99 million during the third quarter. We also spent $10 million of cash for purchasing Magnolia common stock, and we had approximately 259 million total shares outstanding at the end of the third quarter. We generated excess cash of $68 million, or almost $0.30 a share after these outlays and ended the third quarter with $164 million of cash on the balance sheet.

Our long-term debt at the end of the third quarter was approximately $390 million, with our net debt as a percent of total equity of approximately 8%. We do not expect to increase our level of bonded indebtedness or draw on our $550 million credit facility, which is in keeping with our strategy of maintaining low leverage. Our quarterly interest expense of $7 million was only 4% of our cash flow from operations.

Summary balance sheet as of September 30 is shown on Slide 6. Total production for the company averaged 71,300 BOE per day during the third quarter, representing a nearly 10% sequential quarterly increase and slightly ahead of our guidance. Third quarter oil production of 38,300 barrels per day represented nearly 54% of our total volumes, which was at the high end of our guidance range. The higher oil percentage is a result of additional Karnes operated wells turned in line during the quarter.

Looking at Slide 7, revenues totaled $245 million in the third quarter, up slightly compared to the second quarter, mainly due to higher production and partly offset by lower product prices. We continue to realize a premium for our oils sold relative to WTI recognizing 105% of the benchmark price in the third quarter. Oil continues to be the primary driver for Magnolia as both natural gas and NGL prices have a much smaller impact on our revenue and cash flows.

Turning to costs on Slide 8, our total cash operating cost declined by 9% to $9.96 per BOE from $10.98 per BOE in the second quarter. LOE came in at $3.71 per BOE for the third quarter compared to $4.20 per BOE in the prior period due to the combination of higher production and lower work-over expense. We expect our cash operating costs on a absolute basis to be similar in the fourth quarter.

Third quarter G&A expenses were $17 million, or $2.64 per BOE compared to $19 million, or $3.22 per BOE in the second quarter. Third quarter G&A also included $2.8 million, or $0.43 per BOE of noncash employee stock compensation cost. The sequential decline in G&A is a result of lower professional services and consulting fees as some of these activities have been assumed by the Magnolia corporate staff. We still expect G&A cost to fluctuate moderately from period to period as we continue to incur some additional expenses related to the build-out of our IT systems and other corporate staff functions. We anticipate that our G&A cost for the full year of 2019 to average below $3 a BOE including employee stock compensation.

Our effective tax rate for the third quarter was 16.9% compared to 14% in the second quarter, increases primarily due to additional state taxes and a decrease in the noncontrolling interest due to additional shares outstanding as a result of the warrant exchange. We expect our fourth quarter tax rate to be approximately 16%.

Our third quarter adjusted EBITDAX as shown on Slide 9 was $183 million. Third quarter D&C capital declined by 24% sequentially representing 48% of our adjusted EBITDAX, and in line with our ongoing strategy. We expect our fourth quarter D&C capital to be slightly lower on an absolute basis compared to the third quarter.

Turning to guidance for the fourth quarter, we expect our total production to be similar compared to volumes in the third quarter, which accounts for the lower level of D&C capital during the second half of the year. While our drilling activity during the last 2 quarters has been more heavily focused in Karnes, we've already shifted towards additional activity in Giddings for the remainder of the year. As Steve mentioned, we brought 2 wells online in Giddings late in the third quarter, which are currently producing about 2,900 BOE per day, including more than -- including more than 1,800 barrels per day of oil and approximately 6,700 Mcf per day of gas. We also plan to bring online 3 additional wells in Giddings later in the fourth quarter. These new wells should allow our production in the Giddings area to grow approximately 10% sequentially in the fourth quarter.

Slide 10 summarizes how Magnolia has advanced in the brief 14 months that we've been in business. Of the $816 million of cash flow from operations generated during this period, $507 million, or approximately 60%, was spent on D&C and facilities capital as part of our organic drilling program with $233 million of cash spent on acquiring oil and gas properties in addition to 7 million shares issued as consideration for these acquisitions.

As shown on Slide 11, our production grew by more than 20% over this period to 71,300 BOE per day. We've also increased our net acreage position in the Karnes area by more than 50%, adding nearly 7,500 net acres through bolt-on acquisitions. We had $48 million worth of more -- of additional cash on the balance sheet at the end of the third quarter than when we started, and we did not incur any new debt.

We're now ready to take your questions.

[Operator]

[Operator Instructions] Our first question today will come from Jeffrey Grampp with Northland Capital Markets.

[Jeffrey Grampp, analyst]

Was curious, Steve, you mentioned the acquisition market slowing down a bit, but thinking it will pick back up early next year. Was just kind of curious as you're kind of I guess reading the tea leaves here, do you think you can get back to kind of the acquisition levels that we saw in the first half of this year? Or just I guess hopefully a little bit more color on what you guys are seeing and expecting on the acquisition front?

[Stephen Chazen, executive]

Well, the issue is not somebody is outbidding us, simply that the whole -- we don't meet the whole values that the sellers have. They basically say, well, maybe it will be better next year, which has been a losing strategy for the last 5 years. So that's really what's going on. And we're not willing to overpay for the assets. So I'm hopeful that next year there'll be more rationality in the sellers. They don't want to really want to realize a loss on the asset sale. At this point, maybe they're raising a fund or something. I mean I'm hopeful for next year, but there's no way really to know.

[Jeffrey Grampp, analyst]

Sure. Sure. Okay. Great. Appreciate those comments. And my follow-up on the Giddings results here, you mentioned I think in the prepared remarks that the 2 wells are about 15 miles apart from each other. I was wondering if either of those were in any I guess close proximity to the first handful of wells that you guys first announced way back on the SPAC transaction. And then just kind of taking a step back, was wondering how you guys kind of feel about I guess your confidence level in the thousand or so locations that you guys had preliminarily quoted in the play, is there I guess an increased confidence given these recent results and upcoming? Or just overall I guess was hoping to get a little bit more qualitative thoughts on the prospectivity of the play given what we've seen here today?

[Stephen Chazen, executive]

Yes, these wells are a fair distance from our other shops. We're not giving locations right now, eventually it will show up in the state records. But we're not giving locations right now because we might want to lease around it. There might be some -- I don't mean there's a company, but there might be some leases that we could buy, we could get at a reasonable price. And we're not trying to be clever about it.

We've gone to sort of a multivariate analysis in order to pick our locations. We started out sort of a simpleminded one, and then developed the one with a lot of data in the field. So our confidence level is rising. These next 3 wells are pretty risky wells actually, a fair distance from other production. So we'll see how they turn out and see how good the multivariate analysis is. But I -- we're clearly feeling better about there's a lot of -- we could easily turn to a development program when we get ready. But I think we're a ways from that. I'd really like to define the field and maybe pick up some more acreage where we can see opportunity.

[Operator]

Our next question will come from Brian Downey with Citigroup.

[Brian Downey, analyst]

I'm curious on 4Q, your commentary that fourth quarter production should be similar to 3Q levels, but completions will be weighted more towards Giddings. How should we think about the oil cut trending within your 52% to 54% range for next quarter? I realize the early time data on the 2 new Giddings wells actually look slightly above corporate average, although Giddings on average tends to be gassier than Karnes, so curious how that all shakes out when you run those numbers through the calculator for a fourth quarter oil cut?

[Stephen Chazen, executive]

Yes, predicting between a percent or so of oil cut is certainly beyond my skill level at my advanced age. So whether it's going to be 54% or 53% or 52%, I really don't know. It depends on how much gas is produced by the Giddings wells and when exactly the well gets turned on and that sort of thing. It's very similar to this quarter, could be a little more or little less. The Giddings wells are not all that gassy, the new ones. Giddings is because there's historic production there that acts as a base, but the new wells are fairly oily. So I don't think it changes the mix very much. There'll be fewer wells turned in Karnes would probably have more effect than whatever happens in Giddings.

[Brian Downey, analyst]

Great. Appreciate the color there. And then on those new Giddings wells, any changes to lateral length or completion design or anything like that we should be aware of compared to the older wells?

[Stephen Chazen, executive]

Well, as in how much older? But compared to the more recent -- the wells in last year though, these are widely spaced wells, these are miles apart. So -- and we have a lot of leasehold, so there's no reason -- we don't vary the lateral length very much. So there shouldn't be any difference, but they're far enough apart and in different areas, different counties, maybe a couple of counties apart that you're going to have an actual variation. That's more important here than how we complete the well. Obviously, we can botch the completion, but other than that…

[Operator]

[Operator Instructions] Our next question will come from Neal Dingmann with SunTrust.

[Unknown Analyst]

Actually, it's [ Wells ] here. On the -- you spoke to Karnes, the -- maybe not the bid ask any wider, but the [ AND ] market being a little bit seized up. Can you talk to Giddings, are you guys still seeing relatively little competition out there and what do you think the running room might be if you have success on these next 3?

[Stephen Chazen, executive]

Well, I mean, we're looking for leases, not really an acquisition in the usual sense of the word. So we're not interested in buying somebody else's problems. So -- and a lot of the stuff that's for sale is real gassy. And it doesn't really fit the model that we're trying to do. So we're looking for leases. If you've got information that other people don't have, I mean it's in our interest to use that information to lease up. So I don't really know how much, we already have 450,000 net acres out of 600,000 and some gross. Could you add 50,000 more net? Yes. Could you double it? I doubt it. So we're looking for strategic adds, not necessarily a lot more acreage. We're looking for adds where we can put a large scale development program to work and really not move the rig at all because these acreage blocks that seemed to work at this point are fairly large contiguous acreage blocks and we're just looking to fill in and maybe extend them around the edges.

[Unknown Analyst]

Okay. No, that makes sense. And then so my follow-up, you mentioned that the lateral length and completion design are relatively similar on these -- the 2 new wells reported. Is -- the 2 vertical depths, is that substantially different? I mean is that something that will move the needle on the well cost or not so much?

[Stephen Chazen, executive]

No. Well, actually I think we'll start to see the well cost reduce a little bit. Maybe a little less science fair project on each well, and rig costs have declined a little bit. So not huge, but -- so we should start to -- as we move into next year, we'll be focused on reducing the cost per well as we go forward, but it won't be anything other than that.

[Operator]

This will conclude the question-and-answer session as well as today's conference. Thank you for attending today. And you may now disconnect.