Unit Corp

OTC:UNTC

Earnings Call Transcript 2018-Q3

[Operator]

Hello, and welcome to the Unit Corporation's Third Quarter 2018 Earnings Call. My name is Michelle, and I will be your operator for today's conference. [Operator Instructions] And please note that today's conference is being recorded.

During the course of the conference call today, the speakers may make statements that constitute projections, expectations, beliefs or similar forward-looking statements. The company's actual results could differ materially from the results anticipated or projected in any such forward-looking statements. Additional detailed information concerning the important factors that could cause actual results to differ materially from the information given today is readily available in today's press release under the heading forward-looking statements.

Additionally, during the conference, the company will be discussing certain non-GAAP financial measures. The reconciliation of those non-GAAP measures to GAAP measures can also be found in today's press release. This document is available on the company's website.

I will now turn the call over to Mr. Larry Pinkston, President and CEO. Sir, you may begin.

[Larry Pinkston, executive]

Thank you, Michelle. Good morning, everyone. Thank you for joining us this morning. With me today are David Merrill, Les Austin, Frank Young, John Cromling and Bob Parks. Each will be providing you with updates about their areas of responsibility. We will take questions then at the end of the call.

We noted a premium in the commodity price outlook during the third quarter, which has been supporting the increased activity levels. The enhanced activity level on our part and as well as third parties has helped facilitate growth in each of our business segments. While we have seen a slightly more inviting energy industry outlook, many macroeconomic factors have contributed to heightened volatility in the broader market. Concerns surrounding issues such as rising interest rates, the potential trade wars, the mid-term elections and corporate earnings have resulted in the VIX Index reaching heightened levels. At Unit, we are doing our part by delivering a very good quarter, which we will discuss further.

I now would like to turn the call over to David Merrill.

[David Merrill, executive]

Thank you, Larry, and good morning, everyone. As Larry mentioned, we had a very solid quarter with growth in all 3 business segments. We believe our progress continues to position our company well going forward.

Our oil and natural gas segment saw a nice increase in production during the third quarter. We continue to experience success with our BOSS drilling rig program and have deployed the 11th and received orders under long-term contracts

[Audio Gap]

Our midstream segment appears to be very well situated to take advantage of organic growth opportunities in many areas. Finally, from a corporate perspective, we recently extended the term of Unit's credit facility, which Les Austin will discuss for us in further detail.

I'll now turn the call over to Les.

[George Austin, executive]

Thanks, David. We reported net income attributable to Unit for the third quarter of $18.9 million or $0.36 per diluted share. Adjusted net income attributable to Unit for the quarter, which excludes the effect of noncash derivatives, was $15.7 million or $0.30 per diluted share. Our non-GAAP financial measure reconciliation is included in our press release.

For the oil and natural gas segment, revenue for the third quarter increased 9% over the second quarter of this year with higher oil, natural gas and NGL prices and increased NGL and natural gas volumes, while oil production was essentially unchanged. Operating costs for the third quarter decreased 1% from the second quarter of this year because of lower lease operating expense.

For the contract drilling segment, revenue for the third quarter increased 8% over the second quarter of this year due to increased utilization, day rates and mobilization revenues. Operating costs for the third quarter remained relatively unchanged compared to the second quarter of this year.

For the midstream segment, revenues for the third quarter increased 7% over the second quarter of this year, primarily due to increased liquid recoveries and increased volumes transported, combined with increased gas sales, liquids and condensate prices. Operating cost for the third quarter increased 9% over the second quarter of this year because of increased purchase prices and volumes.

We ended the third quarter of 2018 with total cash and cash equivalents of $91.6 million and long-term debt of $643.9 million. Long-term debt consists entirely of our senior subordinated notes, net of unamortized discount and debt issuance costs. Our net leverage ratio was 1.6x at the end of the third quarter.

As David mentioned, on October 18, Unit amended its credit facility extending the term through October 18, 2023. The agreement is subject to elected commitment and available borrowing basis, which currently stand at $425 million. In addition to extending the term, the amendment increases Unit's flexibility around the issuance of new senior notes as well as lowering pricing on future borrowings and fees.

At this time, I will turn the call over to Frank for our oil and natural gas segment update.

[Frank Young, executive]

Good morning. Total production for the quarter was 4.4 million Boe, a 3.5% increase over second quarter production. On a per day basis, third quarter production was 47,400 Boe, 2.4% higher than second quarter production and in line with expectations.

During the quarter, production from our wells across Western Oklahoma saw some sporadic curtailment due to higher line pressure events, but the resulting production loss was not significant. However, until Cheniere's Midship Pipeline becomes operational in the third quarter of 2019, gas takeaway capacity in Western Oklahoma will continue to be tight and could result in curtailments. Unit's forecast for 2018 production is 17.1 million to 17.3 million Boe, a 7% to 8% increase over 2017.

In our SOHOT area in Grady County, Oklahoma, we completed 2 more extended lateral wells, the Schenk Trust #2-17HXL and #3-17HXL, which were brought online in August with IP30s of about 1,500 Boe per day each and oil cuts exceeding 75%. These wells had lateral lengths greater than 7,000 feet. Our rates of return in this play exceed 100%, and we will continue running 1 rig for the foreseeable future, with the possibility of adding a second rig in the first quarter of 2019.

In Western Oklahoma, Unit's nonoperated STACK drilling activity or average working interest is about 5% has exceeded our expectations and results continue to be very good. Offset well results near our operated dry gas STACK areas have very impressive flow rates and reserves, and we look forward to potentially beginning an operated drilling program once Cheniere's Midship Pipeline is commissioned and realized gas prices improve. In 2018, Unit will participate in about 65 nonoperated wells in the STACK play, and we expect this activity level to continue in 2019.

In the Texas Panhandle, we drilled and fracture stimulated our first 2 Granite Wash G extended lateral wells in the Buffalo Wallow field. While too early for any definitive conclusions about the ultimate reserve recovery from these wells, both are currently exceeding our top curve. The G interval well that was completed first is currently flowing over 9 million cubic feet equivalent per day with 1,250 pounds of flowing pressure.

Until now, Unit's drilling program was focused on the C1 interval, which is one of 11 Granite Wash intervals in Buffalo Wallow field that provide a healthy inventory of horizontal drilling targets. All of the gas produced from the Buffalo Wallow field is gathered and processed by Superior, Unit's midstream subsidiary. We plan to operate 1 drilling rig in the Granite Wash for the foreseeable future, with the possibility of adding a second rig for all or part of 2019.

On the last conference call, I emphasized the historical success in current prospect depth of our exploration program in the Wilcox. So this quarter, I'm just going to give a brief update. Production from the exploration delineation wells in the Wing prospect near Gilly field in Polk County, Texas, has been outstanding, and we will continue exploring and developing this area in 2019.

In our Brandt prospect, near Goliad, Texas, the Engel #1, our discovery well, has performed very well from the orange sand; however, our subsequent wells, the Engel #2 and Albrecht #1 were not commercial in the orange sand, and we will be testing uphole zones in these 2 wellbores soon.

In the Cherry Creek prospect, which is located approximately 7 miles southwest of the Gilly field, we have received the pipeline permit from the Army Corps of Engineers, and we plan to spud the [ Wolf Pasture #1 ], a delineation well to the Trinity #1 discovery well in the next few months.

Production from the Trinity #1, which appears to have stacked pay intervals continues to be encouraging, and we remain cautiously optimistic about the potential size of the Cherry Creek Prospect. Our plans are to continue running a 1 rig program for the foreseeable future with the possibility of adding a second rig for all other portion of 2019.

At this time, I will now turn the call over to John for the Drilling Company update.

[John Cromling, executive]

Thank you, Frank, and good morning. The third quarter was very positive for the contract drilling segment. Even though our rig utilization fluctuated during the quarter, our revenue increased, daily operating cost decreased, and we completed several rig equipment upgrades. The average day rate for the third quarter was $17,589, an increase of $259 per day over the second quarter. The average total daily revenue before intercompany eliminations was $18,115, an increase of $650 over the second quarter.

Our total daily operating cost before intercompany eliminations decreased by $230 for the third quarter as compared to the second. The average per day operating margin for the third quarter before elimination of intercompany profits was $6,291, which is an increase of $879 over the previous quarter. Our non-GAAP reconciliation can be found in today's press release.

Our rig utilization increased throughout the quarter from 34 to 35 rigs, and currently, there are 34 rigs operating. All 11 of our BOSS rigs are operating with 7 of them under term contracts. We were awarded 2 long-term contracts for our 12th and 13th BOSS rig. The first of these 2 rigs will be completed in the first quarter of 2019 and operate in Wyoming. The operator for this rig also extended contracts on 2 other BOSS rigs, which we're currently drilling for them. The second new build will also be completed in the first quarter of 2019 and operate in Oklahoma.

During the quarter, we completed the major refurbishment and upgrade of our one of our 2,000-horsepower SCR rigs, which began operating in October in Oklahoma. We also recently completed upgrading another rig with the skidding system, and it is also working in Oklahoma. Of the 23 SCR rigs operating, 12 are working under long-term contracts.

We have several additional SCR rigs, which are excellent candidates for refurbishment as the market dictates. It is important to note that all the above projects are being financed by operating cash flow and within the CapEx budget. We continue to be optimistic of our opportunity to grow during the next quarter and into next year.

At this time, I'll turn the call over to Bob for the Superior Pipeline update.

[Robert H. Parks, executive]

Thank you, John. Through 3 quarters of 2018, Superior continued to produce positive results. Total throughput volume increased 6% to 416 million cubic feet per day compared to the second quarter of 2018. The increase was mainly due to connecting additional wells to our existing facilities, primarily at Pittsburgh Mills and Cashion.

Gas liquids sold volume increased 4% to 700,523 gallons per day, up from the second quarter of 2018. This increase was due to higher processed volume at our Cashion and Hemphill facilities, primarily from new well connects and additional offload volumes from third parties along with operating ethane recovery mode at most of our processing facilities.

Operating profit before depreciation and amortization was $14.7 million for the third quarter of 2018, which was slightly higher compared to the second quarter of this year and was an 11% increase over the same quarter last year. We had invested approximately $29 million in capital projects in the first 3 quarters of 2018. These expenditures were for initiating the construction of an additional processing plant in the Cashion area, we call the reading plant, the pipeline extension project to connect the new well pad of our Pittsburgh Mills system and for an upgrade to the Buffalo Wallow compressor station.

I will now discuss several key midstream assets. In the Appalachian area at our Pittsburgh Mills gathering facility in the third quarter of 2018, our average total gathered volume increased to approximately 142.6 million cubic feet per day. This increase was due to connecting 7 new infill wells late in the second quarter and receiving its production for the entire third quarter.

Construction of a new pipeline to connect the next scheduled well pad is operationally complete, and the related compressor station upgrade will be completed in the fourth quarter. This new well pad will include 7 long lateral wells and will be connected to our Kissick compressor station located on the southern portion of our gathering system. We anticipate production from this well pad to begin early in the first quarter of 2019.

At our Hemphill facility in the Granite Wash area, the average total throughput volume increased to approximately 74.1 million cubic feet per day for the third quarter of 2018, and total production of natural gas liquids increased to approximately 316,100 gallons per day. Unit Petroleum continues to operate a rig in this area, and we anticipate connecting additional wells in the fourth quarter. The stretching of the Buffalo Wallow compressor station expansion project is complete, and we are prepared to add additional compression capacity in order to accommodate future volumes.

At our Cashion processing facility located in Central Oklahoma, the average throughput volume for the third quarter of 2018 was approximately 47.5 million cubic feet per day, and natural gas liquids production increased to approximately 233,700 gallons per day. This system is operating at full processing capacity, and we have begun the process of adding an additional 60 million cubic feet per day processing plant to the system. This 60 million cubic feet per day plant will be relocated from our Bellmon facility to Cashion. The $20 million plant construction and compressor project is currently underway and will increase the total processing capacity to approximately 105 million cubic feet per day. This project is expected to be completed and operational in the first quarter of 2019.

In summary, we are pleased with our financial results this year and look forward to being in a position to continue to grow the midstream segment. Financial results for the third quarter of 2018 showed positive increases in several areas, and operating profit continues to improve. We feel we are well positioned to complete the fourth quarter with favorable financial results and look forward to continued success in 2019.

At this time, I will now turn the call back over to Larry for his final comments.

[Larry Pinkston, executive]

Thank you, Bob. As you can tell, as we've been over all 3 of our segments, has had a very good quarter. Our oil and natural gas segment, we experienced solid quarter-over-quarter production growth, and we have demonstrated that we can produce highly economic and competitive results.

We are excited about the expansion of our BOSS rig fleet with the new contracts to build the 12th and 13th rig. I believe the rig performance has enabled us to see the strong acceptance level in a difficult but improving rig market. The superior partnership is focused on identifying organic and strategic growth opportunities, and the third quarter results continue to show the benefits of those focus.

Finally, we are focused on keeping our capital expenditures in line with cash flow and proceeds from noncore asset sales. This focus has stood the test of time, and we feel confident that we will continue to do so.

At this time, we'd like to open the call up for questions.

[Operator]

[Operator Instructions] We do have one question in the queue, and it comes from Neal Dingmann with SunTrust.

[Neal Dingmann, analyst]

Larry, a question for you or John. You continue to have great margins in the contract drilling segment. Could you talk about just sort of what you see now and for the remainder of the year and going into next year? I mean do you see that business at least holding that or maybe even gaining more margin, unless you've been able to do, basically throughout this year?

[John Cromling, executive]

Yes. I think we will see some additional improvements. We know some contracts that we have already completed -- or not completed, but we completed contracts, so we will rate increases later on. Costs will probably go down a little bit because we're not going to have as many rigs in this quarter that will be out of service for a couple of weeks to do refurbishments on. So I think we'll see some modest gains. They may not be as substantial at this quarter, but we'll continue to gain on that.

[Neal Dingmann, analyst]

Okay. And then maybe one last one, if I could, for Frank. Frank, SOHOT, obviously with the oil exposure there and just -- I guess, my question is, what's the potential for -- I know, we've talked to you and Mike and the guys about organically sort of boosting that. Could you just talk about either organically or external what the potential for growth there is for the next -- throughout the next year or so?

[Frank Young, executive]

We are close to having the acreage we need to be able to run 2 rigs in SOHOT. And then we also have another area in Western Oklahoma that's oily, that we potentially would be able to run an oil rig on. We understand that it's important for us to try to become more oily from a cash margin basis, and it's just a slow when you do it organically like this. And so we are also looking on the acquisition side to evaluate different acquisitions that are oily. And we will continue to do that trying to make a bit more bigger lead in terms of our oil production.

[Operator]

[Operator Instructions] And sir, I have no further questions in the queue at this time. Actually one just joined the question. This question comes from Colin Boese from Leith Wheeler.

[Colin Boese, analyst]

With the current strength in your balance sheet and the recently amended credit facility, how do you see your credit -- your capital structure evolving over the next 6 months?

[George Austin, executive]

Yes, as you noted, we've got the new credit facility that's been extended for 5 years. We've got the cash on the balance sheet that we talked about. Our senior notes do not mature until 2021, but we have been looking at the market. And as I said in my prepared comments, we did provide more flexibility for the ability to issue senior notes rather than the senior subordinated notes that we currently have outstanding. So we'll continue to look at market and evaluate when it might be a good time to look at refinancing those notes.

[Colin Boese, analyst]

Okay, perfect. And then one follow-up question would be, could you please provide some color on your hedging exposure for Q4 '18 and then as you transition into 2019 on your hedging strategy?

[George Austin, executive]

Yes, let me -- so right now, we are currently hedged for 2019, about 30% in the first quarter of 2019 and about 25% for the remainder of 2019 for our natural gas hedges. And then for our oil hedges, for 2019, we are at about 50% for 2019.

[Larry Pinkston, executive]

Fourth quarter, he's asking about fourth quarter.

[George Austin, executive]

Fourth quarter, we're still about 79% of our fourth quarter volumes are hedged for oil. Natural gas is about 72% of volume.

[Larry Pinkston, executive]

No. 30%.

[George Austin, executive]

30%, sorry -- 30% for natural gas.

[Larry Pinkston, executive]

All this information will be in the 10-Q also when it's filed, which should be later today.

[Operator]

Sir, we have no further questions in the queue. I'll turn the call back over to Mr. Pinkston for any final remarks.

[Larry Pinkston, executive]

Thank you, Michelle. I want to thank everybody for joining us this morning. Of course, we're all excited about seeing the results of the election today and what happens for the rest of the year. But thank you for joining us. And we'll hopefully be seeing most of you over the next 60 days or so. Thank you.

[Operator]

Thank you, ladies and gentlemen. This concludes today's teleconference. Thank you for participating. You may now disconnect.