Greetings, welcome to EQT Corporation's second quarter earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Patrick Kane, Chief Investor Relations Officer for EQT Corporation. Thank you, Mr. Kane. You may begin.
Thanks, Doug. Good morning, everyone, thank you for participating in EQT Corporation's conference call. With me today are Rob McNally, Senior Vice President and Chief Financial Officer, David Schlosser, Senior Vice President and President of Exploration and Production, Jerry Ashcroft, Senior Vice President and President of Midstream, and Blue Jenkins, Chief Commercial Officer. Dave Porges is not participating as he had a previously scheduled conflict. The replay for today's call will be available for a seven-day period beginning this evening. The telephone number for the replay is 201-612-7415, with a confirmation code of 13674485. The call will also be replayed for seven days on our website. To remind you, the results of EQT Midstream Partners, ticker EQM, and EQT GP, ticker EQGP, are consolidated in EQT's results.
Earlier this morning, there was a separate joint press release issued by EQM and EQGP. EQM and EQGP will have a joint earnings conference call today at 11:30 A.M., which requires that we take the last question of this call at 11:20. The dial number for that call is 201-689-7817. In a moment, Rob and David will present their prepared remarks. Following these remarks, Rob, Dave, Jerry, and Blue will be available to answer your questions. I'd also like to remind you that today's call may contain forward-looking statements.
You can find factors that could cause the company's actual results to differ materially from these forward-looking statements listed in today's press release under Risk Factor, under Risk Factors in EQT's Form 10-K for the year ended December 31st, 2017, filed with the SEC as updated by any subsequent Form 10-Qs, which are on file at the SEC and available on our website. Today's call may also contain certain non-GAAP financial measures. Please refer to this morning's press release for important disclosures regarding such measures, including reconciliations to the most comparable GAAP financial measures. I'd now like to turn the call over to Rob McNally.
Thanks, Pat, good morning, everyone. I'd like to start by discussing several of our key achievements during the quarter before moving on to our standard quarterly update. We've made tremendous progress towards the separation of our midstream and upstream businesses. We've completed all of the midstream streamlining transactions that we previously announced in April. On May 22, we closed two transactions, the sale of EQT's Ohio Gathering assets to EQM for $1.15 billion in cash and 5.9 million EQM units, and the sale of RMP's IDRs to EQGP for 36.3 million EQGP units. On July 23, EQM completed the acquisition of Rice Midstream Partners in a unit-for-unit transaction at an exchange ratio of 0.3319. To support these transactions, EQM successfully issued $2.5 billion of senior notes.
Proceeds from the offering were used to repay the amounts outstanding under EQM's 364-day term loan to pay off RMP's revolver and for general business purposes. The two remaining important items in our separation plan are the appointment of a new CEO and the filing of the Form 10. The CEO search is well underway, we expect to have a CEO named prior to the separation. We plan to file the Form 10 by mid-August, which means the separation will likely occur in the fourth quarter. While the ultimate timing depends on the SEC and IRS, we cannot be certain as to how quickly they will act. Our goal is to close the separation as soon as possible. We are committed to ensuring that both the production and midstream businesses emerge from the separation with strong investment-grade balance sheets.
To achieve this objective, EQT will retain 19.9% of SpinCo's stock, which will be used to reduce debt at EQT Corp, and to fund the stock buyback program. As a result of this share retention, we do not expect SpinCo itself to have any outstanding indebtedness at the time of the separation. Our board has authorized a $500 million share repurchase program effective immediately. Given our view that EQT stock is not reflecting the full value of our E&P and midstream businesses, we expect to begin using this buyback authority as soon as possible. We are pleased with this approval as it is one way for EQT to return value to its shareholders. In the same light, we did repurchase 700,000 EQT shares in the second quarter, taking advantage of the previously approved share repurchase authorization.
Buying back EQT shares ahead of the split will benefit the shareholders of both companies. In June, we completed the sale of our Permian Basin assets for $64 million in cash, which also relieved EQT of approximately $40 million of liabilities associated with the assets. Earlier this month, we completed the sale of our non-core Huron assets for $575 million in cash and relieved EQT of approximately $200 million of assumed liabilities. Now focusing on the midstream side. As you may have read in EQM and EQGP's second quarter press release- The MVP JV announced a modification to its construction schedule and now anticipates a first quarter 2019 in-service date. More information on MVP can be found in EQM and EQGP's press release issued earlier this morning. Now on to results for the quarter.
EQT announced second quarter adjusted earnings per diluted share of $0.44, compared to $0.07 in the second quarter of last year. Adjusted operating cash flow attributable to EQT was $526 million for the second quarter, a $296 million increase year-over-year. SEC rules prevent us from adding expenses related to the separation back to adjusted operating cash flow. As a reminder, the results of EQGP, EQM, RMP, and Strike Force Midstream are consolidated in EQT's results. Net income attributable to non-controlling interest was $118.5 million for the quarter, compared to $81.5 million in the second quarter of last year. Moving on to the segment results. Starting with EQT Production. Second quarter sales volumes were 363 BCFE and fell within the stated guidance range of 360-370 BCFE. Volumes were 83% higher than the second quarter of 2017, primarily as a result of the Rice acquisition.
Average differentials of -$0.43 for the quarter came in 33% better than the -$0.64 in the second quarter of 2017. Differential improvements were offset by lower NYMEX price of $2.80 compared to $3.18 last year. The average realized price, including cash settled derivatives, was $2.81 per Mcfe, a 2% decrease compared to the second quarter of last year. Operating revenues totaled $951 million for the second quarter of 2018, $320 million higher than the second quarter of 2017, due to increased production associated with the acquisition. Approximately $13 million of EQT Production's operating revenue is considered pipeline and net marketing services revenue. We recast the segment to reflect the midstream asset drop, which resulted in third-party gathering revenue generated from the dropped assets being moved from the EQT Production segment to the EQM Gathering segment.
The $13 million in EQT Production's results cannot be directly compared to our stated guidance in April of $15 million-$20 million. Adjusting for the recast, the pipeline and net marketing services revenue would've been $24 million. Total operating expenses, excluding $118 million of asset impairments, were $912 million, or 58% higher year-over-year, and cash operating costs per Mcfe were 20% lower than last year. Moving on to the midstream results. As mentioned, EQM's results have been recast to include the pre-acquisition results of the midstream assets acquired by EQM from EQT. EQM Gathering operating income for the second quarter was $122 million, $38 million higher than the second quarter of 2017. Operating revenues were $68 million higher than the second quarter of 2017, primarily due to the acquired Ohio gathering assets.
Operating expenses for EQM Gathering were $59 million, $30 million higher than the second quarter of 2017. This variance was primarily from the acquired assets. EQM Transmission operating income for the second quarter was $61 million, $3 million higher than the second quarter of 2017. Operating revenues were $4 million higher than the second quarter of 2017. Expenses for EQM Transmission were $29 million, which was $2 million higher than the second quarter of 2017. Moving to RMP Gathering and RMP Water. RMP Gathering reported an operating income of $40 million, while RMP Water reported an operating income of $24 million. On to our cash flow and liquidity position. As of June 30, EQT had $200 million of borrowings and no letters of credit outstanding under the $2.5 billion credit facility.
EQT's current cash balance, excluding EQM and EQGP, is approximately $200 million, and there is full availability on our $2.5 billion revolver. We currently forecast between $2.7 billion and $2.8 billion of adjusted operating cash flow for 2018 at EQT, which includes approximately $350 million to $400 million from EQT's interest in EQM, EQGP, and RMP. Please note that the adjusted operating cash flow guidance for the year has been adjusted for the Huron asset sale and does not include taxes or costs related to the separation. For our forecasted adjusted operating cash flow and cash on hand, we expect to fully fund our forecasted 2018 capital expenditure plan of $2.4 billion. Lastly, I want to thank our employees and advisors for their hard work and dedication, and our shareholders for their continued support. With that, I will turn the call over to David to make some comments on operations.
Thanks, Rob, and good morning, everyone. Let me start by providing an update on 2018 sales volume. As Rob mentioned, Q2 volume was within guidance at 363 BCFE and represents a slight increase over Q1 volume of 357 BCFE. We still expect sequential quarterly growth for the remainder of the year and are guiding Q3 at 370 BCFE to 380 BCFE, an 8% quarter-over-quarter growth increase adjusting for the Huron. Huron-adjusted full-year guidance is now 1,490 BCFE to 1,510 BCFE and is consistent with prior guidance. Moving on to operations. We continue to realize capital synergies from the Rice acquisition as we develop our large contiguous acreage position. In our Southwestern Pennsylvania core, our 2018 drilling program is now expected to deliver an average lateral length of 14,200 feet, which is 55% higher than our 2017 Southwestern Pennsylvania average prior to the Rice acquisition.
In addition, our land group's efforts have also allowed us to lengthen approximately 70 prior year ducts by an average of 3,000 feet each. As a reminder, we typically use top hole rigs to drill the vertical section and curve of a well, and then bring in a more extensive horizontal rig to drill the lateral. The timing gap created by swapping out the rigs, which is typically four to six months, creates an additional opportunity for land to extend laterals even after we spud a well. This was of particular importance following the Rice acquisition, as we had the opportunity to significantly lengthen many wells, even though those wells had already been spudded by EQT or Rice.
As a result of these efforts, and in conjunction with our 2018 drilling program realizing longer than planned lateral lengths, we will reach our targets for feet of pay completed and feet of pay drilled, two important productivity targets, while spudding 34 fewer wells than we planned in 2018. On an activity level, the second quarter was the highest in EQT history, with the company operating as many as 15 rigs and 12 frac crews. This resulted in nearly 680,000 feet of pay being fracked, which is 55% higher than our previous record. On the drilling side, we have already drilled as much footage in the first half of 2018 as we did in full year 2017. This activity was completed while making significant efficiency gains with fracked footage per day and drilled footage per day up 20% and 25% respectively over 2017 numbers.
These results illustrate the benefits of EQT's manufacturing model and specifically our real-time operating centers. The increased activity in Q2 will result in higher sales volumes in Q3 and Q4, with us turning in line approximately 50% more feet of pay in the second half of 2018 than we did in the first half. We expect Q2 to be the high point for CapEx this year and reiterate our full year guidance of $2.2 billion for well development. In the second half of 2018, we will return to a more moderate activity level, ramping down to six to seven frac crews running at the end of the year and 13 to 14 rigs. I will now turn the call over to Pat.
Thank you, David. This concludes the comments portion of the call. Doug, will you please open the call for questions?
Thank you. We will now be conducting a question and answer session. If you'd like to ask a question, you may press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from the line of Brian Singer with Goldman Sachs. Please proceed with your question.
Thank you. Good morning.
Hi, Brian.
You talked a lot about the buyback here, and it seems like there are three avenues you have to fund the buyback: asset sales, which you've done with the Huron sale here, the midstream SpinCo proceeds, which you're highlighting might be an option to use for share repurchase, and the third lever might be activity levels and growth. Can you talk about the key constraints that you're looking for, particularly on the latter two, i.e., what your target balance sheet would be as you think about how much proceeds could be used from the midstream SpinCo towards share repurchase, and then also whether you would consider slowing your growth rate and using the excess free cash flow for share repurchase?
Yeah. There's several things in that question, Brian. Let me start and deal with them one at a time. As we think about the appropriate growth rate for the company, we certainly see the need to balance generating free cash with a moderate growth rate. We're currently working through that with the board, and we'll have a better guidance for you later in the year on what we think the forward growth rate will be. We certainly do think there has to be a balance between returning cash to shareholders with growth. In terms of the share repurchase, we have a $500 million authorization from our board, and once we have used that up, depending on what the balance sheet looks like and what the environment is like, we could certainly consider going back to the board for further authorization.
In previous calls and in commentary, we have said that we want to see our leverage levels less than two times debt to EBITDA, and preferably more like 1.5 times debt to EBITDA. That's the target range that we still believe is right for EQT going forward.
Great. Thank you. My follow-up is maybe a little bit of the reverse, which has to do with the better environment here for natural gas prices locally and as well, the storage situation nationally. Given the deficit we have in storage and some improvement that we've seen in local Appalachia prices, combined with some of the efficiency gains you've highlighted, how do you think about potentially increasing activity, or what would you need to see to increase activity?
Yeah. I think, clearly, Brian, in a higher gas price environment, higher realizations, the math on returns will tell us that we're better off to increase growth rates and production. We haven't seen a significant move in realized prices. While there have been some modest improvements locally in basis, that's been partially offset by lower NYMEX pricing. I would say that that dynamic isn't pushing us to increase production at this point.
Great. Thank you very much.
Yeah. Thanks, Brian.
Our next question comes from the line of Scott Hanold with RBC Capital Markets. Please proceed with your question.
Yeah, thanks. Good morning.
Hi, Scott.
Hi. On retaining those SpinCo shares, can you give us some sense of how do you look to monetize that? Is it something we should expect pretty quickly? Is it going to be systematic, opportunistic? With that, what was really the driving force behind making that decision to retain those SpinCo shares? Was it specifically to have the access to extra liquidity, or was it for more during the spin process to make it a little cleaner for investors that would have been spun a little bit more shares?
Yeah, the real driver here was this was an avenue for us to right-size the EQT balance sheet and get to the liquidity levels that we want and be able to fund the share buyback prior to the spin because we were retaining that value, and it gives us confidence that we have the available capital to fund the buyback without putting undue leverage at the SpinCo level. Right? Our goal all along was that we would have two independent companies with strong, healthy balance sheets, and this was the most elegant way to accomplish that goal as well as fund the share buyback.
Okay. How do you want to execute that?
The share buyback?
No, the sale of the retained shares.
Yeah, sorry. We're required by the IRS in the spin that we would have to dispose of those shares within five years. My expectation is, though, that we will do it significantly quicker than that. It's not something that likely happens right out of the gate. I think that there will be some churn in the SpinCo shares as they trade to more natural shareholders. Within the first couple of years, I would expect that we would exit that position.
Okay.
The requirement is just that we do it within the first five years.
Got it. As a follow-up to a question Brian Singer had there just on looking at growth rates versus capital returns to shareholder. You had previously, obviously, when you gone down this path with the separation, talked about 15% kind of growth rates. Now there's a little bit more moderation. Can you give a little background again? What's really driven sort of that thought process change, and how meaningful of a change in that growth rate are you guys evaluating?
Well, I think that the driver really is feedback from the market. It appears to us that there's not really an appetite by shareholders and capital markets in general to fund growth outside of cash flow. We think that getting to a position where our growth is we can fund it within cash flow, and then also return some cash to shareholders is the right way to go. I think that we've been, as an industry and as a company, we've been moving in that direction for at least the last year. In terms of what the particular growth rates are going to be, I would say it's less than what it has been historically. I don't think that 15% plus growth rates are the right thing to do for the company and for shareholders.
As we work through the budgeting process with our board this fall, we'll give you more concrete guidance on what that growth rate looks like. It's also going to be dependent on what the commodity price environment is as well, where I think in a higher commodity price environment, we'll be biased towards a bit higher growth, and in lower commodity price environments, I suspect it's going to be lower.
Yeah. This is something you guys are looking to initiate pretty quickly, this potential shift. Is that right? Would it have an impact on 2019, or is 2019 pretty much locked and loaded with the drilling activity in 2018?
It could have a modest impact on 2019. As you point out, the drilling activity that we have undertaken in 2018 largely sets the 2019 growth profile.
Understood. Appreciate the color. Thanks.
Okay. Thanks, Scott.
Our next question comes from the line of Arun Jayaram with JP Morgan. Please proceed with your question.
Yeah, Rob, I was wondering if you could kind of walk us through the steps in terms of the separation. You mentioned that the Form 10 would be filed in mid-August, but walk us through kind of the timing and what kind of happens from here. At what time would you be prepared to provide standalone kind of guidance for EQT Production?
Yeah. From here, we've essentially completed all of the cleanup transactions that we announced in April and the related financing transactions. I would like to say that I'm extremely happy with the progress that we've made and the hard work that our teams have done. I'm really impressed with what we've gotten done. What's left now is to file the Form 10, which we expect to do by mid-August. That starts the process with the SEC, which that timing then is a bit out of our control, and it depends on how many rounds of questions the SEC has. We're also waiting on the PLR from the IRS. We think that that likely pushes us into the fourth quarter now between those two gating items.
I suspect that as we get closer to separation, we will likely want to get out and meet with investors. At that point, I think you'll get standalone guidance from both EQT and SpinCo. I don't know what the dates of that will be, but I think in the month leading up to the spin being finalized, you would expect to hear from us with more concrete guidance for both SpinCo and EQT.
Okay. Just my follow-up, slight delay here in MVP. Just wondering, Rob, if you could walk through some of the implications to EQT Production, obviously that will delay the timing of where you'll incur the transportation costs. Just maybe walk through maybe the impact to EQT from the delay.
Yeah. There's really not much of an impact for EQT. It will delay the time at which we can sell volumes at Transco 165. It just means that we'll have more volumes being sold at M2 prior to that. The financial impact is fairly limited to EQT.
All right, great. Thanks a lot.
Our next question comes from the line of Welles Fitzpatrick with SunTrust. Please proceed with your question.
Hey, good morning.
Good morning.
To follow on the MVP comment from the last caller. It seemed like there was a little bit of a bump up on the top end of the guidance range as far as CapEx is concerned. Is that just conservatism because of the modest delays? Is that all we should read into that?
Yeah, with delays and inefficiencies, costs go up. For instance, with the stay that the Fourth Circuit Court put in place, it's caused us to have to jump around a bit and hop over water crossings. It's just become less efficient, and that does drive costs up a bit.
Okay. That makes sense. Just one follow-up. Obviously you guys have talked about slowing the growth rate a little bit. Have you guys seen any of that effect flowing through to well costs? Do you think that that could provide some downward pressure on completion costs as we move through the year?
Yeah, this is David. I'll tackle that one. I would say yes, we have. Certainly, the pricing environment is different than it was in the first half of 2018. Especially on the pressure pumping side, which I think we've seen the most movement. I don't know if I have a exact number for you, but it's definitely downward pressure on pricing.
Great to hear. That's all I have. Thanks, guys.
Our next question comes from the line of Sameer Panjwani with Tudor, Pickering, Holt & Co. Please proceed with your question.
Hey, guys. Good morning.
Good morning.
Sticking with the service theme. Obviously you guys are saying that you're seeing downward pressure on costs, I did notice that your updated development costs came down a couple %. I'm wondering if there's anything besides the cost that there is to provide an update on in terms of capital efficiency improvements.
Yeah, I think the driver of that was the lengthening of the laterals that we talked about in my script. That's lowering that, I think, by $0.01, I believe it was, the development cost.
Okay. Any changes to your estimated maintenance CapEx? I think it was $1.2 billion that you provided previously, in light of the service cost gains also in light of the Huron sale.
No, it's essentially unchanged.
Okay, thank you.
Our next question comes from the line of Devin McDermott with Morgan Stanley. Please proceed with your question.
Morning, guys.
Good morning.
Rob, I guess this one's for you on the leverage target, and it's related to the proceeds from the SpinCo shares as you monetize those down the road. Is there some thought in your mind to target that previous leverage target you had mentioned 1.5 times, or to push that lower? How are you thinking about using the proceeds between share buybacks or return of cash to shareholders and debt reduction?
Well, I think that the $500 million share repurchase that we have authorized, that's all that we have authorized at this point, the majority of the rest of the value will likely go for debt reduction. We do think that getting down to that 1.5 times debt to EBITDA is the right place for EQT to be. It puts us in a strong liquidity position. We don't feel the need to move it a lot lower than that, but if it were a little lower, that's fine, too.
Thanks, Rob. That's all I have.
Thank you.
Our next question comes from the line of Holly Stewart with Scotia Howard Weil. Please proceed with your question.
Good morning, gentlemen.
Hi, Holly. Good morning.
Maybe the first for David. Just kind of thinking about the TIL schedule for 3Q and 4Q. Obviously a big jump up in 3Q. Then you got 4Q down, which actually looks a lot lower than 4Q 2017. Is this just timing or should we think about a different pace as we move into 2019 just on this TIL schedule?
Yeah, I think you should think about it in terms of it is just timing. That has such an impact and we were really active fracking in the second quarter, so that's going to probably lead to most of those TILs happening in the third quarter, and that's really all you should read into it.
Okay. Maybe, I guess also for David Schlosser on just the NGLs. The C3 plus production looks like it's come in a bit. The guidance also a little lighter. Is there something we should think about on the NGL side? Maybe adding to that ethane pricing moving up here a bit on the ethane side. Is there more you can do in terms of pulling out more ethane out of the stream?
Well, on the first part of the question, I think what you're talking about are the C3 pluses was due to the Huron, the impact of the Huron being gone. Maybe Blue will answer the second part of that.
Yeah. In terms of incremental ethane, we do have some flexibility at the plant in which we process our gas to pull out some incremental ethane. As you would expect, we do that. We've got term contracts in the portfolio, then we obviously look to optimize the spot opportunities, we will continue to do that. Some flexibility around that, Holly.
Okay, great. Maybe one last one for me, just maybe a little housekeeping. LOE seemed to come in a good bit during the second quarter. Anything to highlight there?
Coming in lower than you expected? Is that what you're saying?
Yes. Yep.
Nothing other than the first quarter maybe was a little on the high side because of weather. The second quarter didn't have those kind of impacts.
Okay. Thanks, guys.
Thanks, Holly.
Our next question comes from the line of Jeanine Wai with Stifel. Please proceed with your question.
Thank you. Good morning. My first question, what are the key milestones that we need to watch in regards to Mountain Valley Pipeline?
Yeah, sure. This is Jerry Ashcroft. Good question. The key milestones for us continues to be both weather and us waiting on the Fourth Circuit. We believe in the merits of the motion by the Corps and are pretty hopeful that that stay will be lifted soon.
I see. On the oil field service side, do you know what exactly is causing this softening in the oil field service environment? Is it like other public companies decelerating or is it private mostly?
Yeah. I'd say just broadly, it's just a deceleration of activity by us and some of our peers where we've laid down a few frac crews, a few rigs. It doesn't take much slack in that market for it to really impact pricing. I think it's just a general slowing. There's a bit of excess capacity, particularly on the pressure pumping side.
Do you think is it short-term or is it something like a trend that's pointing to the overall deceleration in the sub-basin?
Well, I'd go back to some earlier comments where I think that there's not much appetite for companies to grow outside of cash flow. If you think that the industry as a whole is moving towards a model where growth is constrained by cash flow, I think that that does put some downward pressure on growth rate, which then presumably creates some excess capacity in terms of services and might continue to put pressure on pricing.
Okay. Do you guys think that this will help you to reduce the well cost sometime in the future, or at least review the well cost assumptions?
Certainly if we see a meaningful move down in service cost, then that does impact our well cost, and we would update you on that as that progresses.
Okay, sounds good. Thank you so much.
Thank you.
There are no further questions in the queue. I'd like to hand the call back to management for closing comments.
Thank you, David. This concludes today's call. Thank you all for participating.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.