Good day, and welcome to the Magnolia Oil and Gas Conference Call and Webcast. All participants will be in a listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Brian Corrales. Please go ahead.
Thank you, Chantal, and good morning, everyone. Welcome to Magnolia Oil and Gas' 2nd quarter 2019 earnings conference 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 the risk factors that could cause results to differ is available in the company's annual report on Form 10 ks 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 Q2 2019 earnings press release as well as the conference call slides from the Investors section of the company's website at www.magnoliaoilgas.com. I will now turn the call over to Mr. Steve Chazen.
Thank you. Good morning and thank you for joining us. I'll provide a brief update on the overall business and Chris will go into some of the details and financials, provide some additional guidance before we take your questions. We've recently crossed the 1 year mark as a public company, and I wanted to reflect on some of the things we've achieved as an organization and reiterate the aspects of our business model as these are the same principles that will continue to guide us going forward. We're fortunate to have started Magnolia through the acquisition of some of the highest quality oil producing Eagle Ford assets in the core area of Karnes County.
These assets generate some of the highest economic returns in Lower forty eight and the capability of providing moderate and consistent growth while generating significant free cash flow. The acquisition of our extensive acreage position at Giddings Field has provided the sizable low cost resource optionality as we continue to further appraise and ultimately develop some of this resource. We continue to manage these assets in disciplined manner with the overriding principle of spending within 60% of our gross cash flow on drilling completing wells, which provides us with meaningful and consistent free cash flow through the year. Maintaining low financial leverage is also part of our ongoing philosophy, and we do not expect any of these founding principles to change. Free cash flow we generate provides further enhance the business and generate stock market value over time.
Over the past year, we've completed several small to midsized bolt on asset acquisitions. These accretive acquisitions have not only strengthened our underlying asset base by providing additional production and cash flow, but have also given us additional running room by expanding our footprint and acreage position in the Karnes area. Our Q2 was marked by strong performance as we achieved both our operating financial objectives. Our 2nd quarter production grew by 4% sequentially to 65,000 BOE a day, in line with our earlier guidance, with our oil production approximately 54% of total volumes. While we completed a small acquisition late in Q2, most of the sequential improvement in our production was driven by a combination of operated and non operated wells coming online in the Karnes area.
Appraisal and exploration program around our large position at Giddings Field is proceeding well,
and
we expect to provide further update later in the year. Our drilling completion capital declined to 64% of our adjusted EBITDAX in the second quarter, and we expect this percentage to fall further during the back half of the year. Our cash balance increased by about $20,000,000 during the second quarter, inclusive of cash outlays for our capital program and acquisitions. Since the company's inception a year ago, Magnolia's overall production has grown by about 30% and we've increased our Karnes acreage position by more than 50%. Our growth was entirely internally funded and achieved without adding any new debt.
We also recently completed an exchange offer for all of our outstanding warrants. Resulting benefits in this exchange are more simplified capital structure, reduction in the ultimate potential dilution associated with the warrants, elimination of the frequent hedging activity deemed to warrants in our common stock. As a result of the recent annual reconstitution of Russell indices, Magnolia was added to the Russell 2,000 index based on its market capitalization. While we have accomplished much over the last year, we also recognize we have more to do in order to generate value for our shareholders. Our ability to continually generate free cash flow provides us with options.
With respect to M and A, we remain mindful of the objective of an acquisition is always to make the company better, not worse. We've had good success over the past year at allocating most of our free cash flow towards acquiring small oil and gas producing properties that are financially accretive and provide us with additional attractive drilling opportunities. We will continue to pursue small to midsize bolt on asset acquisitions, which makes sense and add value to the business. In addition to potential acquisition opportunities, there are other options for us to allocate some of our free cash. As we noted in our press release, Magnolia's Board of Directors authorizes initial share repurchase program of 10,000,000 shares based on market conditions and to be funded with cash on hand.
While the notion of allocating some capital towards repurchasing our shares may run contrary to our relevant low public share flow, we do not believe our shares to trade well below their intrinsic value. The goal of this program is to repurchase shares at an attractive price for the remaining shareholders and not to reward the exiting shareholders. To summarize, our high quality asset base, low level of debt and ongoing disciplined strategy to spend within 60% of our gross cash flow in drilling completing wells underpins our ability to continue to generate free cash flow to add value to the business. We remain encouraged by our progress and results and are very optimistic about Magnolia's future potential. Now I'll turn the call over to Chris.
Thank you, Steve, and good morning, everyone. I'll go through some of the details around the Q2 results and then provide some additional guidance before turning it over for questions. For reference, any variances in my remarks related to the Q2 will be compared to the Q1 of 2019. Looking at Slide 5 of the presentation that's posted on our website, we reported GAAP net income attributable to Class A common stock of $18,500,000 or $0.12 per diluted share for the Q2 of 2019. Total net income for the period, which includes the non controlling interest was $31,300,000 or $0.12 per diluted share, which includes both Class A and B common stock.
Investors and analysts should use total net income in calculating EPS when comparing us to other similar companies. This compares to total income of $22,700,000 or $0.08 per diluted share for the Q1 of 2019. Sequential increase in net income was primarily due to higher oil production for the quarter. Total production for the company averaged 65,100 equivalent per day during the Q2, representing a 4.3% sequential quarterly increase and in line with our previous guidance. 2nd quarter oil production of 35,000 per day represented nearly 54% of our total volumes at the high end of our guidance, an increase from approximately 52% during the Q1.
The higher oil percentage is a direct result of additional new wells coming online during the quarter. Turning to Slide 6, revenues totaled $243,000,000 in the 2nd quarter, up 11% compared to the 1st quarter, mainly due to a combination of higher oil production and higher oil price realizations and minimally offset by weaker natural gas and NGL prices. Our oil price realizations increased by roughly $5 per barrel compared to the Q1. We continue to receive a premium to WTI with our realizations averaging 107% of the benchmark in the Q2. Our NGL price realizations averaged about 25% of WTI compared to 33% in the Q1 and closer to natural gas equivalent prices.
As oil is the primary driver for Magnolia, both lower natural gas and NGL prices had a much smaller impact on our revenue and cash flows. Turning to costs and looking at Slide 7, our LOE during the 2nd quarter was 4 point $2 per BOE compared to $3.83 per BOE in the prior quarter, with the increase due to higher workover expenses in both Karnes and Giddings. Total cash operating costs fell to $7.66 per BOE from $8.05 per BOE in the Q1, and we expect our total cash operating costs to run about $7.75 per BOE for the 3rd quarter. DD and A was $21.28 per BOE compared to $20.64 per BOE in the Q1. The slight increase is mainly the result of our increased production from the Karnes area.
Since we're only using 1 year of PUDs in our reserve base, our DD and A rate remains relatively high as we are over depreciating our asset base during the year. Our total DD and A amount this year is expected to outpace our capital spending by almost 20%, So we expect our DD and A rate to ultimately decline in the coming years. Exploration expense was $3,600,000 in the second quarter compared to $2,500,000 in the prior quarter. The increase was mainly due to the continued application of microseismic related to our ongoing appraisal and exploration program in Giddings. 2nd quarter G and A expenses were $19,100,000 or $3.22 per BOE, which increased compared to $16,200,000 or $2.88 per BOE last quarter and partly due to fees for professional services related to corporate activities.
2nd quarter G and A costs also included $3,100,000 of non cash employee stock compensation expense. On a unit basis, we expect these costs will fluctuate from period to period as we continue to incur some additional costs and expenses related to the build out of our corporate structure and IT systems. We expect our G and A per BOE in the Q3 to be about the same as the most recent period. Effective tax rate was approximately 14 percent in the Q2 and in line with the prior period. We expect the full year 2019 rate to be about 15% due to the accounting treatment of the non controlling interest and based on the current split in ownership.
Our adjusted EBITDAX, as shown on Slide 8, was $182,000,000 for the 2nd quarter with a sequential increase primarily due to higher oil production. Our capital spending associated with drilling and completing wells was $116,000,000 dollars during the Q2, which includes capital accruals. 2nd quarter D and C spending was approximately 17% below 1st quarter levels and represented 64% of adjusted EBITDAX. As Steve mentioned, we expect our capital spending levels to continue to decline during the second half of the year and average 60% of our adjusted EBITDAX for full year 2019 and in keeping with our ongoing strategy. Looking at our cash flows for the Q2 on Slide 9, we had cash flow from operations before changes in working capital of $178,000,000 and our change in working capital was a positive $15,000,000 Our cash outlays for capital spending, including drilling completions and facilities, was $133,000,000 and we spent $39,000,000 of cash acquiring oil and gas properties.
We ended the 2nd quarter with $97,000,000 of cash on the balance sheet, an increase of about $20,000,000 sequentially and an undrawn $550,000,000 credit facility, which provides us with ample liquidity to continue to execute on our plan. Our long term debt at the end of the Q2 was approximately $389,000,000 and our net debt as a percent of total enterprise value is approximately 10%. We do not expect to increase our bonded indebtedness, which is in keeping with our strategy of maintaining low leverage. A summary balance sheet as of June 30th is shown on Slide 10. Turning to guidance, we expect our total production to be approximately 70,000 equivalent barrels per day for the 3rd quarter and in line with our prior guidance.
Our oil production mix is now expected to be about 54% and at the high end of our guidance range. The continued strong percentage of oil production is the result of both new operated and non operated wells coming online during the quarter. Our capital spending for drilling and completing wells is expected to be approximately 50% of adjusted EBITDAX during the second half of the year, assuming current product prices. Prices. This decline in capital allows us to meet our strategic objective of spending within 60% of our gross cash flow for the full year.
Product price changes at current prices affect our earnings before income taxes by roughly $12,000,000 on an annualized basis for every $1 per barrel change in oil prices and $4,000,000 on an annualized basis for a $0.10 per Mcf change in natural gas prices. As we noted in the press release, we completed the exchange of all of our outstanding warrants in July. Not only simplifies our capital structure, but also reduces the ultimate potential dilution associated with the warrants. For the Q3, we expect to have approximately 260,000,000 shares outstanding as a result of the warrant Magnolia Management owns 4% of the total outstanding shares. Enervest owns approximately 49% and the public shareholders own the remaining 47 percent of the company.
To sum up, I'd point you to Slide 12, which shows what we've done with all the cash generated by Magnolia's operations during the 11 months since our formation last August. Approximately 60% of our cash flow from operations was allocated to capital spent on our organic drilling program. Nearly all of the free cash flow, approximately $230,000,000 is spent on small bolt on acquisitions of oil and gas properties. Our production is expected to be about 30% higher since the company's inception and all of which has been internally funded without incurring any additional debt. We're now ready to take your questions.
Thank you. We will now begin the question and answer session. Thank you. Your first question comes from Neal Dingmann, SunTrust. Go ahead please.
Good morning all. Steve, my question I've noticed obviously you on the release added potential share buybacks to your basket of things you could potentially do. I'm just wondering given the irrationality of the market, when you and Chris are sort of stacking things up today, how do you view that, I guess, more specifically versus the exploitation or opportunities in getting some kind of question between those? Or is it maybe not one or the other, just wondering how you sort of would layer those?
Given whatever you want to call it, the irrationality, I guess you used the phrase, at these levels or even somewhat higher levels in this, probably the best use we have right now is buying the shares. I'm not excited about buying the shares because it reduces the already lack of liquidity in the stock, but nobody else wants to buy them. We probably should. So that's how I feel about it right now. Our capital program is more driven by the 60% rule than anything else.
And so, if oil prices decline $3 a barrel a day or whatever, we'll probably reduce our lay down a rig or something. The issue in Giddings is simply, we really haven't been able to hook up as many wells as we've drilled. And then we think that problem sort of goes away here in the 3rd Q4. So, I think we'll have more to talk about. We're not trying to hide anything.
It's just that we haven't been able to hook up the wells and show the production yet. The wells have been completed, but not hooked up. And there's some right away issues, which I think will get solved. So I'm not really I think we'll have more to talk about in giddings in the 3rd Q4 and just we're not there's really nothing that we can now that makes any sense.
No, that's helpful. And then lastly, just wondering in this type of environment where there is pricing pressure, are you and the team seeing more opportunities in Karnes? I mean, you've always talked about seeing small pieces there, what others sort of got
to sell.
We see opportunities. But when you have this kind of oil price correction in a short period of time, a seller says, gee, I was stupid, I should have sold last month. And so it's too short a timeframe and basically it usually gums up the works. Generally, we don't compete against we're competing against hold bids rather than real bidders. So somebody says, I can't sell below X dollars because he told his investors it was worth that or something.
So until you get some change of that attitude, we'll be cautious on acquisitions. We need to do things that are accretive given where our stock is, not where we hope our stock to be. Very good. Thank you. Thank
you. Your next question comes from Irene Haas, Imperial Capital. Go ahead please.
Yes. Hi. My question really has to do with, you got some really good hedges going on in 2019. You got some layer on 2020. Any opportunity to add more?
Is it difficult and also in terms of protecting the basis as well for both oil and gas, just a little color on that please?
Generally, we don't hedge. So, there's no particular reason to hedge. Our hedge is basically our financial structure, which is sort of debt free and generates cash and our hedge basically is cutting the capital to keep the spending down. So I think that's pretty much what we think about hedging.
So to the extent that we see upside, we would earn it. If not, we'll just kind of have to deal with it. But again, you said you have absolutely a really clean balance sheet, so it's less of an issue. Yes, I
don't the problem hedging is that your the goal of a hedge is to buy insurance. You can't hedge the value of the business, but you can buy insurance for this year's capital or next year's capital or some other year. Our insurance we're self insured. I think we probably are our self insurance is probably cheaper than going to Goldman Sachs and buying insurance from them. Got you.
I assume they're not running a philanthropic organization, at least not deliberately.
Okay. If I may have one follow-up question. How is the Eagle Ford also the scene looking? Any deflation that you can capture?
We haven't the change has been in the last month really. And so you don't really see much. And all we saw was a few percent. There's no shortage of people to do the work. You can drop a rig or add a rig and without much problem, but you haven't really seen any massive deflation yet because it's just too short a period.
And you still have a fair level of activity among some of our partners, at least they haven't slowed their activity down. So the demand because a decent Karnes, decent Eagle Ford well, you could make a, say, 20% return down in the $40 oil price environment. And that's not true everywhere. So, I think, I don't know if Sam will be the last place people cut back, but it's certainly not the 1st place.
Great. Thank you.
Thank you, Erin.
Thank you. Your next question comes from Jeff Grampp, Northland Capital Management. Go ahead please.
Good morning guys. Steve, just to build on your last comment there on Karnes probably not being the 1st place you'd cut capital. Is it fair to think as we look at 2020 and you guys maybe toggle the capital program up or down depending on kind of product prices, is Giddings kind of the incremental flex capital on the upside or downside? Is that the right way to think about it?
I think Giddings is the upside flex capital. We'll almost surely Giddings is okay and it will run reasonably well at $40 oil. But if we have extra money, it will probably go into putting another rig in Giddings. If we don't, we may go to 1 rig in Giddings or in some extreme circumstances, no rigs and just rely on non op activity to run the business Because we have enough non op activity that we could probably keep our production pretty flat without any activity on our part at all. Basically take our capital and current oil prices down to 30%, 40%.
Got it. Understood. Appreciate that. And for my follow-up, I was curious on the buyback, how you guys kind of centered in on the $10,000,000 as kind of the initial size and understanding that the liquidity of the stock is important to you. But to the extent there's still some opportunities there, how do you guys kind of think about opportunities to expand that and balancing trading liquidity?
We're not going to borrow any money to do it. And that's roughly what the cash we had on the balance sheet at the end of the quarter. So we I took out my ancient calculator and divided the current stock price $100,000,000 divided by the current stock price and I got 10,000,000 shares. So that was the thoughtful process that went into it. And as we build cash, I could probably take out the old calculator And you're lucky I don't still have a slide roll.
All right. So effectively,
we'll take the 4 function calculator every quarter
and That's right. Yes. This calculator actually is a I buy them on eBay as used calculators and it has LOTUS 123 on it, which is probably before you were born.
I'll dig into the interwebs. I appreciate that.
The Your next question comes from Tim Rezvan, Oppenheimer. Go ahead please.
Hi, good morning all. I was hoping to get a little clarity on this. I think you mentioned CapEx, you of course reiterated your guidance less than 60% of EBITDA. Is your confidence stem from these delayed turn in lines in Giddings that may have kind of skewed your cash flow? No.
Okay.
No. It's basically we have a forward calendar from our 3rd parties. So we know what the non op people are probably going to do between now and the end of the year, give or take a few wells. We know what we're going to spend. And we have if we ran into trouble that is oil prices fell too much, we just take our one rig that's in cartons down.
So, it's within our ability to manage. So, it's not very complicated. So we'll be running close to 50% this current quarter, which we we're not good forecasters. We're nearly halfway through the quarter, so we could probably guess this. And similar 50% level probably in the Q4 too.
So we got pretty good visibility on this number at this point.
Okay. Thank you. I appreciate that color. And then a follow-up is somewhat related, it's a little bit philosophical. If you look at Slide 12 of your deck, you kind of show kind of the cash flow reconciliation for the company.
And I know that the mantra, what you see as the differentiator is the growth in income and the free cash flow. But you can't help notice that acquisitions have essentially consumed all of that free cash flow. And then if you look at EBITDA versus CapEx plus acquisitions this year, it's that same trend being flat. Is there a thought that maybe or can you give a little more going forward, a little more quantitative guidance on acquisitions just to give people comfort on some sustainable free cash flow net of all these acquisitions because
Remember, we were talking about 4 quarters. And so the acquisitions, for example, the last acquisition was right at the end of the quarter. So you don't get any EBITDA for something you do in August. So I think we don't really know. We've run about $50,000,000 a quarter.
Our cash flow from operations is actually up. And basically, while we're consuming it, you can say we're consuming it, just building cash isn't really particularly relevant either. So, as we've built we've got about $100,000,000 of cash. We'll use that probably to reduce the share count. There's no debt really to cut.
We can't really use it to reduce debt. And the business is not mature enough to start paying regular dividends. We're still in our first really just our 1st year of existence. And so to promise a dividend flow at this point, it's probably not responsible. So the amount of acquisition activity, we just don't know.
We've run around $50,000,000 a quarter, but I don't think the past is necessarily reflective of the future. If we found something that was all these acquisitions are generate cash and especially free cash that is accretive to the company's value is better than the base company. So, I mean, that's really what the point of it was. So, we don't the production is up 30% in the year. So, it's clearly adding value.
Our product price is really about the same on oil as it was when we started. Our net price is very similar to what we started a year ago. So we've had some better prices and worse. But I think this is a sort of a rough business plan, but we don't we could easily if we wanted to build cash, we could easily do that. We'll just stop acquiring.
And production would because the production for the 3rd Q4 doesn't really have any new acquisitions in it.
Okay. If that
answers your question.
Yes. I appreciate the comments. Thank you.
Thank you. Your next question comes from Kashy Harrison, Simpson Energy. Go ahead please.
Good morning and thank you for taking my questions. So understanding that it may be too early for a fixed dividend, I was just wondering if you could discuss the appetite to use some of that free cash flow to pay out special dividends to your shareholders, just given your concern around the float?
For us, it's simply it's really a stock price question. If the stock were trading at normal multiples, whatever that might be, then you say, okay, we're not smart enough to buy in shares, and so you pay out the dividend. If the stock is trading well below, say, a simple measure like book value, not just a little below. So, it's not really a close call on the stock versus the dividend that the repurchasing of shares is generally better for the shareholders over time. A lot of people go into the share repurchase program, they just say they're going to buy shares, they tell the broker to buy them 10,000 shares every day.
That's not what's going on here. We're pretty price sensitive on the stock. So we're looking to add value that way for now. A dividend at some point is likely. But right now, where the stock is, we're not convinced that the share repurchase isn't the better choice given the current stock price.
Got you. And then maybe switching gears a little bit to A and possible
to
quantify in net acres, possible to quantify in net acres the total population of small bolt on opportunities that exist in Karnes. So for example, when you look over, do you think there's 100,000 net acres of opportunity in Karnes that you think you could grab 200,000, just any color would be helpful to the
extent of your share? I mean, if you just say what's sort of for sale, maybe that's a better way, okay? I can't tell you how much stuff is not for sale, right? So if you look at what people say is for sale, it's close to 50,000 acres. I don't think that will be transactional by the way.
But I mean that's sort of what's out there in the Karnes general area for sale currently. There's no way to say what somebody might all we can look at and say, this is what people have talked about wanting to sell, that they assume they can get some price for it. And that's and sort of we're also pretty picky on what we pay and that sort of thing. But I think you just that's sort of what's there, which more than twice roughly twice what we currently own.
Got you. And historically, just in past cycles, how from your perspective anyway, how willing do you think sellers become if we run into $40 oil or $35 oil? Do you think that do you think the willingness to sell increases or people just kind of hold on?
No, you never know. It just depends on how it's held, I guess. If you're a manager or whatever you want to call it, of some assets and you're making a nice salary and price of oil is 40, it's going to be hard to dislodge you. And so there's a fair amount of stickiness on that. I think that the volatility and the negative aura in the market will eventually create opportunities.
But I don't think we're there yet. I think they're still they still remember that 6 months if they sold 6 months ago, they'd have gotten more or a year ago or 5 years ago. And there's a belief that it's going to get better. And you have to go through wear through that because these corrections last a month or 2 and then seems to get better for a while. And so you need a longer period of negativity, plenty of negativity in the equity markets.
But on oil price, and again, there's a certain amount of stickiness in the management's desire to continue to get paid salaries. It's sort of like the mutual private equity or mutual fund business where they're focused on getting the management fee and they don't worry about the profits. So they're getting 1.5% 20% of the profits. It's not going to get any 20%, I'd be happy to take the 1.5%. So I think there's a lot of stickiness and a lot of, I suspect, in the private equity people where the assets have not been mark to market appropriately.
And so the investors don't know how much they lost.
That makes sense. That's helpful. And then finally, what's the appetite to look outside of Karnes in the Giddings area within the Eagle or just anywhere? Like what's the appetite to expand outside of Karnes in Giddings?
I think the appetite is not overwhelming. But if we could find the same sort of results where we could buy it, not invest more than 60% of the cash flow and grow the business and there's opportunities for consolidation, we would do that. But the acquisition cost is and where we can have a decent return on investment also, the acquisition cost is the key. And while acquisition costs have probably declined in areas, they're still fairly expensive. And so I think there's nothing immediate that's sitting out there that we say, oh, we've got to do this.
So if you look at the Delaware Basin, the reservoirs will generate these sorts of you can invest 50%, 60% and do just fine. But the acquisition cost is quite high per acre, however you want to measure them. And so, while there's been some correction in that, Surely, you can't be paying $40,000 $50,000 an acre and expect to make any money.
Got you. Do you think do you see any other reservoirs in Lower forty eight that can do what you're looking for, maybe the PRP?
I think it's really either the Permian or the Eagle Ford or something where you basically don't pay much for it. And while your finding costs might be higher, you really haven't paid anything for the asset. But I don't know where that is. There are some places where you don't want to go. So I think that I'm not watching one for crossing the river.
All right. Well, thank you. Appreciate it.
Thank you. Your next question comes from Jeffrey Campbell, Tuohy Brothers Investment. Go ahead please.
Hi, Steve. Since you guys are going to be with us tomorrow in New York, I don't want to use up all my questions, but I want to ask one. Today, there's been some discussion about possible restraint in acquisitions. I was wondering if your evolving Giddings results remain attractive. Will you just continue to execute your previously stated desire to acquire sweet spot acreage there cheaply?
Our appetite is the same, just our prices last. Okay. I guess that's the way if I'm answering your question.
Right. Well, yes. Yes.
We use around $55 oil as our benchmark for acquisitions. And I think that's a reasonable number. But the stock market and future market, at least today, is below that. And it's hard to ignore. Right.
Well And so I think so I'm trying my interest in acquisitions is the same, just but I simply can't afford to pay a premium price for premium acreage.
So kind of another way to put it is that if the price of the acreage goes down in response to the commodity market, then the appetite is the same and
The appetite is the same, but it hasn't yet.
Right. Okay. Thanks. I appreciate that color. We'll see you tomorrow.
Okay.
Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.