Good day, and welcome to the Magnolia Oil & Gas conference call and webcast. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there'll be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Brian Corales. Please go ahead.
Thank you, Chantelle, good morning, everyone. Welcome to Magnolia Oil & Gas' second quarter 2019 earnings conference call. Participating on the call today are Stephen Chazen, Magnolia's Chairman, President, and Chief Executive Officer, and Christopher 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-K filed with the SEC. A full safe harbor can be found on slide two of the conference call slide presentation with the supplemental data on our website.
You can download Magnolia's second quarter 2019 earnings press release as well as the conference call slides from the investor section of the company's website at www.magnoliaoilandgas.com. I will now turn the call over to Mr. Stephen 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 of the financials, provide some additional guidance before we take your questions. We've recently crossed the one-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 were 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 the Lower 48, have the capability 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 a disciplined manner with the overriding principle of spending within 60% of our gross cash flow on drilling and 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 us with options to further enhance the business and generate stock market value over time. Over the past year, we've completed several small to mid-size 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 second quarter was marked by strong performance as we achieved both our operating and financial objectives. Our second 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 the second quarter, 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. The appraisal and exploration program around our large position at the 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 million 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 from this exchange are a more simplified capital structure, a 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 the Russell Indices, Magnolia was added to the Russell 2000 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&A, we remain mindful that 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 mid-size bolt-on asset acquisitions which make 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 authorized an initial share repurchase program of 10 million shares based on market conditions and will be funded with cash on hand. While the notion of allocating some capital towards repurchasing our shares may run contrary to our relatively low public share flow, we do not believe our shares should 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 discipline strategy to spend within 60% of our gross cash flow on drilling and 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. I'll now turn the call over to Chris.
Thank you, Stephen. Good morning, everyone. I'll go through some of the details around the second quarter results and then provide some additional guidance before turning it over for questions. For reference, any variances in my remarks related to the second quarter will be compared to the first quarter of 2019. Looking at slide five of the presentation that's posted on our website, we reported GAAP net income attributable to Class A common stock of $18.5 million or $0.12 per diluted share for the second quarter of 2019. Total net income for the period, which includes the non-controlling interest, was $31.3 million or $0.12 per diluted share, which includes both Class A and Class 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 $22.7 million or $0.08 per diluted share for the first quarter of 2019. Sequential increase in net income was primarily due to higher oil production for the quarter. Total production for the company averaged 65.1 thousand equivalent per day during the second quarter, representing a 4.3% sequential quarterly increase and in line with our previous guidance. Second quarter oil production of 35,000 per day represented nearly 54% of our total volumes at the high end of our guidance and an increase from approximately 52% during the first quarter. The higher oil percentage is a direct result of additional new wells coming online during the quarter.
Turning to slide six, revenues totaled $243 million in the second quarter, up 11% compared to the first quarter, mainly due to a combination of higher oil production and higher oil price realizations, minimally offset by weaker natural gas and NGL prices. Our oil price realizations increased by roughly $5 per barrel compared to the first quarter. We continue to receive a premium to WTI, with our realizations averaging 107% of the benchmark in the second quarter. Our NGL price realizations averaged about 25% of WTI compared to 33% in the first quarter 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 seven, our LOE during the second quarter was $4.20 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 first quarter. We expect our total cash operating costs to run about $7.75 per BOE for the third quarter. DD&A was $21.28 per BOE compared to $20.64 per BOE in the first quarter. The slight increase is mainly the result of our increased production from the Karnes area. Since we are only using one year of PUDs in our reserve base, our DD&A rate remains relatively high as we are over-depreciating our asset base during the year.
Our total DD&A amount this year is expected to outpace our capital spending by almost 20%, so we expect our DD&A rate to ultimately decline in the coming years. Exploration expense was $3.6 million in the second quarter compared to $2.5 million 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. Second quarter G&A expenses were $19.1 million, or $3.22 per BOE, which increased compared to $16.2 million or $2.88 per BOE last quarter, and partly due to fees for professional services related to corporate activities. Second quarter G&A costs also included $3.1 million 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&A per BOE in the third quarter to be about the same as the most recent period. The effective tax rate was approximately 14% in the second quarter 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 eight, was $182 million for the second quarter, with a sequential increase primarily due to higher oil production. Our capital spending associated with drilling and completing wells was $116 million during the second quarter, which includes capital accruals.
Second quarter D&C spending was approximately 17% below first 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 second quarter on slide nine, we had cash flow from operations before changes in working capital of $178 million, and our change in working capital was a positive $15 million. Our cash outlays for capital spending, including drilling completions and facilities, was $133 million, and we spent $39 million of cash acquiring oil and gas properties.
We ended the second quarter with $97 million of cash on the balance sheet, an increase of about $20 million sequentially, and an undrawn $550 million credit facility, which provides us with ample liquidity to continue to execute on our plan. Our long-term debt at the end of the second quarter was approximately $389 million, 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 third 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. 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 million on an annualized basis for every $1 per barrel change in oil prices and $4 million 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.
This not only simplifies our capital structure, but also reduces the ultimate potential dilution associated with the warrants. For the third quarter, we expect to have approximately 260 million shares outstanding as a result of the warrant exchange. The warrant exchange also increased the public shareholder flow. As shown on slide 11, post the exchange, Magnolia Management owns 4% of the total outstanding shares. EnerVest owns approximately 49%, and the public shareholders own the remaining 47% 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 million, was 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'll now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up the handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Thank you. Your first question comes from Neal Dingmann, SunTrust. Go ahead, please.
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 Giddings, some kind of question between those? Or is it maybe not one or the other? I'm just wondering how you sort of would layer those?
Given the, whatever you want to call it, the irrationality, I guess you used the phrase. At these levels or even somewhat higher levels than 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. If nobody else wants to buy them, we probably should. That's how I feel about it right now. Our capital program is more driven by the 60% rule than anything else. If oil prices decline $3 a barrel a day or whatever, we'll probably 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 we think that problem sort of goes away here in the third and fourth quarter.
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 of way issues, which I think will get solved. I think we'll have more to talk about in Giddings in the third and fourth quarter, and there's really nothing that we can say now that makes any sense.
No, helpful. Lastly, just wanted in this type of environment where there is pricing pressure, are you and the team seeing more opportunities in Karnes? You've always talked about seeing small pieces there when others sort it out.
We see opportunities, 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." It's too short a timeframe, basically it usually gums up the works. Generally, we're competing against hold bids rather than real bidders. Somebody says, "I can't sell below X dollars" because he told his investors it was worth that or something. 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.
Okay.
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? Also, in terms of protecting the bases as well for both oil and gas, just a little color on that, please.
Generally, we don't hedge. 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. I think that's pretty much what we think about hedging.
To the extent that we see upside, we would earn it. If not, we'll just have to deal with it. Again, you said you have absolutely a really clean balance sheet, so it's less of an issue.
The problem with hedging is that 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. Our self-insurance is probably cheaper than going to Goldman Sachs and buying insurance from them.
Gotcha.
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?
The change has been in the last month, really. You don't really see much. All we saw was a few %. There's no shortage of people to do the work. You can drop a rig or add a rig and without much problem. You haven't really seen any massive deflation yet because it's just too short a period. You still have a fair level of activity among some of our partners. At least they haven't slowed their activity down. The demand in Because a decent Karnes, decent Eagle Ford well, you could make, say, a 20% return down in the $40 oil price environment. That's not true everywhere. I think, I'm not saying we'll be the last place people cut back, but it's certainly not the first place.
Okay, great. Thank you.
Thank you, Irene.
Thank you. Your next question comes from Jeff Grampp, Northland Capital Markets. Go ahead, please.
Morning, guys. Steve, just to build on your last comment there on Karnes probably not being the first 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. Giddings is okay and it will run reasonably well at $40 oil. If we have extra money, it would 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. 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 on current oil prices down to 30%-40%.
Got it. Understood. Appreciate that. For my follow-up, was curious on the buyback, how you guys kind of centered in on the $10 million as kind of the initial size and understanding that the liquidity of the stock is important to you. To the extent there's still some opportunities there, how do you guys think about opportunities to expand that and balancing the trading liquidity?
We're not going to borrow any money to do it. That's roughly what the cash we had on the balance sheet at the end of the quarter. I took out my ancient calculator and divided the current stock price, $100 million divided by the current stock price, and I got 10 million shares. That was the thoughtful process that went into it. As we build cash, I could probably take out the old calculator and you're lucky I don't still have a slide rule.
All right. Effectively we'll take the four-function calculator every quarter.
That's right. Yeah. This calculator actually is a I buy them on eBay as used calculators, and it has Lotus 1-2-3 on it. Which is probably before you were born.
I'll dig into the interwebs. I appreciate the offer.
Okay.
Thank you. I will just take the opportunity to remind everyone, it is star followed by one to register for a question. 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 stemmed from these delayed turn-in-lines in Giddings that may have kind of skewed?
No.
The CapEx?
No.
No? Okay.
No. It's basically, we have a forward calendar from our third parties. 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. If we ran into trouble, that is oil prices fell too much, we just take our one rig that's in Karnes down. It's within our ability to manage. It's not very complicated. We'll be running close to 50% this current quarter. While we're not good forecasters, we're nearly halfway through the quarter, so we could probably guess this. Similar 50% level probably in the fourth quarter too. We got pretty good visibility on this number at this point.
Okay. Thank you. I appreciate that color. A follow-up is somewhat related. It's a little bit philosophical. If you look at slide 12 of your deck, you show the cash flow reconciliation for the company. I know that the mantra, what you see as the differentiator is the growth and income and the free cash flow. You can't help notice that acquisitions have essentially consumed all of that free cash flow. If you look at EBITDA versus CapEx plus acquisitions this year, it's that same trend being flat. Can you give a little more going forward, a little more sort of quantitative guidance on acquisitions just to give people comfort on some sort of sustainable free cash flow net of all these acquisitions?
You got to remember.
To keep us at bay over.
Remember we're talking about four quarters. The acquisitions, for example, the last acquisition was right at the end of the quarter. You don't get any EBITDA for something you do.
Last year
August. I think we don't really know. We've run about $50 million a quarter. Our cash flow from operations is actually up and basically while we're consuming it, you could say we're consuming it. Just building cash isn't really particularly relevant either. As we've built, we've got about $100 million 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. The business is not mature enough to start paying regular dividends. We're still in our first, really it's our first year of existence. To promise a dividend flow at this point is probably not responsible. The amount of acquisition activity, we just don't know. We've run around $50 million a quarter, but I don't think the past is necessarily reflective of the future.
All these acquisitions generate cash, and especially free cash that is accreted to the company's value is better than the base company. I mean, that's really what the point of it was. The production is up 30% in the year. 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. We've had some better prices and worse. I think this is a sort of a rough business plan. If we wanted to build cash, we could easily do that. We'll just stop acquiring. Because the production for the third and fourth quarter doesn't really have any new acquisitions in it.
Okay.
If that answers your question.
Yeah. I appreciate the comments. Thank you.
Thank you. Your next question comes from Kashy Harrison, Simmons Energy. Go ahead, please.
Good morning. Thank you for taking my questions. 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.
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," you pay out the dividend. If the stock is trading well below, say, a simple measure like book value. Not just a little below, it's not really a close call on the stock versus the dividend, that the repurchasing the 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 the 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. We're looking to add value that way for now. A dividend at some point is likely.
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. Maybe switching gears a little bit to A&D. To the extent that you can, I was wondering if it was possible to quantify in net acres the total population of small bolt-on opportunities that exist in Karnes. When you look over, do you think there's 100,000 net acres of opportunity in Karnes that you think you could grab 200? Any color would be helpful to the extent that you can share it.
If you just say what's sort of for sale, maybe that's a better way. Okay?
I can't tell you how stuff that's not for sale, right? If you look at what people say is for sale, it's close to 50,000 acres. I don't think that'll be transacted, by the way. 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. Sort of we're also pretty picky on what we pay and that sort of thing. I think that's sort of what's there, which more than twice, roughly twice what we currently own.
Got you. Historically, just in past cycles, from your perspective anyway, how willing do you think sellers become if we run into $40 oil or $35 oil? 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 a 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. 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. I don't think we're there yet. I think they still remember if they sold six months ago, they'd have gotten more, or a year ago or five years ago. There's a belief that it's going to get better. You have to wear through that because these corrections last a month or two, and then it seems to get better for a while. You need a longer period of negativity.
Plenty of negativity in the equity markets, but on oil price. Again, there's a certain amount of stickiness in the management desire to continue to get paid salaries. It's sort of like the private equity or mutual fund business, where they're focused on getting the management fee, and they don't worry about the profits. They're getting 1.5% and 20% of the profits. I'm not going to get any 20%, I'd be happy to take the 1.5%. 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. The investors don't know how much they've lost.
No, that makes sense. That's helpful. Finally, what's the appetite to look outside of Karnes and the Giddings area within the Eagle Ford, or just anywhere? What's the appetite to expand outside of Karnes and Giddings?
I think the appetite is not overwhelming. 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. Where we can have a decent return on investment also. The acquisition cost is the key. While acquisition costs have probably declined in areas, they're still fairly expensive. I think there's nothing immediate that's sitting out there that we say, "Oh, we've got to do this." If you look at the Delaware Basin, the reservoirs will generate these sorts of returns. You can invest 50, 60% and do just fine. The acquisition cost is quite high per acre or however you want to measure them.
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 see any other reservoirs in the Lower 48 that can do what you're looking for? Maybe the PR1-
I think it's really either the Permian or the Eagle Ford, or something where you basically don't pay much for it. While your finding costs might be higher, you really haven't paid anything for the asset. I don't know where that is. There's some places where you don't want to go. I'm not one for crossing a Red 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'm going 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 continue to execute your previously stated desire to acquire sweet spot acreage there cheaply?
Our appetite's the same, just our price is less.
Okay.
I guess that's the way if I'm answering your question.
Right. Well, yeah.
Yeah. We use around $55 oil as our benchmark for acquisitions. I think that's a reasonable number. The stock market and future market, at least today, is below that. It's hard to ignore.
Right.
I think my interest in acquisitions is the same, but I simply can't afford to pay a premium price for premium acreage.
Another way to put it is that if the price of the acreage goes down in response to the commodity market, then the appetite's the same.
The appetite's 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.