Ladies and gentlemen, good morning and thank you for participating in Magnolia Oil and Gas Corporation's Third Quarter 2018 Earnings Conference Call. My name is Adam, and I will be your moderator for today's call. At this time, all participants will be placed in a listen only mode as our call is being recorded. I would now like to turn the program over to Mr. Brian Corrales, Investor Relations for prepared remarks, which will be followed by a brief question and answer session.
Thank you, Mr. Corrales. You may begin.
Thank you, Adam, and good morning, everyone. Welcome to Magnolia Oil and Gas' 3rd quarter 2018 earnings and inaugural conference call. Participating on the call today are Steve Chazen, Magnolia's Chairman, President and Chief Executive Officer and Chris Stavros, Executive Vice President and Chief Financial Officer. As a reminder, today's conference call contains certain projections and other forward looking statements within the meaning of the federal securities laws. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those expressed or implied in these statements.
Additional information on risk factors that could cause results to differ is available in the company's proxy statement 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 Q3 2018 earnings press release as well as the conference call slides from the Investors section of the company's website
atwww.magnoliaoilgas.com.
I will now turn the call over to Mr. Steve Chazen.
Thank you. Well, it seems like just yesterday, I ended my 63rd earnings call at Oxy. Given my current age, it's unlikely that I'll be able to do 63 here.
So
in my remarks, I'll refer to both GAAP and pro form a financial information. Chris will discuss this in more detail. But for reference, the pro form a information includes the results of the Karnes assets, Giddings assets and the subsequent Gulftex assets that were acquired by Enervest on March 1, 2018, for all periods presented and excludes transaction costs. The admittedly, the financial statements to read are fairly complicated and the most useful I think is to talk about the pro form a. When we originally set out to create a publicly traded independent E and P company, which is now Magnolia, we did so with the understanding that had to be investable within an energy sector that has generally struggled to perform both absolutely and relative to the S and P 500 over the last decade.
Our business model was designed to be differentiated and with a primary objective to generate stock market value over the long term. Our strategy was to establish the company's characteristics would demonstrate a certain basic set of criteria that would appeal to generalist investors who are more accustomed to an industrial model. There are several basic elements to our business model and we're off to a good start so far as we've exceeded the delivery of our objectives. We've summarized this on Slide 4 of the presentation slides. We expect to generate real GAAP net income and growing earnings per share over time.
Magnolia's pro form a net income for the Q3 of 2018 was approximately $58,000,000 $151,000,000 in the 1st 9 months of this year. One of our goals is to generate high operating and full cycle margins. As you can see on Slide 8, we generated pre tax operating margins of 23% on a GAAP basis and more than 41% on adjusted basis during the period that Magnolia owned the assets in the Q3 of 2018. We plan to spend within 60% of our annual EBITDAX or gross cash flow generation on drilling and completing wells and in order to achieve moderate production growth of 10% to 15% a year. We had originally said this level of spending is expected to deliver approximately 6,000 BOE per day of annual organic production growth for the company.
As our organic production growth is well ahead of our expectations this year, we're in the midst of recalibrating our outlook for 2019 and we'll have more to say about that production as we move forward into next year. And the event this level of spending and growth is expected to result meaningful free cash flow generation. For the 9 months ending September of this year, dollars 285,000,000 of capital was spent on drilling completing wells, which represented 50% of our pro form a EBITDAX for that period, shown on Slide 9. Our Q3 2018 pro form a production of 55,200 BOE a day exceeded our previous guidance and provided year over year organic production growth of 59%. Bear in mind that much of this growth is achieved during a period when we're only running 1 rig in our Karnes County assets.
Our strategy is to maintain a very strong balance sheet with a low amount of leverage. We have approximately $400,000,000 of long term debt at the end of the 3rd quarter, which was less than a half a turn of our annualized pro form a EBITDAX for the most recent quarter. We have an undrawn revolving credit facility of $550,000,000 at the end of the quarter. As part of our plan, we expect that approximately 40% of our annual gross cash flow to be free cash flow or undesignated and beyond our needs required to achieve our moderate annual production growth targets. The free cash flow will be used for accretive acquisitions, share repurchases and debt reduction.
During the Q3, we announced the acquisition of substantially all of South Texas assets of Harvest Oil and Gas Corporation for $133,000,000 in cash and 4,200,000 Magnolia shares. The assets produced approximately 4,800 barrels a day during the first half of twenty eighteen and added approximately 114,000 net acres to our Giddings field position and 15 net undrilled locations to our core Karnes County inventory. The transaction closed at the end of August. We continue to evaluate several small to medium sized bolt on acquisition opportunities that fit our business plan and have similar financial and operating characteristics to Magnolia's existing assets. During the Q3 of 2018, we operated 3 drilling rigs across our acreage with 2 rigs in Karnes County and 1 rig in the Giddings field with a plan to continue this level of activity for the remainder of the year.
Our 3rd quarter production partially benefited from a step up in non operator related activity. Our production in Giddings saw a sequential quarterly increase of 3,800 BOE a day to 13,800 BOE per day in the Q3, a result of completion of several new wells during the period, plus 1 month of production from the Harvest acquisition. We expect to see further growth in production at Giddings for the Q4 as a result of additional well completions. Looking into next year, we expect to add a second rig in Giddings in the Q1 of 2019 to appraise and delineate the opportunities within our large net acreage position. All in all, we're off to a terrific start and I'm very pleased with what our assets have delivered so far.
Our 2018 development plan continues to exceed our original expectations while generating significant free cash flow after capital. Our pro form a EBITDAX of $575,000,000 for the year to date is running at a pace that is well ahead of what we had forecast when we announced the original transaction with Enervest back in March. As we look forward into 2019, we are very optimistic regarding our prospect of opportunities, which should allow us to continue to deliver on our business model objectives and help enhance Magnolia's stock market value. I will now turn the call over to Chris Stavros, who will review our Q3 financial items and operating highlights in greater detail and also provide some guidance for the Q4. Chris?
Thank you, Steve, and good morning, everyone. Before I walk through some of the numbers, I'd like to talk for a moment about the corporate structure and financial reporting implications that you may notice as a result of the business combination. As a result of the closing of the transaction with EnerVest in the Q3, U. S. GAAP requires us to present the financial statements for the period prior to the acquisition, which include the results of only the Karnes County assets as the predecessor, while the financial statements on or after July 31st include the results of both the Karnes County and the Giddings field assets and 1 month of the results of the Harvest acquisition, which we refer to as successor.
We were also required to allocate the fair market value of the acquisition to our individual assets, including oil and gas properties based on their estimated fair values. As a result, the financial statements on or after July 31st lack comparability with those prior to that date. We recognize that this required presentation format may make it difficult to compare the predecessor successor periods. So wherever possible, we will try to provide additional context between the two periods in order to try and help you understand the underlying financial and operational trends of the business. We will also sometimes refer to pro form a information, which includes the results of both the Karnes and the Giddings assets as if they had been combined as of January 1, 2017.
As Steve noted, the pro form a results also include the results of the Gulftex acquisition that occurred on March 1, 2018 as if it had been included in all periods presented, but exclude any non recurring items such as transaction costs. Additionally, it's important to note that Magnolia has adopted an Up C structure in order to preserve certain tax benefits to both Magnolia and the sellers of the Collins County assets. The consequence of this structure is 2 classes of shares A and B, which have equal voting rights. This also means that we report a non controlling interest line for the shared income associated with the Class B shares. The important thing is that from an investor standpoint, the Upsea structure is generally neutral with the exception of taxes and in the current periods earnings for Magnolia, the one time transactions cost of $22,400,000 that were incurred in connection with the business combination.
Our Class B shares associated with the non controlling interest are not included in the diluted share count because they would be anti dilutive. We reported an average diluted share count of approximately 157,000,000 shares in the 3rd quarter, which includes the dilutive effect of warrants of 5,100,000 shares. However, for EPS modeling purposes, you should use our full net income, including the non controlling interest and our combined total of Class A and Class B shares outstanding, as well as the dilutive effect of warrants during those periods of solidly positive income. Looking ahead to the Q4, we met the 3rd and final tranche of our Karnes County earn out consideration. So we expect the Class A and Class B share count to be approximately 250,000,000 shares outstanding, which is reflected on the face of our 10 Q that will be filed later today.
Moving on to the numbers. Magnolia reported net income of $6,700,000 on a GAAP basis or $0.04 per diluted share for the 2 month successor period ending on September 30. Net income including the non controlling interest was $25,500,000 for the 2 month successor period. Earnings for the successor period were affected by a number of non recurring one time cash charges including $22,400,000 of transaction costs related to the business combination, dollars 11,000,000 associated with a seismic license purchase and a $6,700,000 loss associated with a payment made to EnerVest as an early settlement of a liability in lieu of a $47,000,000 contingent earn out payment based on certain net revenue thresholds that were payable in 2021. Revenues totaled approximately $178,600,000 for the 2 month successor period and $267,700,000 on a pro form a basis for the Q3 of 2018.
The company's average realized oil price was $70.79 per barrel for the successor period or $72.55 on a pro form a basis for the Q3. Overall revenue benefited from strong relative price realizations as our oil realizations are indexed to LLS waterborne prices and as such our realizations were 105% of WTI during the Q3. Turning to the cost side, unit costs for the quarter highlight our field efficiencies. For the purposes of modeling the company, we would recommend using the per BOE cost metrics shown in Slide 8 of the conference call slides for the successor period and as these costs are representative of the current basis of accounting for the assets. LOE came in at $3.14 per BOE for the successor period and $3.46 per BOE on a pro form a basis for the Q3 of 2018 and lower than expected as a result of the Harvest acquisition as well as new wells brought online in the Q3.
DD and A costs were $19.25 per BOE for the successor period and reflects Magnolia's plan to focus on near term development of PUD reserves. Exploration expense was $11,200,000 in the successor period. This reflects a one time purchase of a seismic license for $11,000,000 In the future, we would expect that our exploration expense to be lower as our operations are largely focused on development. G and A expenses of $10,300,000 or $2.94 per BOE during the 2 month successor period were higher than normal and due to additional G and A costs related to acquisition and professional service fees. We would expect our per unit G and A cost to gradually fall over time as some of these fees subside and as our production continues to grow.
The effective tax rate for the successor period was approximately 12%. We expect our effective tax rate to remain in the range of approximately 13% to 15% due to the accounting treatment of the non controlling interest. At the close of the business combination which formed Magnolia, we had $115,000,000 of cash on hand. On a pro form a basis, adjusted EBITDAX as shown on Slide 9 was approximately $216,000,000 for the Q3 ended September 30 and $575,000,000 for the 9 month period of 2018. Capital spent on drilling and completing wells was $112,000,000 during the Q3 and well within our objective of spending within 50% to 60% of cash flow.
The cash consideration for the Harvest acquisition was $133,000,000 and we spent another $2,000,000 on other leasehold acquisitions $11,000,000 on the seismic license during the Q3. We paid EnerVest $26,000,000 in cash during the quarter as an early settlement for an earn out obligation. We ended the Q3 with $37,000,000 of cash inclusive of the outlays I just mentioned. We ended the period with $388,000,000 of long term debt on the balance sheet and our revolving credit facility was undrawn with a capacity of $550,000,000 A summary balance sheet can be seen on Slide 10. As we noted in the press release, we increased our due to better than expected results from our drilling program in the Q3, the completion of the Harvest acquisition as well as higher non operated activity.
Turning to guidance for the remainder of the year, we expect our total production to grow sequentially and average approximately 59,000 BOE per day during the Q4. The improvement is primarily due to additional wells expected to be turned in line during the quarter and also partly due to a full period of capture from the Harvest acquisition. Giddings is expected to see solid sequential growth with expected 4th quarter production of 17,000 BOE per day as additional wells are completed and turned in line. We continue to expect that our total capital will be in a range of 50% to 55% of our full year 2018 EBITDAX and in line with our earlier guidance. We expect to drill and complete approximately 60 net wells through our asset base during 2018.
Looking into 2019, we expect that our capital spending will be in a range of 50% to 60% of our total EBITDAX for the year and in line with our business model. We currently plan to run a total of 4 rigs next year continuing with 2 rigs in Karnes and as Steve mentioned adding a second rig in Giddings early in the year and in an effort further appraise our large net acreage position. Product price changes at current prices affect our earnings before income and taxes by roughly $12,000,000 on an annualized basis for every $1 per barrel change in oil prices and $3,000,000 on an annualized basis for every $0.10 per Mcf change in natural gas prices. We're now ready to take your questions.
Thank you. Ladies and gentlemen, we will now be conducting our Q and A session. Our first question comes from the line of Neal Dingmann from SunTrust. You are now live.
Good morning, guys. Congratulations on a great Q1. Steve, for you or Chris, my question is really just when you had that second rig or maybe talk about both the rigs in the Giddings field, can you talk about where you believe the focus will be there at least initially to start off next year?
With the 2nd rig especially, we'll be looking at different areas, not necessarily where we've drilled so far to try to see what might be there, probably some in the south and then some probably in our east northwest corner of it right now. As the results come in, that rig isn't in a development mode. And so we'll probably move that around as the year progresses. It's still we're still really in early days of this and I think the planning should be viewed as flexible for next year.
Okay. And then just lastly, anything you could add? Just I know you guys have been great on bolt on acquisitions on timing behind these anything and its size potentially? Thank you so much.
Well, we look at a lot of stuff. So and we just we expect there'll be some in this quarter, probably fairly small. But we don't we're not interested in large public deals. So and there are not very many large private deals either. So I would expect there will be some modest growth from that in the 4th quarter and maybe more in the Q1.
There's volatility that we're currently enjoying or experiencing, however you want to describe it, probably makes more acquisitions likely as people get more nervous. And to some extent, we're set up to respond to that.
Very good. Thanks so much, Steve.
Thanks.
Thank you. Our next question comes from the line of Jeffrey Campbell from Tuohy Brothers. You are now live.
Good morning and congratulations on your first call. Can you disclose
You always remember that you always want to you only have one chance to make good first impressions.
Well, your record precedes itself. Can you disclose how much you're getting as average working interest increased due to the Harvest acquisition?
I think it was about 15 percentage points.
Thank you. And it was mentioned that you're going to add a rig in Giddings Q1 next year. Will Giddings still be a self funding program with the 2 rig
program? Yes.
Okay. And if I could add
something But it won't be it probably won't be a 50%, 60%, probably closer to 100%. So we'll probably use all the cash flow from Giddings to work Giddings and Karnes will probably continue sort of around 50%, I would guess.
Okay. And if I could ask one last one, because I didn't see it in the presentation. Are you currently hedging any production? And what's your approach to hedging going forward?
If we had to, we would buy insurance, but that's the only reason we had. My track record of oil and gas price is pretty crummy. And so and I could prove that to you if I had to. So our idea is that you hedge when you need to, you need to protect your capital program or you need to protect your balance sheet. And we're designed to do that.
I assume the good folks who sell hedging products actually make money on it. So I just I'm really not in the business of enriching Goldman Sachs.
Okay, great. Thank you and congratulations again on the quarter.
Thank you. Our next question comes from the line of Irene Haas from Imperial Capital. You are now live.
Yes. Hi. I was noticing that your NGL pricing was quite strong this quarter. Could you give us a little color on that? Should we expect the same trend next quarter?
Then secondarily, how is your in house staffing coming along? Because you still probably has that service contract with Enovest team and when would you bring in a COO?
Well, we actually hired an operating executive. I think it was announced, a guy named Steve Milken. So we hired an operating executive last few weeks ago. And we filed because he's a reporting person. So he was at Intervest.
He ran their south the stuff we bought essentially. So we have an operating person and we're in no hurry at all. Right now, the EnerVest people are doing a great job for us at a reasonable cost. And there's no real reason to change that unless it changes. As far as the NGL pricing goes, NGL pricing has been strong and there's no reason to think it would it's going to change for this quarter.
It's been running pretty good as a percentage of WTI. Probably its percentage is up as the WTI price seems to want to decline above a barrel a day.
Right. And also gas price is looking pretty good. So you guys should be positioned to enjoy that as well?
Yes. We produce about $80,000,000 a day roughly in gas. So, dollars we've had a dollar change basically. So, it's $80,000 a day. So, roughly speaking, I think that not so bad.
Okay, great.
Thank you. Thank you, Irene.
Thank you. Our next question comes from the line of Jeff Grampp from Northland Capital Markets. You are now live.
Good morning, guys. Sticking over on Giddings, can you guys maybe touch a little bit on how maybe some of the recent wells that you've recently completed, how those have been performing and maybe how some of the longer term performance has been from the first few batch of wells that you guys announced earlier this year?
I think when we started, we said that one of our goals was not to provide a lot of detail because there's still open acreage. And so we'll file when we have to. But generally speaking, the wells have been performing in line with the ones we disclosed in the offering. So they've been and there's been some small decline, but clearly, a lot of these wells are you got a well making 1,000 barrels a day of oil. They've been making it for 6 months.
So I mean, it's pretty good, but it's not perfect. Obviously, there's things that some are a little better than others. But we haven't drilled any really bad wells. But given enough time, enough wells, I'm sure we will. So we'll file when we have to.
You'll be able to see the wells as we file them. But generally speaking, we've been pleasantly surprised.
All right. That's fair. I appreciate that, Stephen. And I'm curious as you guys look into 2019 here with the added rig in Giddings, do you guys need a frac crew that would support each of the activities in each kind of operating area? Or would you look to keep the 1 crew and bounce it back and forth in 2019?
Or is that
We'll probably keep the single crew unless we pick up some the Giddings because the other well is going to be drilling sort of one off wells rather than development wells, it's going to be a little slower than we might have in a development mode. And so we ought to be able to make do with a single crew. Makes the production a little lumpier than we might like because you suddenly all of a sudden it's going along, you think it's all of a sudden you turn on some wells and you get a big run up. But you're watching quarterly numbers, you're probably it's maybe a little confusing.
Okay. That's helpful. I appreciate that. And then last one for me. We've seen a couple non energy SPACs lately do some tender offers on some warrants.
I was just curious if you guys have given that any consideration, obviously generating a lot of free cash and that's kind of a roundabout way of a buyback, which you kind of referenced earlier. So I was just kind of curious to get your all thoughts on some sort of transactional thing related to the warrants.
We view the warrants as having exceptional value. So I think that's probably all we can say about it.
All right. Fair enough. Appreciate the time, guys.
Thank you.
Thank you. Our next question comes from the line of Michael McAllister from MUFG Securities. You are now live.
Thank you very much. Welcome back to all. I don't know about that. I'm thinking about how we get out of this in the future. Oh, I'm sorry.
Go ahead. If you could, what was Harvest production at the close of the deal? About the same as it is now. Same as what we said. It was heavily towards the Giddings.
The production was almost entirely Giddings, I think. And so you can see where the Giddings production is. So it's about what we said from the beginning when it closed because it will mirror pretty close the growth that's in our outlook for Giddings. Maybe a little better on average because the locations are a little some of the locations are better. Okay.
And with the thought of getting bigger, what about going outside of the 2 core areas in acquisitions? Well, I think what we said to that question over time there's you don't have to fit the business model. So 50%, 60% of the cash flow to grow the business 10% to 15% a year, high operating margins of 40%, 50% EBIT margins. It would take a so that implies a high quality reservoir and would take a considerable reduction in purchase price to make that work because I count purchase price as part of the EBIT calculation. A lot of people ignore the purchase price because it's a non cash charge of DD and A.
Once it was cash, but now it's non cash. So I think we're just cautious about going out. If we could find an exceptional value, we consider that. But we spent a year looking for that and didn't find it. So I think that's there might be something, but it's probably not imminent.
Okay. That's all I have. Thank you very much. Thank you.
Thank you. Our next question comes from the line of Joe Evans from SG Capital. You are now live.
Hi, it's John Evans. I was just curious
No, he hasn't the guy thing doesn't work for us. Yes.
No, no, no. I was just just from the standpoint, you're building this kind of unique company from a generalist standpoint. And I guess I was hoping maybe you could help me understand how you guys go about thinking of spending the extra EBITDA that you have relative to dividends or stock buybacks as opposed to just buying more oil and gas properties, etcetera. A lot of industrial companies obviously do that over time, and I'm curious to understand your guys' thought process towards that.
Okay. So the oil and gas, if you can buy oil and gas properties, it fits the business model. As you say, you earn decent good EBIT, it doesn't dilute us, good EBIT, and you can have generate in aggregate growth out of it, 10% to 15% organic growth with under 60% of the cash, and that's a non dilutive acquisition, we go do that. If you get eventually, you would think there'll be more happiness in the oil industry and the opportunity to do that goes away. And so once we can't do that anymore, then we'll turn our attention to either dividends or share repurchases or both.
We're not we don't plan to there's not hardly any float anyway. So you wouldn't want to go in the open market now to buy in shares. Okay. And so obviously, EnerVest has shares, but I'm not sure they're sellers at current prices. So I think you it's just a matter what the where the value would be at the time.
The bias, if it's neutral, that is between share repurchases and dividends, my bias has historically been for dividends, easier
to count. And then just a follow-up question. With this tumultuous slide that we've seen in crude, do you think that gives you better opportunity as you go in to next year to make some more of these accretive bolt on acquisitions?
I hope so. Okay. It's the old line about when everyone is frightened, we're greedy and when everyone is complacent, we doze off. So generally speaking, in a buoyant environment where everybody is all happy, probably less opportunities for sure. In a more volatile environment, people get more frightened and we've set the company up, so we don't have to be frightened.
Great. Thank you for your time.
Sure. Thank you.
Thank you. Ladies and gentlemen, we have no further questions in queue at this time. I'd like to turn the floor over to management for closing.
Thank you. Appreciate y'all's time today.
Thank you, ladies and gentlemen. This does conclude our teleconference for today. You may now disconnect your line at this time. Thank you for your participation and have a wonderful day.