Q.E.P. Co Inc

Good morning, everyone. This is Will Kemp for QEP again. We're going to get moving as people are dialing in. Thank you for joining us this morning, a little bit late, for our third quarter 2020 results conference call. With me today are Tim Cutt, President and Chief Executive Officer, Bill Beze, Chief Financial Officer and Treasurer, and Joe Redmond, Vice President of Energy. If you've not done so already, please go to our website, QEPRES.com, to obtain copies of our press release. which contains tables with our financial results along with the slide presentation with supporting materials. In today's conference call, we'll use certain non-GAAP measures, including EBITDA, which is referred to as adjusted EBITDA in our earnings release and SEC filings, and free cash flow. These measures are reconciled to the most comparable GAAP measure in their earnings release and SEC filings. In addition, we'll be making numerous forward-looking statements. We remind everyone that our actual results could differ materially from our forward-looking statements for a variety of reasons, many of which are beyond our control. We refer everyone to our more robust forward-looking statement disclaimer and discussion of these risks facing our business and our earnings release and SEC filings. With that, I'll turn the call over to Tim.

Thanks, Will, and apologies again, and thanks for your patience. This is recorded, so people will be able to dial in and hear the recording. Good morning, and thank you for joining the call. I'll begin with an overview of our third quarter operational performance. We continue to focus on delivering value over volume, and are holding firm to this principle through these unprecedented times. We remain focused on lowering costs while generating significant free cash flow to pay down debt. Following my update, I'll turn the call over to Bill to discuss our third quarter financial performance. Production declined as expected during the third quarter as a result of limited new wells being brought online. In the Permian, DSUs 0312 and 1125 East continue to perform well as shown on slide 9 of the IR deck. Early in the quarter, we brought two wells online on the disco pad in the Williston. Both wells are outperforming their type curves, as shown on slide 10 of the IR deck, and we look forward to completing the remaining four wells on the pad during 2021. Nine non-operated Williston wells were also brought online and are now delivering approximately 5,000 net barrels of oil per day. We are currently running two rigs in the Permian and resumed completion of operations earlier this month. Given the additional production in the Wilson, along with the increased activity in the Permian, we expect production to begin building during the fourth quarter, leading to an exit rate greater than 50,000 barrels a day. Production performance during the third quarter, along with the expected growth in production during the fourth quarter, allows us to increase the midpoint of our oil guidance from 19.25 to 19.55 million barrels of oil for 2020. Our drilling and completion team also continues to improve on both cost and efficiency. As you can see from slide 11 of our IR deck, wells drilled and completed in the Permian during the first three quarters of the year were delivered at a cost of less than $430 a foot and completed at an average pace exceeding 3,800 lateral feet per day, which remains peer leading. We anticipate drilling and completion costs to improve during the fourth quarter, and we are budgeting $420 a foot in 2021. Our completion performance in terms of stimulated feed per day is well above the industry average as shown on slide 12 of the IR deck. Through the continued improvement to capital efficiency, our outlook for capital spend in 2020 has been lowered from $360 million to approximately $340 million. LOE was up in the quarter primarily as a result of an increase to work over activity focused on returning shedding wells to production. In the Permian, LOE for BOEs is expected to finish the full year at approximately $3.50 per BOE, with full business remaining below $5 per BOE. G&A continues to come down, as demonstrated on slide 13 of the IRR deck, and we spent 49% less on G&A expense in the first three quarters of 2020 as compared to the same timeframe in 2019. I will now discuss briefly our current outlook for 2021 as demonstrated on slide 13 of the IR deck. Although we plan to complete the remaining four wells on the disco pad in the Wilson, our 2021 development program will be primarily focused in the county line area of the Permian, where we anticipate completing 51 new net wells. We expect this program to maintain production relatively flat and deliver positive free cash flow at WTI price of approximately $35 per barrel. Although we expect to drill and complete more wells in 2021 than we did in 2020, we have lowered our expected capital spend in 2021 to approximately $300 million, given the capital efficiencies discussed earlier. In summary, we have adjusted our development base, continue to lower costs, and expect to deliver more than $200 million of free cash flow during 2020 and expect to generate positive free cash flow at $35 WTI in 2021. The increase in expected free cash flow from $150 million to our new forecast of $200 million is a result of continuous improvement in cost and efficiency and is not related to the announcement of an additional tax receivable. Our recent development activity in County Line demonstrates our ability to be a low-cost developer of core acreage while delivering outstanding well results. We believe we're well positioned to move through this unprecedented reduction in demand while continuing to pay down debt as we look forward to things gradually returning to normal. I will now turn the call to Bill to discuss the third quarter financial results, along with information on our liquidity position. Thanks, Tim.

Good morning, everyone. I'll spend my time this morning providing you with some details about our third quarter results. including the improvements to our balance sheet and liquidity position, updating you on our 2020 guidance, and finally opening the call for Q&A. However, before providing those updates, I wanted to highlight a couple of noteworthy items that we announced during the quarter. On August 27th, we announced the receipt of our $170.7 million AMT credit refund, which included $5.6 million of interest income. We followed that announcement with a second press release on August 31st, announcing that we had issued a notice of redemption for the remaining $275 million of our 2021 senior notes. On September 30th, we announced the completion of that redemption, which left us with fewer outstanding senior notes than we have had since the third quarter of 2012. Finally, yesterday we reported that during the quarter we recognized an additional income tax receivable of $81 million from an additional AMT credit refund, of which approximately $50 million is carried on our balance sheet as a current asset and is expected to be received within the next 12 months. We were pleased to receive the $171 million AMT refund ahead of our anticipated timeline, as its receipt, along with cash on hand, allowed us to redeem the remaining outstanding 21 notes earlier than expected. The repayment of the notes, coupled with our cash on hand, continued free cash flow generation, and the additional AMT refund receivable should allow us to continue to execute our plan of creating value for our shareholders through the strengthening of our balance sheet and improving our liquidity. Turning now to our third quarter results, we delivered another strong quarter of financial results despite the ongoing industry and market challenges. During the quarter, we generated net cash provided by operating activities of $329.6 million, and we reported free cash flow of $98.3 million, a $3 million improvement compared with the $95.3 million of free cash flow generated in the second quarter of 2020. We have now generated free cash flow of $162 million during the first three quarters of 2020, compared with an outspend of $66 million during the first three quarters of 2019, an improvement of more than $225 million. The improvement was primarily due to a $212 million decrease in accrued capital expenditures, which was primarily driven by two factors. First, a significant reduction in operating activity in the third quarter, and second, and equally as important, by our peer-leading drilling and completion costs. A $12 million increase in adjusted EBITDA and $10 million decrease in interest expense also impacted the increase in free cash flow. We reported a net loss of $49 million in the third quarter compared with a net loss of $184 million in the second quarter. The $135 million decrease in net loss was primarily driven by a $115 million decrease in unrealized derivative losses and a $16 million decrease in DD&A expense. In the third quarter, we generated $160.4 million of adjusted EBITDA a $3.1 million increase compared with the $157.3 million generated in the second quarter. The increase was driven by a $57 million increase in oil and NGL sales in the quarter, which were partially offset by a $51 million decrease in realized derivative gains, both largely driven by higher commodity prices. Combined total LOE and transportation expense was up nearly $7 million compared to the second quarter to a combined $48 million for the quarter. The increase was largely tied to our work over activity returning to more typical levels during the third quarter. Finally, G&A expense decreased by more than $5 million quarter over quarter, primarily due to a decrease in the mark-to-market adjustments of our deferred compensation plan. We continue to enter into commodity derivative contracts during the quarter, and we currently hold swap contracts totaling 4.3 million barrels of oil at an average price of $57.58 per barrel for the remainder of 2020. For 2021, we currently hold swap contracts totaling 10.4 million barrels at an average price of $43.48, and costless collar contracts totaling approximately 400,000 barrels at a 40 by $49.20 collar. Please see the 10-Q for additional details on our derivative portfolio. Turning briefly to our balance sheet, at the end of the third quarter, total assets were approximately $5.2 billion, and total shareholders' equity was approximately $2.8 billion. Total gross debt was approximately $1.6 billion. We had no borrowings outstanding under our credit facility, $12 million of letters of credit outstanding, and $9.5 million of cash on hand. On the liquidity front, at quarter end, we estimate that we could borrow up to $747.6 million under our credit facility and incur up to $500 million of junior guaranteed indebtedness and still remain in compliance with our financial covenants. You can find more details about our liquidity on slide 18 of the IR deck. With regard to the liability side of the balance sheet, as I mentioned earlier, we redeemed the remaining $275 million of our 21 senior notes during the quarter. In 2020, we have now either redeemed or repurchased more than $430 million of our senior notes, leaving approximately $1.6 billion of those notes outstanding. As shown in slide 16, you can see that since January 2019, we have now repaid more than $900 million of outstanding debt. Moving on to guidance, as provided in yesterday's release, we have updated the company's 2020 guidance to reflect our current expectations for the balance of the year. Tim already shared updated guidance for oil production and capital investment earlier, so I'll just provide a couple of other quick updates. The midpoint of our 2020 guidance for lease operating expense is $4.75 per BOE, while the midpoint for adjusted transportation and processing costs is $3.65 per BOE. This results in total lifting cost guidance of $8.40 per BOE at the midpoint, a $0.50 per BOE decrease from our prior quarter guidance. And finally, our 2020 guidance for G&A expense is $86.5 million at the midpoint, of which approximately $11 million was related to share-based and deferred compensation expense, which fluctuates with the price of QEP stock as well as other general stock market changes. The midpoint of our updated guidance represents a $1 million decrease from our prior quarter guidance. Please see our earnings release for additional details on this guidance. With that, I will now open the call up for questions.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question comes from the line of Arun Jayaram with JP Morgan. Please proceed with your question.

Yeah, good morning, guys. Tim, I was wondering if you could maybe address kind of the decision to go to more of a maintenance mode versus, you know, I think your previous outlook was more of a mid-single-digit kind of growth. We do note that you did take down your CapEx

Yeah, you know, part of that was just the math. You know, we're going to end the year with a 50,000 barrel a day exit rate. We're going to up about 300,000 barrels. You know, if you look at the math, we haven't changed what we're doing a lot. We started just a little bit earlier with our completion activity to make sure we got the consistency of the crews we needed. And when you do the math on that, it goes flat year on year. And we're focused a whole lot more on getting the cost down, delivering enough volume to deliver the appropriate amount of cash. So, you know, it really is a value over volume. And so the volume, you know, we didn't try and drive to a flat year on year, but we don't see a need to grow until we see growth in price. So I hope that helps.

That's helpful. Just my follow-up, Tim, we've seen some pretty good well productivity on the University 0312 development. As we think about the county line asset next year, you talked about 51 net wells. Thoughts on maybe the ability of the program to replicate this level of well productivity, or is it too early to say?

I think it's a little early to say. As you can imagine, there's changes in the geological formations as you work through all of these fields. I think the next wells we're bringing online are wells that have no interference with previously drilled wells. That'll tell us a lot. As we move south, you'll see a little bit of change in the geology, but in general, it's consistent throughout. So we alter spacing a little bit. We move away from carbonates. We do all the right things to try and replicate, but I think it would be a little early to say that. We've obviously risked down somewhat against the Oak Creek wells, but... I hope to replicate it. I mean, the dean and Will Campe have been a real positive surprise, so we hope to continue to see good performance there. But, yeah, as we go in the year, we'll continue to update you guys. We'll continue to alter as we need to, but hopefully the ROC gives us the same kind of results.

Great. Thanks a lot.

All right. Thanks, Arun.

As a reminder, if you would like to ask a question, press star 1 on your telephone keypad. Our next question comes from the line of Derek Whitfield with Stiefel. Please proceed with your question.

Thanks, and good morning, all. Hi, Derek.

Hi, Derek.

Perhaps for you, Tim, to start out, your team is clearly operating at a different efficiency level relative to industry as evidenced by the charts on page 12 and 13 of your IR deck. In your view, what are the one to two key enablers of your frack efficiency?

All right, well, I've got Joe Redman here, and he's accountable for delivering all these good things, so I'm going to turn that question over to him.

All right, thank you. Good morning. Yeah, I would say that over the course of time, you've seen that we've continued to drive down our drilling and completion costs. Actually, that's happening on both disciplines. As we look at the drilling costs, we've continued to optimize our bit, motor, and bottom hole assembly selections, which really the goal there is to reduce the number of trips in and out of the well so that we get to TD more quickly. So we're continuing to make advances on that front, which is driving down the cost of our drilling phase. And then as we look at completions, as we've shared with you guys before, the key thing we do there is simulfrac technology, where we are pumping on two wells at one time and then efficiently move through a pot of wells with that simultaneous operation. We've continued to work on that front, improving our efficiencies. As you recall, we shut down the frack crew back in March and then picked back up earlier this month, as Tim mentioned. We used that quiet period to plan and prepare for activity coming back, and our team got efficiencies back on track very, very quickly, just within a few days. We actually hit a new record, fracking over a mile of lateral in a 24-hour period. Mike Valdes- Here in this month, so that team's done a great job our focus there has been just eliminating downtime and the measure we use there is a pump time efficiency. Mike Valdes- Historically, we average something around 80% and after we got back rolling this month we're have seen an average over 90% on pump time efficiency again just eliminating downtime and. Mike Valdes- Keeping everything running as often as we can, which lowers costs and gets us done more quickly, but. We do continue to pump the same frac designs as we have on the 0312 wells, and the team's done a great job focusing on driving up efficiency, which is driving down cost.

Great. Thanks for that added detail. And perhaps this is my follow-up for Bill. Bill, after updating our model for your quarter and your operational guidance, There now appears to be a path to organically address your outstanding 22 and 23 notes, assuming your free cash flow profile at a low to mid-40s price deck and the utilization of your credit facility. Is that a reasonable assessment in your view?

Hey, Derek. Again, our goal is to generate as much free cash as possible to continue to address our debt maturities. You know, I don't know that, you know, we're going to generate $465 million between now and September of 22. I mean, if prices improve, that's certainly a possibility, but that is our goal. We're striving to do that. But we have the flexibility under our credit facility as it stands today to take care of that. And then, you know, with that coupled with free cash flow generation, you know, we believe that there is a, you know, a path to address this important topic, which is front of mind for me every day. And quite frankly, the gentleman sitting across from Mr. Cutt, We talk about it daily, so it is something that is number one on our list at this point, and we are keenly focused on it and think there is a path to success there.

Very helpful. Great update, guys, and thanks for your time.

Mr. Kutt, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

All right. Thank you very much. Apologies again for the confusion at the beginning of the call. I hope you see that we're continuing to focus on taking our costs down, paying down debt, just doing the blocking and tackling the best we possibly can during this really difficult time. We're not relying on price recovery, and we believe we have more to give when it comes to cost reduction. The biggest thing I want to do, again, like I did last call, is to thank our organization. You can imagine how stressful this is to run the organization from an employee standpoint, in a remote fashion. And a special shout-out to our field organization. They're showing up every single day. They're taking the things into account they need to to work safely, and we're super proud of you guys and appreciate everything you're delivering. So with that, I think we'll end the call.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.