Falcon Minerals Corporation (FLMN) 2021 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Falcon Minerals Q2 2021 Earnings Call. (Operator Instructions) At this time, it is my pleasure to turn the floor over to your host, Matt Ockwood. Sir, the floor is yours.

Thank you, Kat. Good morning, everyone, and thank you for joining today's call to discuss Falcon Minerals second quarter 2021 results.

Before we begin, I would like to remind everyone that during this call, we will make certain forward-looking statements that address our expected future business, financial performance and financial conditions. Actual results achieved by the company may differ materially from those made or implied in any forward-looking statement due to a wide range of risks and uncertainties, including those set forth in our SEC filings. I would also like to caution you not to place undue reliance on these forward-looking statements, which reflect management's analysis as of the date hereof. The company expressly disclaims any obligation to update or revise any forward-looking statements.

Additionally, this discussion also includes non-GAAP measures. Reconciliations of these measures to the most directly comparable GAAP measures are included in the earnings release which is posted on our website. Lastly, the company will be presenting at the Barclays CEO Energy and Power Conference on September 9th and hosting investor meetings throughout the conference.

With that, I will now turn the call over to Falcon's President and Chief Executive Officer, Bryan Gunderson, for his remarks. Bryan?

Thanks, Matt, and good morning to those on the line. I appreciate everybody joining Falcon Minerals second quarter 2021 earnings call. I'm joined today by Falcon's recently appointed Chief Financial Officer, Matt Ockwood, who you just heard from; and Falcon's Chief Operating Officer, Mike Downs. After my remarks, Matt will speak to the financials, and then we will take questions from those on the line.

First, I'd like to welcome Matt Ockwood. Matt is a terrific addition to the Falcon team, and I'm confident that our shareholders, other key stakeholders, and the equity research community will enjoy working with them as much as I do. That is a final part of Falcon's path forward, and we are excited to have him on board.

Next, I'd like to take a moment to take stock of where we are. During my time as Falcon's Chief Financial Officer, I had the opportunity to participate in hundreds of meetings and discussions with our world-class shareholder base. As CFO, I also had the opportunity to participate in hundreds of meetings and discussions with best-in-class potential shareholders who were not yet invested in Falcon Minerals. In addition to these conversations, I've had hundreds more conversations with the equity research analysts who cover Falcon and study our releases, calls, and SEC filings in detail. Over two-plus years as CFO, these conversations, both individually and in aggregate contributed to my view of where we are and where we should go. And now as CEO, Falcon's management team and Board of Directors are committed to executing on this view.

My vision for Falcon begins with the unwavering recognition that we have a world-class asset base in the Eagle Ford Shale. Our position in the Karnes Trough is among the best rock in the United States and is being developed by some of the premier oil and gas operators in the world. The assets that we have in the Eagle Ford are among the lowest breakevens in the U.S. and compete for capital with the best portion of the Permian Basin. Falcon's assets will be developed over time and Falcon can serve as an efficient pass-through of the associated cash flows for a decade plus. These contours have been well-articulated and are well known. My vision for Falcon also reflects a belief that the company would benefit from being larger and more diverse. Falcon's existing assets are core to core. And in certain instances, our results are meaningfully influenced by high net revenue interest wells within our portfolio.

This truth serves as a strong tailwind for Falcon as these high NRI locations are developed and can serve as a crosswind when these specific locations are not included in our operators' development plans. My view that enhanced diversity and scale, provided that it comes from largely from Tier 1 assets and Tier 1 operators will lay this contour, add to Falcon's existing top-tier assets and serve as an engine to grow free cash flow on a per share basis. Addressing these contours is a material portion of my focus as CEO.

Now on to the second quarter 2021 results. We are pleased with the way the business performed. The assets delivered as we expected it would, and the results of the quarter are directly in line with the direct trajectory we outlined in the first quarter call. Reported production was 5,034 BOE per day, which represents a 22% increase above daily production levels from the first quarter. The production increase was driven primarily by high NRI wells being turned in line late in the first quarter and early in the second quarter, highlighting the tailwind I mentioned moments ago.

These wells delivered meaningful growth in production quarter-over-quarter, which contributed to Falcon generating free cash flow per share, excluding onetime costs associated with the executive transition of $0.153. This represents an increase of 48% above first quarter 2021 levels. The free cash flow that Falcon generated in the second quarter allowed us to declare a dividend of $0.15, which represents a 98% payout ratio, excluding onetime items associated with the executive transition. The second quarter dividend also reflects a meaningful increase of 50% when compared to the first quarter.

We are excited by the cash flow generated in the business during the second quarter and the way in which our shareholders are immediately benefiting from the strong commodity backdrop we have seen during the first half of the year. The second quarter dividend on an annualized basis translates to $0.60, which represents a 13% dividend yield based on yesterday's closing price. We believe this presents a very attractive yield for investors in an environment where inflation concerns abound and the 10-year treasury is under 1.2%. Falcon's high payout ratio allows investors to continue to benefit directly from the constructive macro market backdrop.

Looking at the balance sheet, we have a conservative approach to leverage. The balance on our revolver decreased by $4 million quarter-over-quarter and Falcon's net debt to LTM EBITDA decreased to 0.92x. We see that ratio tightening further as we close out 2021 under current commodity pricing.

Looking ahead, we anticipate free cash flow per share to remain healthy for the balance of the year. Based on the current pricing environment, we expect free cash flow per share to be between $0.13 and $0.15 in the third quarter, and we anticipate being able to maintain similar levels going into the fourth quarter. As we look at free cash flow that we generated in Q2 '21 and our expectations for the third quarter, this implies an approximately 12% to 13% forward free cash flow yield.

Now I would like to take a moment to speak about our Hooks Ranch position, which is operated by ConocoPhillips. As we have previously discussed, ConocoPhillips permitted six sharing wells in the third quarter of 2020. The six permanent wells are known as production sharing wells because they are drilled from the Hamilton Trust B unit, which sits to the north of the Hooks Ranch lease. And the well lateral extends into our interest in the Hooks Ranch lease to the south. Our expectation was that these wells would be drilled in the first quarter 2020 and turned in line during the fourth quarter -- the first quarter of 2021 and turned in line during the fourth quarter 2021. The wells have not yet been drilled. The delay in development of this pad stems from a dispute over the surface use regarding the location of the pad between the operator and the surface owner on the Hamilton Trust B unit.

While frustrating, disputes of this kind are not uncommon in the oil and gas industry, and we are optimistic that the dispute is nearing resolution. This view is informed by our review of public records and a recent judgment in favor of the operator. Once a resolution is reached, we have a high level of conviction that these wells will be developed. The Hooks Ranch position is among the best quality rock in the United States, and ConocoPhillips have deployed significant capital in this area. Therefore, while we are confident that the permits will be developed and turned in line as soon as the matter is resolved and it's unlikely that Falcon shareholders will benefit from the production of the specific pad in 2021. In terms of when investors will see the benefit of the existing Hooks Hamilton permits, we anticipate that the Hooks Hamilton wells will be turned in line during 2022.

Moving to the M&A side, for what we would consider strategic level transactions, the market is substantially more active than it has been over the last 18 months. Given this backdrop, we see an opportunity-rich environment that could allow us to scale and diversify the business, consistent with the (inaudible) I laid out earlier.

While the environment is opportunity-rich, one thing governs our approach above all else. We are laser-focused on enhancing free cash flow on a per share basis. The Falcon team is committed to remaining thorough and disciplined as we manage the existing portfolio and as we consider opportunities to grow the business.

With that, I'll now turn the call over to our CFO, Matt Ockwood. Matt?

Thank you, Bryan. I'm honored and excited to be a part of the Falcon team. Turning to the second quarter results. Our assets generated $18.9 million in royalty revenue during the second quarter 2021. We recognized a cash loss of $1.2 million from our commodity derivative instruments during the period. The growth in production and revenue during the second quarter is consistent with our expectations from the first quarter call and aligns with the activity we are seeing from our key operators. The increase in revenue was driven by high NRI pads turning in line during the first quarter, along with 0.51 net wells, 55 gross wells, which turned in line during the second quarter. These second quarter wells include two pads, which totaled approximately 0.25 net wells that were turned in line during May and will support production into the third quarter.

Since the end of 2020, we have seen operators completing DUCs and taking advantage of high oil prices. Specifically, ConocoPhillips has grown production in the Eagle Ford by 21% compared to the first quarter of this year and 24% cumulatively since the fourth quarter of 2020. Current Eagle Ford production from ConocoPhillips is now exceeding late 2019 production levels. ConocoPhillips stated this week during their second quarter call that they expect to maintain four rigs and three frac crews in the Eagle Ford for the remainder of the year, which should contribute to increased permitting in the second half of 2021.

Falcon's net realized price for oil during the first quarter was $64.45 per barrel. The average realized price for natural gas was $2.79 per MCF, and our NGL realizations averaged $25.23 per barrel. During the second quarter, Falcon did not enter into any new commodity derivative instruments. Associated pricing for all hedge volumes are laid out in the company's investor presentation, which is available on Falcon's website.

Cash operating costs for the second quarter 2021 were $1.6 million. Ad valorem and production taxes comprised approximately $1.1 million of this figure for the quarter. Marketing and transportation expenses were the remaining $0.5 million or $1.03 per barrel, which is down slightly from $1.06 per barrel equivalent in the first quarter of 2021. Cash G&A expense was approximately $2.4 million for the second quarter after adjusting for approximately $1.7 million of expenses incurred during the quarter related to the executive transition. Second quarter cash G&A also includes approximately $1.7 million of noncash stock-based compensation income recognized during the period. The noncash stock-based income primarily reflects a reversal of prior period non-cash stock-based expenses due to forfeitures of unvested shares associated with the executive transition.

Adjusted EBITDA for the second quarter, excluding onetime expenses associated with the executive transition, was $13.8 million, which represents an increase of $4.3 million from the $9.5 million reported in the first quarter of 2021. The increase was largely attributable to an increase in average production volumes of 918 BOE per day compared to the first quarter as well as a 14% increase in realized oil pricing.

At the end of the second quarter, Falcon had $36.5 million outstanding on its revolving credit facility and $3 million cash on hand, resulting in net debt of approximately $33.5 million. As Brian mentioned, Falcon's net debt to LTM EBITDA ratio as of the end of the second quarter was 0.92x.

Falcon reported second quarter net income of $3.6 million on a stand-alone basis and $7.2 million of net income, inclusive of noncontrolling interest. Falcon reported second quarter -- excuse me, Falcon's reported second quarter net income of $7.2 million is inclusive of a non-cash gain of $0.8 million associated with the revaluation of the company's warrant liability. GAAP income tax expense of $1.3 million for the quarter is mostly attributable to the utilization of our deferred tax asset. This is primarily due to the tax benefit of a step -- basis step-up related to the assets that Falcon acquired as part of the transaction with Royal Resources in 2018. We expect to be able to utilize the stepped-up basis to reduce our taxable income for the foreseeable future.

Falcon expects that more than 50% of the dividends paid to Class A shareholders during 2021 will be classified as non-dividend distributions. This treatment will generally result in a nontaxable reduction to the tax basis of shareholders' common shares. As a result, non-dividend distributions are treated as a reduction of basis until the time when an investor's basis is fully recovered. This reduced tax basis will increase shareholder capital gain or decrease shareholders' capital loss when the shareholders sell their common shares. Pro forma free cash flow per share was approximately $0.153 for the quarter.

On August 4, 2021, Falcon declared a second quarter dividend of $0.15 per share. This dividend is payable on September 8, 2021, to shareholders of record as of August 25, 2021, and reflects a payout ratio of approximately 98%. We define pro forma free cash flow as adjusted EBITDA inclusive of non-controlling interests, less interest expense, and cash income taxes. Our estimate of free cash flow for the second quarter of 2021 did not include any amount for cash income taxes.

Now with that, I will now turn the call back over to Bryan. Bryan?

Thanks, Matt. Kat, let's begin on the questions.

(Operator Instructions) And our first question comes from Derrick Whitfield from Stifel.

Perhaps for you, Bryan, with regard to your strategic perspective, I wanted to focus on how important diversification is, in your view, and is important? How do you plan to affect a diversification strategy?

I mean, I think that my point of view -- as I mentioned after two years in the seat as CFO is that the business would benefit from diversification and scale. I feel pretty strongly about it. In terms of where we see that coming, I think the best way to execute on it is I think that for see Falcon is an attractive asset and attractive combination vehicle for assets that are held in private hands. And so that's the way we'd see it manifesting.

I'm sorry, you dropped out of the queue. (Operator Instructions)

We'll take you when you come back on the line, Derrick.

Hey, Bryan. Sorry about that. My follow-up, I wanted to ask a question on your outlook. And if possible, could you place some broad parameters around how you're thinking about 2022 at present based on what you know with the Hamilton update, line of sight activity, and current industry activity?

Yes. I think it's a little too early to put broad parameters on 2022. I think that's certainly something we'll come back to post on the November call with -- but I'm not sure I'm ready to put a broad brush stroke on it quite yet.

Next question comes from Pearce Hammond.

Thanks for the helpful prepared remarks about the strategy moving forward. Just curious, Bryan, on the payout ratio, given the desire to become more diverse, how do you see that trending over time?

I mean, we've been really clear with the market that we're kind of 90 plus percent. We're cognizant of the fact that our peers are throttling back on their payout ratios. Some of them we are watching closely. Were we ever go down that road of throttling back our own payout ratio, we would message it very, very clearly with the market over time. But it's not something that we're looking at right now.

Okay. And then my follow-up, some of your peers are instituting the base in the variable dividend. And I was just curious what your thoughts were on that for Falcon.

Yes. I mean, it's a good question. It's something we've obviously noticed. It's something we've obviously seen. It's something that we get questioned about. Right this second, I think -- and I kind of laid it out in the prepared remarks, which is we see Falcon as an efficient path through of commodity prices and the cash flows of our operators. And so we really want to leave it as a full -- as paying out that full amount to our shareholders. So we're not focused on it, but we certainly noticed that it's a narrative going on in the market, and we're going to keep an eye on it.

And our next question comes from Brian Downey from Citigroup.

Maybe a follow-up on strategic question. How do you, I guess, currently see your -- the queue of ground game or A&D opportunities to move the needle towards achieving that scale over time? Or do you foresee the need for potentially something more chunky at the structure?

I mean I think, like on the ground game side, I think that I'm less focused on it than I am on the larger side. The -- on the grounding side, as we see things that are -- that really, really meet stringent criteria and that come across our desks that we really, really like, we do them. But those are going to be -- that's more of a one-off type thing for us at this juncture. I think you're willing to -- I think the focus, in my mind, is really going to be on those chunkier ideas.

Great. And then maybe one for Matt. I guess, on the -- as you're thinking about on the hedging front, from a quick look at the slide deck, it doesn't appear you added any hedges in the quarter, given where the balance sheet sits. Could you give us an update around how you're thinking about hedging going forward? Is that something you're going to continue to systematically do? Or are you going to leave the upside exposure excluded commodity price?

I think there's a couple of ways we can break that apart, thinking about the gas side and the crude side. We're obviously looking at winter gas and opportunities near $4 there, that's attractive. We haven't done anything yet. I think if there's an opportunity to sell some winter gas, we might look at that. I don't think we would do anything really long-term on the natural gas side on the crude side. Haven't had -- haven't layered on any new hedges. You mentioned balance sheet being consideration there, under 1x is a good place for us to be. We think that will trend lower this year. So we're always keeping an eye on it, but we're happy with where we sit at the moment.

Yes. And I'll just add there. I mean, I think Matt really articulated it well. I mean, the gas side is interesting. Obviously, when you see $4 gas, there's somebody to keep your eye on, and we might be opportunistic there. But again, on the crude side, it's just not where we're focused right now.

And our next question comes from Alley Ryan from Stephens. Alley, you're live. You're on mute. Let's go to the next question. Next question is from Jon Evans from SG Capital.

Brian, can you talk a little bit about, I guess, in Devon's slide deck, they talked about the Eagle Ford. I don't know if you didn't mention anything about them, but they were pretty positive and they ramped their volumes like 20% sequentially, they're going to run two rigs. Are you seeing that on any of your pieces in the mineral rights like Devon?

I'm actually going to get Mike down to narrate on this one. So Mike, go ahead.

Yes, as you mentioned, we saw some positive news from the BP-Devon JV when they talked about their production increase from Devon's standpoint of 21% from Q1 to Q2 as well as our rig outlook. They turned in like 21 wells during the first half of the year. We did see a significant number of those wells in our position. So that was, again, positive. I think the other thing, they confirmed that they're going to be running two rig crews two rigs for the remainder of the year. So I think it's all very positive.

And the sense is from their call that those came on pretty late in the quarter. Is that fair? So will you see more of that flush production in Q3?

I mean, some of the wells came on late, and so we would see some of that into Q3, but also some of them came in line sort of end of Q1 into Q2 is where we saw a significant number of wells associated with Devon.

Okay. And then my follow-up question, can you just talk a little bit about your guidance realization because where the Eagle Ford is on natural gas? And what kind of basis you have coming off at Henry Hub?

Yes. I mean, Matt, I wish you take -- now as you take this because I know you were looking at it really.

Well, generally, we trend pretty tight to Henry Hub.

So yes, I mean, Jon, we trend pretty tight to Henry Hub over time. It's really an aggregate of -- it's generally an aggregate of the Appalachia gas number and the Eagle Ford gas number. And so what we reported, something like a blended basis.

And at this time, we have no further questions. I'd like to turn it back to management for any closing remarks.

Yes. I appreciate everybody on the line. Looking forward to talking to everybody over the coming months and on the 3Q call. Thanks, everybody.

Thank you. This does conclude today's conference. We thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.