STR (2020 - Q2)

Good day, ladies and gentlemen, welcome to the Falcon Minerals Second Quarter Earnings Conference Call. [Operator Instructions] At this time, it is my pleasure to turn the floor over to your host, Chief Financial Officer Mr. Bryan Gunderson. Sir, the floor is yours. Bryan Gu

Good morning, everyone, and thank you for joining today's call to discuss Falcon's second quarter 2020 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 statements 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 presentation also includes non-GAAP measures, reconciliations of these measures to the most directly comparable GAAP measures are included in our earnings release, which is posted on our website. Lastly, the company will be attending several virtual investor conferences in the coming weeks, including the Minerals & Royalty's Virtual Conference, the Simmons Gleneagles Virtual Conference, the Barclays CEO Energy-Power Virtual Conference, and the Credit Suisse, Royalty & Mineral Investor Day. With that, I'll turn the call over to Falcon's President and Chief Executive Officer Daniel Herz for his remarks. Daniel?

Thanks, Bryan. Welcome everyone, and thank you for joining the Falcon Minerals Corporation second quarter 2020 earnings call. Bryan Gunderson, our Chief Financial Officer, who you just heard from, will give the financial report following my remarks, and then we will take questions. First, it is nice to speak to all of you. I hope everyone is doing well through these challenging times. We certainly have come a long way over a short period in many respects. I'm not sure there can be a better demonstration of the strength of Falcon's business then the second quarter of 2020. During the treacherous second quarter, Falcon generated positive free cash flow of $0.033, reduced that by approximately 10%. Cut cash G&A from the first quarter by 25% and increased our dividend quarter-over-quarter by 20%. Furthermore, Falcon is extremely well positioned for the months and years to come. Falcon should benefit in the third quarter from production coming back online that was voluntarily curtailed by some of our operators, and that production will be sold at substantially higher prices than existed in the second quarter. In addition, when oil prices rebounded to approximately $40 per barrel, we hedged a substantial portion of our volumes through the first quarter of 2021, which should help provide for meaningful growth in free cash flow as compared to the second quarter. Given the future hedge prices represent almost twice the price realized for oil during the second quarter. Further, with respect to our future. Our line-of-sight gross and net wells have increased quarter-over-quarter, providing further visibility over the next 12 months, as those wells are brought online. And, finally, our operators have continued to reaffirm their long-term commitment to developing our core position in the Eagle Ford, as ConocoPhillips and EOG continue to permit, drill and complete wells across our position and publicly discuss their 10-year development plans. Despite all of these favorable aspects, our stock price remains undervalued by the market, and such, management and the Board are considering all options as to how to create value for our equity holders over the short, medium and long term. I look forward to reporting back as we move forward. Let's now get into some of the specifics of the business. During the second quarter, our operators averaged three rigs running across our position. Today, there are currently two rigs running across our position and our operators are continuing to build DUCs. We currently have 212 gross and 2.52 net line-of-sight wells, of these line-of-sight wells, 1.62 net wells or DUCs or waiting to be turned in line. These specific wells give us confidence in production over the next six to nine months. In addition to these line-of-sight wells, I'm optimistic that we will see further development sooner rather than later in our prized Hooks Ranch position, where we hold a 22.5% net revenue interest. I would also note that ConocoPhillips is currently running 4 rigs and planning one to two frac crews running for the remainder of 2020. And EOG is running three rigs and three frac crews. We averaged 4,450 barrels of oil equivalent or BOE per day during the second quarter. That production reflected voluntary curtailments by our operators of about 25% during May and June, including a portion of our Hooks Ranch wells. I'm pleased to report as of July, all of our Hooks Ranch wells were back online and being sold at substantially higher prices than existed in May and June. This is exactly why we were pleased that ConocoPhillips and EOG curtailed volumes, which allows us to benefit from meaningfully higher prices than when - then where our oil reserves would have been sold just a few months ago. Conoco has publicly stated that they expect that all of their curtailed volumes across our position will be back online by the end of August. ConocoPhillips has noted that they have seen no negative impacts from curtailment. And, in fact, have observed flush production as wells have been brought back online. Finally, we announced last night a dividend of $0.03 per share, which represents a payout ratio of 91%. This return to our targeted payout ratio of greater than 90% is a result of the strength of our balance sheet and the strong cash flow we expect based on our current production and continued commitment and activity by our operators across our core position in the top returning shale play in the United States. With that, I will turn the call over to Bryan to walk through the financial results for the quarter. Bryan?

Thanks, Daniel. Our assets generated $6.3 million in royalty revenue during the period. Falcon's net realized price for oil during the second quarter was $22.03 per barrel. Average realized price for natural gas was $1.71 per Mcf and our NGL realizations averaged $5.44 per barrel. As Daniel mentioned, during the quarter, Falcon initiated a crude hedging program for volumes beginning in the third quarter of 2020 and extending into the first quarter of 2021. All volumes were hedged on June 10, 2020, at approximately $40 per barrel. Exact volumes and pricing are laid out in the company's investor presentation that is available on Falcons website. Total cash operating costs were $3 million for the period. Looking at the component pieces, ad valorem and production taxes were approximately $0.6 million for the quarter. This reflects a $0.2 million decrease compared to the prior quarter, which is due to the lower production taxes resulting from lower realized prices. Marketing and transportation expense was point $0.6 million for the quarter, or $1.50 per barrel. This expense represents an increase on a dollar per barrel basis from the $0.85 per barrel of expense that we reported in the first quarter 2020. Cash G&A expense was approximately $1.7 million for the second quarter. As Daniel mentioned, this represents a decrease of approximately 25% compared to the first quarter 2020 and as a result of the cost cutting measures that Falcon adopted in March of 2020. Cash G&A excludes approximately $1 million of non-cash stock compensation expense recognized in the period. Adjusted EBITDA for the second quarter was $3.4 million, which represents a decrease of $6.7 million from the $10.1 million reported in the first quarter of 2020. The decrease was largely attributable to a 49% decrease in average realized price, and a 14% decrease in production. Falcon reported a second quarter net loss $0.6 million on a standalone basis and $1.3 million net loss inclusive of non-controlling interests. Our GAAP income tax benefit of $0.3 million for the quarter is mostly attributable to the company's incurring - to the company incurring a taxable loss during the quarter, which increased our net operating loss and increased our deferred tax assets. The company incurred no amounts related to the current period income tax expense, incurred no cash income taxes in the second quarter 2020. This is primarily due to the tax benefit of a basis step-up related to the assets that Falcon acquired as part of the transaction with Royal Resources in 2018. Due to the stepped-up basis in our assets, we expect to benefit from a cash tax perspective for the foreseeable future. At the end of the second quarter, Falcon had $40.6 million outstanding on its revolving credit facility, and $1.8 million of cash on hand, resulting in net debt of approximately $38.8 million at the end of the second quarter. Falcon's net debt-to-LTM EBITDA ratio as of the end of the second quarter was 1.12 times. As I mentioned, on the 2019 fourth quarter call, and the 2020 first quarter call, 80% of the dividends paid to Class A shareholders during 2019 were classified as non-dividend distributions, and therefore represent a reduction of basis rather than ordinary income. Non-dividend distributions are treated as a reduction of basis until such time that the investors' basis is fully recovered. The reduced tax basis will increase shareholders' capital gain or decrease shareholders' capital loss when the shareholders sell their common shares, Falcon's mineral interest that was received as part of the transaction with Royal Resources in 2018. Falcon expects that greater than 50% of the dividends paid to Class A shareholders during 2020 will be classified as non-dividend distributions in 2020. This treatment will generally result in nontaxable reduction to the tax bases of shareholders common shares. As Daniel mentioned, yesterday Falcon declared a second quarter dividend of $0.03 per share. This dividend is payable on September 8, 2020 to shareholders of record as of August 25, 2020. The $0.03 dividend payment reflects a payout ratio of 91% to pro-forma free cash flow. Pro-forma free cash flow per share was approximately $0.33 per share for the period. We define pro-forma free cash flow as adjusted EBITDA, inclusive of non-controlling interest less interest expense and pro-forma cash income taxes. Our estimated pro-forma free cash flow for the second quarter of 2020 did not include an amount for pro-forma cash income taxes. Falcon did not have taxable income in the second quarter due to a decrease in average realized prices, a decrease in production and as mentioned previously, utilization of the tax benefit from the stepped-up assets basis resulting from the Royal transaction 2018. With that I will now turn the call back over to Daniel.

Thanks Bryan. Well done. Jess, why don't we open the call up for questions?

Sure. [Operator Instructions] We'll go first to Brian Downey with Citigroup.

Good morning gentlemen. Hope you're well and thanks for taking my questions. I guess, starting off, given the second quarter curtailments impacting production, particularly at Hooks Ranch. I'm curious if you could give us a sense for how you see your normalized production run rate now as volumes return more to a normal level than the back half of the year, maybe a July rate or however you're thinking about that there?

So, I mean, I think you can look at 25% curtailment for May and June and extrapolate out the impact during the second quarter. And we're trying to take and are taking a conservative look at the remainder of the year. And we really look at the second quarter as the trough, and then a flattish third quarter, and then, hopefully a stronger fourth quarter depending on timing of wells turned in line by our operators. But, in any case, we're certainly extremely well set up for a very strong 2021 with a line-of-sight we have and of course, my optimism for additional near-term development with respect to Hooks Ranch.

Got it and then along those lines, admittedly a very similar question to what I asked last quarter. But with the bulk of your line-of-sight wells currently in the DUC are waiting on completion bucket more specifically, as you mentioned, I'm curious if your sense on the completion cadence there from your vantage point has changed at all, given where we've come from a commodity price perspective from last quarter?

I think it has changed, not just because I think it's changed, but ConocoPhillips has indicated they expect one to two completions, crews running in the second half of this year, bringing on wells. That certainly is a shift forward to our benefit with respect to where it's compared to where we were on our last earnings call. And then, of course, EOG, I think is continued to - is on pace and we'll hear more tonight when they release. But, has indicated 200 gross wells and the Eagle Ford turned in line this year. In the first quarter they had 82. So that left them with 118, the vast majority of which would occur as they said, in the second half. So, I think we're set up well. We've certainly seen activity remain across our position at a nice level as compared to the rest of the US energy space. And with the buoying of our curtailed volumes coming back online that should provide a very stable third quarter and the line-of-sight as you mentioned with the bulk in the waiting on completion and waiting to be turned in line category sets us up for what will hopefully be a strong fourth quarter and really first half of 2021. Thanks Brian.

Great, I appreciate.

Thanks Brian.

We'll go next to TJ Schultz at RBC.

Hi, good morning. First just on your comment about the intent of management and the Board to evaluate all options in the short and long term is there anything to read into that or can you expand? I know that comment specifically related to where your stock is trading. But do you feel like there would be a market to monetize some assets to put some type of valuation marker out there? Is there anything more specific on what you're thinking that you can provide? Thanks.

Yes, I don't want to speculate on where we're going to end up as we're looking at really everything that one should look at to drive value to our equity holders in the short, medium and the long term. I do think we are - and we believe we are meaningfully undervalued across every metric. So, I'm not going to speculate on this call as to where we will end up. But I do think we have a lot of options that can really drive the value back to our equity holders in the short, medium and long term.

Okay, understood. Just on the payout ratio. This was absolute dollars in 2Q. There's not a lot of impact from change in the payout ratio. But how are you thinking about that longer term? And is the hedging strategy that you now have playing any role and how you think about payout levels?

So as far as the payout ratio - since our inception almost 2 years ago now, our goal has been to setup a business that returns free cash flow to its shareholders, and we'd stayed at 90% plus payout ratio. So that's our - that has been our acting thesis. And we think the market should value that acting thesis. It certainly is what we see in the many analyst reports. Certainly, TJ, you write and others, that the market is looking for free cash flow, and we certainly generate free cash flow and we hand it all back to - or nearly all the back to our equity holders. And so with respect to the hedges, the hedges were opportunistic. We saw the brink. I think we all felt the brink in the energy market in March and April when oil rebounded to $40. It seemed reasonable to protect the cash flow of the business at what are attractive levels, while remaining un-hedged on a good portion and benefiting from all of the line-of-sight well production, which should grow our production. And if prices are higher, we'll benefit even more. It really positions us, and I'm sure your models and other's models will show, meaningful free cash flow growth, just by way of the fact that we'll have - and we have substantially higher commodity prices hedged and resulting for the third and fourth quarter as well as the first quarter of 2021.

Got it, thank you.

Thanks TJ.

[Operator Instructions] We'll move next to Welles Fitzpatrick at SunTrust.

Hey, good morning.

Hey, Welles.

Hey, Welles.

The Karnes Trough, you guys hit it in the prepared remarks and, I guess, anytime Conoco kind of calls out your backyard and where they're keeping rigs put, it's pretty positive. Have you guys seen anyone trying to kind of come into your neighborhood? Have you seen - I know you haven't done a whole lot of acquisitions recently? But have you seen people kind of trying to butt into Karnes? Have you seen more competition in that bidding recently because of the relative stability of the area?

We are, obviously, by far the biggest - certainly public, but the biggest as far as footprint mineral owner in the core of Eagle Ford in the Karnes Trough. We are and have a world-class organic that is on the ground acquisition effort. We also have, I think, a very strong strategic acquisition effort where we have a motto. We do not miss deals no matter what. And so, while we have been extremely cautious as far as what we have moved forward with, we have seen everything that's going on. And, part of the frustration with where our equity is trading, is that we have opportunities that we see that are attractive to us. No, others aren't coming in, to answer your question directly, and buying those assets. But there are attractive on the ground deals that are what I'd call small bowl and medium-sized bowl that we can execute on based on our relationships and our presence in the Karnes Trough, and we would like to take advantage of that. On the other hand, we see an equity value and I don't blame anybody, or any of our shareholders who been great supporters of ours. What we need is more shareholders to help increase our value, because there are more opportunities for us to acquire at extremely attractive rates. On the other hand, again, we're trading at a substantial discount when we look at our value. So, going out and buying third party assets in any area is very hard to conceive of when we look at the present value that we're trading at on a per share basis. So those are some of the kind of insights into how we're thinking about things at the moment.

Okay. No, that makes sense, and I'm sure it's frustrating. I mean, so needless to say you guys aren't willing to do those smaller bolt-ons and throw on a little bit of debt. That's just kind of off the table for the time being?

Nothing is off the table. And I hope I don't sound frustrated, because I'm appreciative that this is an - this is a market where we know public investors are not overly enamored with or not even a little enamored with energy generally. We think we have an amazing asset base. And I've seen E&P - I run E&P businesses and midstream businesses. I don't think there's a better asset base than a core of the core Eagle Ford mineral business, where we have no CapEx, and it's driven by ConocoPhillips, EOG and BP-Devon, and we're trading as I understand it, at seven times analyst expectations for 2021. This is a business with zero CapEx and I see price targets with similar multiples on E&P businesses. And I think analyst expectations will probably move substantially higher as we move through this call for 2021, and based on our line-of-sight and Hooks Ranch development, et cetera. So I think there's a great undervalued situation here for those equity investors who want to sift through the wreckage of the energy space and really find the diamonds in the sand.

Okay, makes sense. And then just one last one if I could sneak into this, the Hooks Ranch wells were brought back on after curtailment. Can you - do you have any data on what those look like post curtailment? Have those had a little bit of a pop above the curve? I mean, maybe just kind of talk to the performance there as those came back on?

Sure. We do have data on those wells. They're great wells. The Hooks Ranch is in the top of ConocoPhillips's portfolio. Production has been in the top quartile and top docile. I don't want to be ahead of ConocoPhillips in any way, shape or form. They've been great partners, great producers. But they have said that their wells have come online at or even ahead of where the wells had been shut in at. And I simply would echo those comments in their comments.

Thank you so much.

Thanks Welles.

[Operator Instructions] We'll go next Pearce Hammond at Simmons Energy.

Good morning and thanks for taking my questions and very helpful color on the call so far. Daniel, totally understand you want to keep it real high level as it pertains to evaluating all options to increase value to equity holders. Just curious what you're thinking from a time process timeframe, as to when do you think you will report back to analysts and investors? How this process is going? And then would you consider hiring an investment bank?

Well, I'll start with the last question. Of course, we're always talking to investment banks, we value their advice and their breadth of knowledge and the interactions with lots of different parties, from equity holders, to family offices, et cetera. As far as the timing, we're going to run to ground every option available, and then really come back with our strategic vision for the market. I've heard, competitors or peers talk about, well, they're going to hold off on acquisitions, or oh, they're going to pursue acquisitions, or, oh, they're going to increase their payout ratio, or they'll reduce their payout ratio, they want less debt, the market wants this and that. We need to consider and we've been considering. So we're not - this isn't something we're starting. This is something we're along the way in. What we want to do and what I want to do is come back to you in the market with a very specific vision as to what I'll call Falcon 2.0. And that is, where this business is, and where this business is headed and the value proposition that exists for our equity holders as a result. What I can say and I think everybody on this call will - can do the analysis. Is that from an NAV standpoint, a free cash flow standpoint, from every standpoint that we can look at, we're massively undervalued? And so for those lucky few who are listening to this call or read the transcript, the opportunity is now. What I expect is that we'll be back over the coming couple of months with our strategic vision for Falcon 2.0, which I hope will really eliminate that massive value gap between where we're trading today and what our value of our assets really are.

Daniel, that's very helpful. And then turning to Bryan, you all did a good job of layering in some hedges to protect the downside. Just curious what your latest thoughts are on hedging as we start to peer out to 2021 and beyond?

Yeah. Thanks for the question, Pearce. I think that Daniel mentioned it in the - earlier in the call. We're not anticipating layering on any incremental hedges other than the hedges that you've seen for Q3, Q4 and Q1 at this point.

Okay, thank you very much.

Thanks Pearce.

We'll go next to Kyle May at Capital One.

Hey, good morning guys.

Hey, Kyle.

I want to follow-up on one of your comments about Hooks Ranch. You've mentioned an expectation of activity sooner rather than later. First, can you give us a sense of what gives you that inclination? And then second, if you could give us any thoughts around timing of that?

Sure. Thanks for the question, Kyle. Good morning. I will tread very carefully, but remind you and everybody on the call prior to Conoco permitting their last pad for Hooks Ranch I said to the market the same words that I'm optimistic about near-term development of our Hooks Ranch property. And so, I'll stick with that optimism and let things develop publicly as they will. I certainly don't want to get ahead of Conoco and their plans. But I am - and we are optimistic that we'll see near term development. And really what that means and what I think Conoco has said publicly as they laid out their 10-year plan, as they're moving into manufacturing mode in the Eagle Ford. They have a 10-year plan that they're dedicated to. And what that looks like for us is probably more of an annual type cadence for development across our Hooks Ranch property.

Got it, thanks for that and one more for me, I understand there's - as you had mentioned, there's M&A opportunities out there that seem attractive. And given the circumstances that the stock is undervalued in your view, and it seems like you're adverse to levering up the company. Just wondering if there's, other things that you could do or other levers to pull that you could use for M&A purchases?

Sure, I think one of the real advantages we have and I have demonstrated as a management team is our ability to access capital over the last 17 or so years, and do it in creative ways that don't dilute our equity holders, there's certainly options around that. And then that's part of the strategic thinking as to how to take advantage of those opportunities. With that said, thinking about acquisitions at Falcon, it's really - the world's greatest deal would have to present itself, and that's always possible. But the world's greatest deal would have to present itself, given where we're currently trading. And, I guess, to address your point around leverage, I don't - I mean, we've historically been cautious with respect to leverage. I'm not sure levering up to make an acquisition is necessarily the right move. We've seen lots of people bit by that snake before. But that doesn't mean leverage is always a bad thing if leverage allows you to take advantage of uniquely leverage valuable opportunities.

Got it, thanks for that Daniel, I appreciate.

Thanks Kyle.

And with no other questions holding, I would like to turn the conference back to management for any additional or closing comments.

Great, thank you, Jess. Bryan, thank you, and thank you all for listening to this quarterly call. We look forward to coming back and updating you soon with respect to Falcon 2.0. We're excited about the business, as you can hear, and excited to speak to you over the coming weeks and months. Bye-bye.

Ladies and gentlemen, that will conclude today's call. We thank you for your participation. You may disconnect at this time, and have a great day.