Evolution Petroleum Corporation (EPM) Earnings Call Transcript & Summary

My name is Jeff Robertson. I would like to thank everyone for joining us today for a fireside chat. Our fireside chat today is with the senior leadership team at Evolution Petroleum. Before we get started and with the introductions, I would like to reference that today's discussion may include forward-looking statements. Viewers can refer to Evolution's disclosures around forward-looking statements in the company's corporate presentation, which can be found on the Investor Relations section of the company website. The purpose of today's fireside chat is to introduce the senior leadership team, as I said. We have with us today, Bob Herlin, who is Evolution's Chairman of the Board and one of the co-founders of the company. We have Kelly Loyd, who is the Director of Evolution since 2008 and also is the Interim Chief Executive Officer and President. We're also joined by Ryan Stash, Evolution's Senior Vice President and Chief Financial Officer and Treasurer. So with those brief introductions out of the way, I would like to get started. Bob, maybe we can start with you, if you can just introduce Kelly and also talk about the leadership transition that is currently under way.

Sure. Thanks, Jeff. Appreciate it. My pleasure to be here, and good morning to everyone on the call listening later to recorded version. I started the company up back in 2003 with the idea of forming this company to take advantage of technology in [indiscernible] financial approach. And in 2008, '09 time frame, we brought on board a larger group of retail investors and institutional investors. And part of that group included JVL Partners, and Kelly Loyd was a portfolio manager with them. And we invited Kelly to come on board to represent the institutional investor side of the business. Kelly has been a director since that time. He currently is Chair of our Investment Committee. He has served as a member of our Compensation and Nominating and Corporate Governance Committees. He has been associated with JVL Partners since 2004, which is a private energy investment company. And that effort was heavily involved in a lot of upstream direct investments. Therefore, he is highly knowledgeable of the upstream business. Before JVL, he's with RBC Capital Markets, Howard Frazier Barker Elliot and Jefferies & Co. and all in the energy corporate finance side. He is overly educated with the B.S. Economics from SMU and an MBA from Rice. In terms of what we're doing in this process of this transition, 2 to 3 years ago, we were a very simple company. One asset, we had basically 2 checks come in every month. We wrote 2 checks out every month. We had our overhead, very simple operation, had maybe 5 employees. And our focus was how to scale the company up and grow it. And our focus, therefore, was doing mergers and acquisitions, mostly acquisitions, because of the price -- commodity prices being at a fairly low level. Today, we're a tremendously different company. We have 5 significant assets. Our production has trebled. Our reserves have trebled. Our revenues have more than quadrupled. We have more employees, but they were still fairly slim, each operation with about 10 or 11 employees in total. But we're just a different company now. We're looking for a new CEO to take us to the next level, much more mature company, but still maintain our growth focus while staying very conservative financially. So that process is ongoing. We've engaged a search firm to come up with candidates. And in the meantime, I asked Kelly to step in and lead us through this effort and to run the company while we're doing this. So that's kind of where we are. We anticipate this new CEO or the CEO process and transition to be completed by the end of this current quarter or the end of September. And we're excited about where we're going from there.

Thanks, Bob. You ran through Kelly's bio, which is obviously also available for people to look at on Evolution's website and the invitation for this fireside chat. Kelly, Bob went through it over about a 20-year period. It sounds like you've obviously been an investment banker and an investor in public and private companies. Maybe you can talk a little bit about the type of business model or with all that experience that you think works best to deliver sustainable shareholder returns.

Yes, absolutely. Thanks, Jeff, and welcome to everybody joining us. But you bring up a really good point. So at Evolution, our goal is to maximize total shareholder return, and we're going to do that by optimizing the value of every dollar we invest on a risk invested basis. So the business models that companies can do to try and do this sort of include, I would call it, growth at all costs company model. This is the one where every dollar they get, they reinvest and they increase production, increase reserves. The opposite of that would be sort of the pure distribution or the blowdown model, and this is where the company gets one asset, produces all it can from that and distributes all the cash flow. And then you would sort of get the middle ground, which is the hybrid approach. Like each of these is going to have positives and negatives. I think the growth at all costs has probably been the mantra of upstream energy companies for the last several decades. But at some point, production and reserves have to translate into earnings and free cash flow where the investors don't really get much from it. On the other end of the model, you've got, like I said, the pure distribution. This is a great idea, a great way to get investors, distributions from high cash flow producing assets, but the negative there is, of course, when the assets reach the end of their useful life, so does the company. The hybrid approach sort of right in the middle is sort of -- you've seen E&P companies over the last 2 or 3 years start to move here, but Evolution has been there for just about a decade. And over that time frame, we've returned almost $3 a share in the forms of dividends and buybacks and while at the same time building a PDP base that's going to support dividends for many years to come. So to answer your question, yes, I think best way to do it is sort of the hybrid approach like Evolution is doing.

You both mentioned or talked about the company in recent years. And I guess I would say it's kind of with the namesake of the company, that Evolution has evolved quite a bit over the last several years. Dividends started being paid in December of 2013. I think the current dividend rate is $0.10 a share or a quarterly dividend of $0.10 a share, so $0.40 annualized, which got you back to the pre-pandemic level. Acquisitions since 2019 have taken the asset base from the one asset you talked about, Bob, at the Delhi Field. It's operated by Denbury to now assets in 5 different operative areas with 5 different primary operators. How do the recent acquisitions that the company has made fit into the total return strategy, Kelly?

I think they fit in perfectly for our corporate goals. It added, like I said, a substantial PDP base. It's going to be contributing to our cash flow and distributions for more than a decade to come. And they've also provided competition for our dollars in that now we have some drillable locations. The other way they fit, I'd say, look, they're mature, they're long life, low decline assets, which in our yield model, that is exactly what we want. It keeps us off that sort of high decline reserve production replacement treadmill that you've seen [ great ] affect the E&P industry over the years. On the diversity side, I think it's terrific. Look, we were starting off pure-play oil. Then we added some NGL capacity down at Delhi. Now we have natural gas as well. So when one commodity is outperforming the other, we're in a position to really take advantage of that. Look, beyond that, I think the Board is always actively discussing strategies to increase shareholder returns other than through just acquisitions. So...

You all have closed just in the calendar 2022, 2 pretty sizable acquisitions for Evolution, one in the Williston Basin and one in the Jonah Field. Can you talk about how difficult or easy how -- the challenge of trying to scale up through acquisitions?

Look, yes, it is a challenge, Jeff, for sure. But I think we have proven that we can do it, and we will be able to do it in the future. Like our strategy is to maximize our total shareholder return now and in the future. So all of our corporate actions, they're going to compete for capital. So there's going to be times when capital's going to be directed towards increasing dividends or just increasing the runway for our dividend. There's going to be other times where we're going to put it in the ground, either through participating in drilled wells or acquisitions. So look, at the right time, for the right price on our model, we can scale it for sure and have done so.

Evolution has focused so far on nonoperative assets. Do you see opportunities that -- on the operative side of the business that might entice you to where you'd say, well, if we can get scale in an area or scale in a basin, we could add an operating capability to the company?

I mean yes, you sort of hit the nail on the head there, Jeff. It has to be scale. Because to take that step, it's going to require us to add to our team and at least upfront, it's going to be a little more cash intensive. So for sure, it's something we consider and we've looked at, and we'll continue to do so. But it's got to be the right transaction, and it's got to be of enough scale.

Are corporate acquisitions a viable way to think about growing Evolution's scale?

Yes. I think using our equity for transaction capital either through a merger or acquisition has always been something that's been on the plate for us. However, I think every E&P company always thinks they're cheap, but we aren't that different from every other E&P company in that respect. But look, we would only really consider doing it if it were on a highly accretive pro forma basis, and those opportunities may present themselves. We're out there looking for sure.

Ryan, we had a fireside chat back in May where we talked a lot about the balance sheet. But maybe if you can just remind us about the balance sheet capacity with debt headed down from the most recent deals to fund incremental acquisitions?

Yes, sure. Thanks, Jeff. Appreciate you taking the time again. So look, I mean, I think with the improvement in prices that we've experienced here since our acquisitions, the balance sheet is in great shape. Our debt is coming down faster than we originally projected. As we've sort of mentioned right in the public markets, we expect to have it paid off before calendar year -- before the end of the calendar year, which we still fully expect. So I mean, we really feel good about our liquidity position right now. And we think we certainly have the capacity to still be opportunistic and look for acquisitions that make sense in the current environment. I think our peak leverage is around half turn kind of at the height when we do these deals, and we sort of said corporately as a Board, we might be willing to go up to a turn for a period of time. So we certainly have kind of the ability to go out and prosecute acquisitions or organic development for that matter.

Ryan, in May, we also talked about the notion of equity as a component for acquisition financing. How do you think about the relative value of Evolution's equity and how that might play into either using it or not using it in an acquisition?

Yes -- no. I mean I think Kelly has sort mentioned, right, I mean we sort of not unlike everyone right now in the E&P industry that -- we feel like there is a severe discount to our intrinsic value. And specifically for us, kind of hopeful that for -- our fourth quarter earnings coming up and our new reserve report coming up, we are hopeful the market is going to see kind of that step change in cash flow and asset value that we've created here and achieve from these acquisitions, and we hope our equity will follow. And I think right now, the depressed stock price, given our intrinsic value, clearly make it probably challenging for us just by doing a deal -- equity deal for cash to pay for PDP weighted assets. But as you had asked Kelly and he had sort of mentioned, we're still looking at mergers, right? I mean we're not the only one with depressed stock price. And so if there's a relative value that makes sense for our shareholders, it's accretive, it's certainly something we're going to look at.

Commodity prices are obviously very volatile and have risen quite a bit since you all announced the 2 acquisitions. We're getting into second quarter -- calendar quarter reporting season, so we'll probably see a lot of hedge losses by some companies from hedges taken on in a much lower price environment. Can you remind us how Evolution thinks about hedging? As you mentioned, you don't really have a balance sheet that you need to protect, but how do you think about -- I'm sorry, hedges? And how do they -- how do you think about them in the context of an acquisition that you might look at?

Yes. So I mean, our philosophy really hasn't changed, right, at the corporate level. I mean, we prefer to be kind of a call on commodities. We still want that. We put in hedges with our acquisitions as a requirement of our bank facility. And that requirement is still there, but we're now below the threshold that requires us to maintain any hedges. If we ended up buying additional assets, we could potentially go above that threshold and have to add some hedges. But we're generally going to try to remain really not hedged, right? I mean we -- again, we want to be a call on commodities. As far as types of hedges, our strategy has been costless collars. And so in wide collars to that extent, we want to protect for the severe downside right on the floor but also retain the upside. And so I think what you'll see is us -- if we did -- if we looked at an acquisition environment, we would probably only hedge what the bank would require and no more.

Bob, let's turn back to you. You've obviously led Evolution through a number of industry cycles with some pretty extreme peaks and valleys. Can you just shed some light on how the Board thinks about building an E&P company that's capable of delivering sustainable value for investors?

Sure. I guess we've seen the downturns in '08 and '15 and then, of course, in 2020 time frame. We've seen a lot of our peers disappear or become sickly companies with no ability to grow back and recover, primarily because they put too much of their assets -- too much of the cash into assets at a very high commodity price, pretty high asset price, over-borrowed and so forth. And that's why we've always had a very conservative financial philosophy. We've always valued our shares highly. And I know Kelly and Ryan were saying that, well, we are reluctant to use our stock right now as commodity. There is a currency that is undervalued in the market. That's not -- that's not a qualitative or our dog is prettier than the next person's dog or something like that. This is actually very quantitative calculation. We take our reserve reports, we take the forward price curves. We look at the PDP only, look at the cash flows, we track off debt, we track off G&A and say, okay, what is that IRR of our stock price. And we look at that and we say, well, once you use our stock that's being valued by the market at a 17%, 18%, 20% discount rate and go and buy properties that have PV-10 or PV-12, it's just stupid. We try not to do stupid things, because the Board and management team -- and so that's why we're very careful in how we approach this. And as Kelly said, we look at this as a portfolio strategy. Sometimes when commodity prices are low, the best thing to do is to go out and buy production. In today's environment with higher commodity prices, lot more downside room, but with company -- public companies being undervalued, it makes more sense perhaps look at acquiring in that scenario. When commodity prices are high, and we have the ability now of drilling our own puds that have a 30%, 40%, 50% rate of return. Well, that seems like the more appropriate thing to do. And all this, the focus is on what's in the best interest of the shareholder. As the -- since I'm the third largest shareholder, that's very near and dear to me. What's the dividend now? What's it going to be 5 years from now? What's the value of the stock? What's the best way to transfer that value to the shareholders? And so we're always looking at that. Do we increase the dividend? Do we increase the base dividend? Do we look at variable dividends? Do we buy back stock? Or do we put more money into acquisitions? We look at corporates. So we're always looking at every -- that's a constant thing the management is doing and it's something that the Board is doing every quarter. We have that kind of conversation, like what to do, how to do, what's the best interest of the shareholder. So I can't stress that -- I get really frustrated watching a lot of our peers and they announce all these wonderful deals. Over the years, they get bigger and bigger and bigger, and their management pay gets bigger and bigger, because it's justified, because they're a bigger company. But then I look at the stock, I say how's the shareholder's get from all this. And I don't see it. I don't see the stock price going up. I don't see the dividends going up or any dividend. So I guess I'd love to have a pet team, but I think that underlines how the Board looks at this, because every Board member is a significant shareholder. In fact, that's 1 of the philosophy we've had from day 1 starting back since 2003. Every employee, everyone associated with the company is a major -- is a significant shareholder, so that they're driven by that same concept. How do we make the shares worth more, because this is directly impacting them as well.

You talked a little -- talked about capital allocation. Maybe Kelly, we can turn back to you. So 1 thing back to the theme of that Evolution has evolved over the last -- especially in the last calendar year. The Williston Basin acquisition added a pretty sizable inventory of proved undeveloped drilling locations. How do you -- how should investors think about where we are in the current commodity price cycle and now the options that Evolution has to allocate capital between acquisitions, between development drilling, between having Ryan pay down debt to near 0 or 0, and now having a development drilling component that you all can push, because of the joint agreement you have with Foundation, the operator in the Williston Basin?

Sure. Yes. No, but Bob said it a whole lot of it. I mean I think what you -- if you look back over the couple -- last couple of years, we've seen -- sort of seen a little mini cycle, right? We got really stressed when commodity prices were crazy volatile. And then you saw Evolution. What we did, we cut our dividend. We supported our ability to -- we preserved capital by supporting our ability to pay dividends in the future by cutting the dividend at that time. Then you saw when things were covered, right? We made acquisitions, because at this time, we could see the cash flows would support those acquisitions and we raised dividends, because we had the foresight to see that the cash flow would support that. We feel the same way about development drilling. We're always going to highly risk our expected outcomes and way the drilling and acquisition uses the capital against -- again, possibly increasing dividends or increasing the dividend runway and maybe buying back shares. So the answer, look, we always have and we're always going to carefully weigh our options in trying to do what's in the best interest of the shareholders in the most accretive way possible. There's always going to be competition for our dollars among our corporate action options, and these decisions are very dynamic. I can tell you we're going to allocate capital to the highest returning options that we believe are sustainable when they present themselves.

Bob, I'm going to follow up with you and give you a chance to put an exclamation point on your comments around the dividend. But since dividends have been very important part of Evolution's business strategy since you initiated dividends back, I think it was, in December of 2013. How should investors think about the dividend component of the total return to shareholder strategy of the company?

It's for Bob or me?

For me, sorry. It's an important component in the sense that we want to be able to deliver a steady cash flow to the shareholder. But we want to make sure that steady cash flow is something that the shareholders can count on for a very lengthy period of time, not just this year, next year, but for 5, 10 years out at a minimum. To the extent we're looking beyond that, can we increase that to maintain that steady long-term payout. We look at that every quarter. Should we go to more of a variable dividend where we have a base rate and then some additional on top of that. That's something that we always look at. So the dividend is an important part of this whole process. It gets appealing to maybe a little different type of investor that is looking for steady cash flow.

I'd like to thank -- I think we'll leave it there for today. I know Evolution's fiscal year ended on June 30. So the company will report its next earnings and operating report will be for the full fiscal year and the fourth quarter of 2022. So we will look forward to that probably in September. The fourth quarter will also be the first quarter to show the -- fully the impact of both the Williston Basin and the Jonah Field acquisitions and the reserves incorporated into the year-end reserve report. So we look forward to seeing those numbers and look forward to seeing what fiscal 2023 has in store for you. Bob, Kelly, Ryan, I'd like to thank all of you for joining us today, and we look forward to hosting another 1 of these soon.

Thanks, Jeff.