STR (2021 - Q1)

Good day, ladies and gentlemen and welcome to your Falcon Minerals Q1 2021 Earnings Call. [Operator Instructions] At this time, it is my pleasure to turn the floor over to Bryan Gunderson to give the cautionary remarks. Sir, the floor is yours. Bryan Gu

Good morning, everyone and thank you for joining today’s call to discuss Falcon’s first 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 presentation 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 attending several virtual investor conferences in the coming weeks, including Citi’s 2021 Global Energy & Utilities Virtual Conference on May 11 and the UBS Global Oil & Gas Virtual Conference on May 26. With that, I will now turn the call over to Falcon’s President and Chief Executive Officer, Daniel Herz, for his remarks. Daniel?

Thanks, Bryan. Good morning, everyone. Thank you for joining Falcon Minerals’ first quarter 2021 earnings call. Following my remarks, Mike Downs, our Chief Operating Officer, will discuss specifics related to the first quarter as well as the favorable impact that the many recent wells turned in line will have on the second quarter and for the rest of 2021. Then Bryan Gunderson, our Chief Financial Officer, who you just heard from, will give the financial report and then we will take your questions. As you may remember, last quarter I quoted Red Queen’s warning to Alice in Lewis Carroll’s Through the Looking-Glass. When she said, “it takes all the running you can do to keep in the same place. If you want to get somewhere else, you must run at least twice as fast.” Well, I am pleased to say that we at Falcon are in fact now running twice as fast and we really are getting somewhere. I am happy to report the first quarter of 2021 was quite satisfying. Falcon Minerals generated $9.5 million of adjusted EBITDA and free cash flow growth of approximately 28%. Of course, this cash flow growth reflects the impact of the winter storm in Texas. So without the storm, we would have seen even more favorable results. This growth in cash flow has allowed us to increase our dividend 33% relative to the fourth quarter of 2020 to $0.10 or $0.40 on an annualized basis and we are just getting started for the year. As Mike will detail, we had 1.23 net wells turned in line during the first quarter, which we will see the full benefit from during the second quarter. With the benefit of these wells being online for a full quarter plus additional wells that are being turned in line even as we speak and with no impact from weather, production should increase for the second quarter to approximately 5,000 barrels of oil equivalent per day were 20% to 25% higher than the first quarter. Those higher production levels, coupled with the current commodity prices, allow us to continue to expect to see free cash flow at approximately twice the level of the fourth quarter of 2020. In simple terms, we expect free cash flow during the second quarter of approximately $0.15 or $0.60 on an annualized basis implying today a free cash flow yield of approximately 13%. This free cash flow level would be above our 2019 levels of cash flow when our stock traded at over $7 per share. Further booing our outlook is our significant line-of-sight wells and operator activity. With the benefit of such activity and over 200 gross wells already in our line-of-sight, we see production continuing to rise throughout the second half of this year. This continued rise in production and the current commodity price environment gives us confidence in expecting very attractive free cash flow growth for the whole year. Additionally, given our robust line-of-sight wells, we are already getting excited about the prospects for 2022. And this is, of course, all with the benefit of us not spending a dollar on capital expenditures. As always, Falcon benefits from best-in-class operators, such as ConocoPhillips, EOG and BP-Devon, who are prosecuting long-term multiyear development plans. The future certainly looks bright. Now as many of you are aware, we have spent the better part of the last 9 months thoroughly dissecting our business, including the value proposition which exists to investors in considering various options to close the significant discount we are currently trading at. Having completed that work, it is even more clear to us that we have a world-class asset base in the core vehicle first with the best operators in the U.S. prosecuting long-term development plans. Even if Falcon remains static, we would generate and return substantial cash flow for a very long time, likely returning cash flow that is multiples of our current share price. But we are not going to remain static. We fully recognize the value of becoming a larger, more diversified and dynamic minerals business. Falcon Minerals has the potential to be best-in-class with our foundational assets in the Karnes Trough of the Eagle Ford and the opportunity to grow that asset base, while remaining in the core of the core of the top plays in the United States. As such, we have re-engaged our ground game for acquisitions and are actively acquiring top-tier minerals. Of course, we also remain committed to our balance sheet and expect to be approaching 1x debt-to-EBITDA in the second quarter and well below 1x by the end of the year. Knowing that we can do very well without acquiring anything allows us to be discriminating and to acquire only assets that we really want at prices that drive value for Falcon and its shareholders. We as Falcon shareholders are in a scenario where we win, whether the coin is heads or tails. In conclusion, as I think you can tell, I hope you can tell, I am enthusiastic about where we are today at Falcon, where we are headed in 2021 and the investment opportunity that exists for investors. We have clearly defined growth in our base business that will drive production, free cash flow and dividends throughout the year. In addition, we will take advantage of opportunities to further increase value per share through growing our asset base when appropriate. Now, I will turn the call over to Mike Downs, who will get into greater detail about the quarter and further growth in 2021. Mike?

Thanks, Daniel. Thank you for taking time to join our call today. During our fourth quarter earnings call, we expressed excitement about production growth during 2021 related to the increased operator activity and our strong line-of-sight. This is exactly what we are seeing as we enter the second quarter. Our production for the first quarter was flat compared to the fourth quarter due to winter storm Uri, which impacted Eagle Ford production by approximately 5% and the timing of well connections. This aligns with our expectation at the beginning of the year where we expected to see significant production growth from the first quarter to the second quarter. The second quarter production outlook is driven by the following. There were 1.23 wells turned in line during the first quarter of which 1.17 is related to Eagle Ford. These well connections occurred throughout the quarter with the majority of the connections happening during the latter half of the quarter. This will drive production growth in the second quarter as production continues to ramp from these wells and we see a full period of production. Looking forward to the remainder of the year, we have 203 gross and 2.04 net Eagle Ford wells in our line-of-sight inventory. Included in this total are 0.94 net wells that are DUCs or waiting on connection. In our internal forecasting, we assume that the majority of the DUCs and wells waiting their connection will be connected over the next two quarters. To be clear, this means we expect approximately 2.17 net wells to be turned in line over the first three quarters of 2021. For permits, we assume a conservative approach compared to our historical average timing from permit to well turn in line and assume approximately 30% of permits will be connected by the end of 2021. And this doesn’t take into account the more than doubling in completion crew activity currently running compared to the trough of 2020. Using these assumptions, along with a modest amount of new Marcellus well connections, results in our anticipated 20% to 25% production growth from the first quarter to the second quarter. We are also very pleased with the rig activity in the Karnes Trough where there are currently 12 rigs running by the big 3 with an additional 4 rigs running by other operators. Thank you for your time today. I will now pass the call to our CFO, Bryan Gunderson.

Thanks Mike. Our assets generated $14.2 million in royalty revenue during the first quarter 2021. We recognized a cash loss of $1.1 million from our commodity derivative instruments during the period. Falcon net realized price for oil during the first quarter was $56.69 per barrel. Average realized price for natural gas was $3.24 per MCF and our NGL realizations averaged $23.70 per barrel. During the first quarter, Falcon entered into crude swaps for Q2 ‘21 through Q4 ‘21. Hedges and the associated pricing for all hedged volumes are laid out in the company’s investor presentation that is available on Falcon’s website. Total cash operating costs for the first quarter 2021 were $3.6 million. On the tax side, ad valorem and production taxes were approximately $0.8 million for the quarter. Marketing and transportation expenses were $0.4 million for the quarter or $1.06 per barrel, down from $1.15 per barrel in the fourth quarter of 2020. Cash G&A expense was approximately $2.4 million for the first quarter. First quarter cash G&A excludes approximately $1.0 million of non-cash stock compensation expense recognized in the period. Adjusted EBITDA for the fourth quarter was $9.5 million. This represents an increase of $2.7 million from the $6.8 million reported in the fourth quarter. The increase was largely attributable to a 41% increase in average realized oil prices compared to the fourth quarter. At the end of the first quarter, Falcon had $40.5 million outstanding on its revolving credit facility and $2.9 million cash on hand, resulting in a net debt of approximately $37.6 million at the end of the first quarter. Falcon’s net debt-to-LTM EBITDA ratio as of the end of the first quarter was 1.44x. We anticipate that Falcon’s net debt-to-LTM EBITDA ratio will trend back below 1x leverage mid-2021 as the second quarter 2020 rolls off from the calculation. Falcon reported a first quarter net loss of $1.5 million on a stand-alone basis and $0.5 million net income, inclusive of non-controlling interests. Falcon’s reported first quarter net loss of $1.4 million is inclusive of a loss of $3.2 million associated with the revaluation of the company’s warrant liability. On GAAP income tax expense, a $0.4 million for the quarter is mostly attributable to the utilization of our deferred tax asset. The company incurred no amounts related to the current period income tax expense and incurred no cash income taxes for the first quarter 2021. 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. As a result of the stepped-up basis, we expect to benefit from a cash tax perspective for the foreseeable future. Falcon expects that at least 50% of the dividends paid to Class A shareholders during 2021 will be classified as non-dividend distributions in 2021. 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. On May 5, 2021, Falcon declared a first quarter dividend of $0.10 per share. This dividend is payable on June 8, 2021 to shareholders of record as of May 25, 2021. The $0.10 dividend payment reflects a payout ratio of 97% of pro forma free cash flow. Pro forma free cash flow per share was approximately $0.103 per share for the quarter. We define pro forma free cash flow as adjusted EBITDA inclusive of non-controlling interests less interest expense and pro forma cash income taxes. Our estimate of pro forma free cash flow for the first quarter 2021 did not include an amount for pro forma cash income taxes. With that, I will now turn the call back over to Daniel. Daniel?

Thanks, Bryan. Karen, I think we’re ready for questions.

Thank you. [Operator Instructions] We will take our first question from Lee Cooperman with Omega Family Office. Please go ahead.

Good morning and thank you for all the information. I just wanted to focus in on the comment regarding strategic review. The way I read what you said was that we have a very undervalued asset. You remain flexible if something intelligent came about to do. But right now, you want to run your own show. And if accretive acquisitions presented themselves, you’re more likely to be acquired – to acquiring than selling. Is that kind of what you’re trying to say or have said?

Thanks, Lee. Good morning.

Good morning.

I think that’s generally very well said except I would adjust that. We are constantly looking for the way to maximize value and bring forward value. So right now, we see opportunities to acquire, but that certainly doesn’t eliminate other opportunities that would be contrary to that.

Good luck. Thank you very much for your information.

Thanks, Lee.

We will take our next question from Kyle May with Capital One Securities. Please go ahead.

Hey, good morning, guys.

Hi, Kyle.

Daniel, I appreciate the color on the strategic review and following up on the previous question. Just wondering if you can elaborate on what Falcon is doing to become larger and more diversified?

Yes. So, good morning, Kyle. Nice to talk to you. As I mentioned in my remarks, we’ve reengaged our ground game staying true to our core principles of owning core of the core top basins with top operators. And I look forward to coming back next quarter with an update. But I would say we’re starting modestly, but we are actively on the ground buying.

Got it. Okay, that’s helpful. And I believe last quarter, it was mentioned that the prior full year production outlook for around 5,000 BOE per day was conservative. And based on your comments today, that seems to still be the case. Just wondering if you can give us an update on maybe a little bit more granular how you’re seeing production shape up for the year?

Yes. I think it’s very similar to a couple of months ago as we discussed. I think the first quarter is right on line with what we were talking about a couple of months ago and that’s even with the effect of the winter storm. There is high NRI wells came online in January, the other ones came online in March, plus the – all of the additional lower NRI wells, and we’re going to get the full benefit of that production in the second quarter. And really, that peak production without the negative impact of the storms. We then have the significant number of wells that are completed and waiting to be turned in line. And then the next batch of DUCs and so on with the permit. So we really see an upward trajectory through the second half of the year, and we feel very good about that 5,000-plus BOE per day.

Understood. Thanks for taking the questions this morning.

Thanks, Kyle.

We will take our next question from Derrick Whitfield with Stifel. Please go ahead.

Thank you and good morning all. Congrats on a strong front.

Thanks, Derrick.

Picking up on the last question, I wanted to ask if you could place some broad parameters around your 2022 outlook based on your line-of-sight activity and current industry activity?

Thanks, Derrick. That’s a – so we’re really getting pretty excited about 2022, given what’s going on with our main three operators plus others. With that said, I really don’t want to get, I’d say, over our skis here. We see – I think what you’re alluding to is very much what we’re seeing, which is a lot of activity, our operators prosecuting their multiyear development plans and that really bodes well for a strong 2022 on top of the already significant permits that are in place. So beyond that, I think we will hold for now.

Completely fair. And maybe just to dig in a bit on the last part of that comment because we see the same things from our side. And that is when you look at the core operators maintaining activity at that 12-rig level, there’re seemingly an upward bias in our view to your permanent count, assuming you maintain your market share. Is that a fair assessment?

Yes. We definitely see that. And of course, we also benefit from – yes, and it really is attributable to the full Falcon team to just really great relationships with our operator partners. And we were grateful for their openness with what their general plans are and sometimes very specific plans are. So we very much are seeing that. We’re hearing it. We don’t like to – and we’re not going to really get in front of what the – what our operators are saying publicly, but we do have a strong positive bias towards 2022 and where we are headed there.

Very helpful. Thanks for your time guys.

Thanks, Derrick.

We will take our next question from Pearce Hammond with Simmons Energy. Please go ahead.

Good morning and thanks for taking my questions. Just following up on some of the earlier questions and Derrick’s question specifically, Hooks Ranch, what do you see there? What’s the latest? I’ve looked at your slide deck and you said that the four lower Eagle Ford and two upper Eagle Ford wells are expected to be turned in line in Q4 ‘21. Is that still – you feel confident there? And is that going to have more of a production impact for next year or for this year?

Yes. Good question. We remain confident and feel very good about Hooks development coming online in the fourth quarter. I do think that will be partially benefiting the fourth quarter and then really helping early into 2022.

And then Daniel, obviously, you’ve been very successful in the Marcellus in your career. But does it make sense to divest this Marcellus asset that you have here at Falcon and then use those proceeds, whatever they are, to go ahead and add that to your ground game dry powder? Just curious with the Marcellus, what’s the longer term plan?

I think that’s an insightful thought. And that’s the type of work we’re constantly doing to make sure that we are maximizing our returns and that that asset might be better or more valuable in someone else’s hands, and we might be very capable of redeploying that. We don’t currently have any plans to do that, but I think it is certainly something we’ve considered and continue to consider.

Thank you.

Thank you.

We will take our next question from Chris Baker with Credit Suisse. Please go ahead.

Hey, good morning, guys. Solid update. Just hoping to take maybe a bit of a different angle on the strategic review, are there sort of key learnings from that process that you might highlight for us as we think about the approach going forward?

Yes. Good question, Chris. I think the number one takeaway is – I think we have a great team with respect to the management, the Board. We have people who really spent a lot of time diving deep into every aspect of our business and the prospects for our business. And I think the real takeaway is the level of confidence that we have in our existing production and our future production, and what that really means from a value standpoint. And so I think what it means to us is that we’re undervalued in the public marketplace and that theoretically, we should trade at a higher value, which is nice for us to think about. But in I think tangible reality, what it means is we’re going to generate a lot of cash flow over the coming years. And as I said in my remarks likely multiples of and hopefully many multiples of our current share price, and we’re going to hand that back. So doing nothing is a – could be a very good outcome. At the same time, we also have very much recognized that being a larger, more diversified minerals business, could it be valued more highly in the public marketplace. But we will not dilute the great asset base and the great operator base that we have. So we think that we really have a potential to be a best-in-class in the best basins in the core of the best basins with the best operators. And so I think what we’ve learned is, number one, we’ve relearned that we have a world-class asset base where as shareholders, we’re all going to do very well over the coming years. But we also have an opportunity to, I think, trade substantially better as we grow and become larger and more diversified, while staying true to our essence of core of the core top basins, top operators.

Great. That’s helpful. And then just as a follow-up, Kimball put out sort of a comprehensive inventory update this morning. I was curious just to get your thoughts, post strategic review on where you see inventory debt and if there is sort of a right number out there as you think about the restarting the ground game, A&D program?

Yes. I – we have been laser-focused on our work, so have not reviewed Kimball’s release. But from an inventory perspective and this dovetails on the 9 months plus of work we have just under 3,000 top tier gross locations. And if you assume 200 wells gross per year, that’s 15 years of inventory. If you are at 250, that’s 12 years of gross inventory. I think that’s a fair way to look at it, 12 to 15 years of inventory life. That’s all core, core Karnes Trough. And so from our perspective, I mean, that’s as good as it gets in the energy world because our area, I believe is the most economic area to drill for oil in the United States.

Great, thanks.

Thanks, Chris.

And Mr. Herz there appear to be no further questions at this time.

Great. Well, thank you all very much for joining the call. We look forward to speaking to you again very soon.

Ladies and gentlemen, this does conclude today’s teleconference. We thank you again for your participation. You may disconnect your lines at this time and have a great day.