PHX Minerals Inc. (NYSE:PHX) Q2 2023 Earnings Call Transcript May 10, 2023

PHX Minerals Inc. beats earnings expectations. Reported EPS is $0.21, expectations were $0.04.

Operator: Good morning, and thank you for attending today’s PHX Minerals March 31, 2023 Quarter End Earnings Conference Call. At this time, all lines will be muted during the presentation of the call with an opportunity for a Q&A session at the end. As a reminder, this call is being recorded. And I would now like to turn the call over to Rob Fink with FNK, IR. Thank you, Rob. Please go ahead, sir.

Rob Fink: Thank you, operator, and thank you, everyone, for joining us today to discuss PHX Minerals March 31, 2023 quarter end results. Hosting the call today are Chad Stephens, President and Chief Executive Officer; Ralph D’Amico, Senior Vice President and Chief Financial Officer; and Danielle Mezo, PHX’s Vice President of Engineering. The earnings press release that was issued yesterday after the close is also posted on PHX’s Investor Relations website. Before I turn the call over to Chad, I’d like to remind everyone that during today’s call, including the Q&A session, management may make forward-looking statements regarding expected revenue, earnings, future plans, opportunities and other expectations of the company. These estimates and other forward-looking statements involve known and unknown risks and uncertainties that may cause actual results to be materially different from those expressed or implied on the call.

These risks are detailed in PHX Minerals most recent annual report on Form 10-K as such may be amended or supplemented by subsequent quarterly reports on Form 10-Q or other reports filed with the SEC. The statements made during the call are based upon information known to PHX as of today, May 10, 2023. The company does not intend to update these forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law. With all that said, I’d now like to turn the call over to Chad. Chad, the call is yours.

Chad Stephens: Thanks, Rob, and thanks to all of you on this call for participating in PHX’s March 31, 2023, quarter end conference call. We appreciate your interest in the company and are pleased with the financial results we reported yesterday. The first quarter results demonstrated the value creation potential inherent in our minerals-only business model. We generated a significant improvement in adjusted EBITDA even on lower realized commodity prices as we navigate through the current period of extraordinarily weak commodity prices and its impact on the industry. This improvement in financial performance reflects the benefits of higher royalty volumes, which have much better cash flow margins than working interest volumes and a decrease in LOE and other cash expenses as we divested non-op working interest assets.

With higher margins, our model enables us to materially reduce risk and generate cash even when commodity prices are low. We believe we will see an improvement in commodity prices, especially natural gas in the second half of the year as supply and demand imbalances improve, even if commodity prices remain depressed, we believe there are near-term opportunities for further growth in our asset base, as demonstrated by our encouraging results this quarter. Rig counts in the Haynesville dropped approximately 15% during the quarter from 76 to 64 rigs, but rig activity on PHX acreage went up from 10 in January to 14 at the end of the quarter. This is an encouraging sign for us, and it demonstrates the rigor and discipline we have employed in identifying, evaluating and securing minerals in the best rock quality and areas of highest drilling activity.

We have consistently spoken about our efforts to high grade our asset base and we now have a portfolio of highest quality projects, which should be the last to slow down in a commodity downturn. We think we are seeing that dynamic play out in the Haynesville and Scoop. Operators in our core focus areas are converting locations to cash flowing wells at a slightly higher pace this year versus last year, even with the lower commodity prices. We can continue to convert cash proceeds from selling non-operating assets into acquisitions to build our minerals portfolio as well as prudently manage our leverage. We completed a little over $10 million in acquisitions during the quarter, adding to our royalty asset base for future periods with greater emphasis on the scoop and continue to see ample deal flow.

Of note, our debt balance declined versus the December quarter, reflecting the positive cash flow generation of our model as well as flexibility in capital deployment. At this point, I’d like to turn the call over to Danielle to provide a quick operational overview and then to Ralph to discuss the financials.

Danielle Mezo: Thanks, Chad, and good morning to everyone participating on the call. For our March 31, 2023 ended quarter, total production increased 12% from the prior sequential quarter to 2,482 MMcfe. Quarterly royalty production increased 29% sequentially to 2,094 MMcfe, a quarterly company record. This increase was primarily a result of new wells in the Haynesville, Scoop and Bakken being put on production. The majority of which were purchased as undeveloped locations as part of our acquisition strategy. This is a clear indication of our successful execution of acquisitions ahead of the drill bit. Also note that we achieved this record royalty volume despite eight gross Haynesville wells where we have a high royalty interest experiencing intermittent production halt during the quarter due to pipeline constraints.

Had those wells been on for the full quarter, our royalty production volumes would have been even higher. We have been informed by the operator that these wells are back online at this time. On the working interest side, production volumes declined 34% sequentially to 388.5 MMcfe in the March 31, 2023 quarter. As a result of the sale of our legacy Eagle Ford and Arkoma working interest wells on January 31, 2023; and the natural decline of the working interest reserves. Note that working interest volumes will also decrease in the next quarter as the March 31, 2023 quarter had a full month of production associated with the divested assets. This is consistent with our stated strategy to exit this part of our business. Royalty volumes represented 84% of total production during our March 31, 2023 quarter.

As recently as calendar year 2021, royalty volumes were only 45% of our total volume. Reflecting on our reported volumes over the last several quarters, you will note our total corporate volumes have remained relatively flat. This is due to the loss of volumes associated with the sale of working interest assets, offset by the gain in our growing royalty volume. With the divestiture of our working interest assets virtually complete, we estimate our total corporate volumes, which are now 85% royalty will reflect steady growth in the coming quarters. Significantly, our corporate volumes were up by 12% despite working interest volumes being down sequentially 34% due to the sale of non-op working interest assets in January, as I discussed a moment ago.

As we have grown our royalty volumes and divested of our non-operating interest, the quality of our asset base is enhanced with improving margins. Additionally, 79% of our quarterly production volumes were natural gas, which aligns with our long-term position that natural gas is the key transition fuel for a sustainable energy future. Oil represented 13% of production volumes and NGL represented 8%. During the quarter ended March 31, 2023, third-party operators active on our mineral acreage converted 117 gross or 0.46 net wells in progress or WIP, to producing wells compared to 60 gross or 0.27 net WIP converted to PDP in the quarter ended December 31, 2022. The majority of the new wells brought online are located in the Haynesville, Scoop and Bakken.

At the same time, our inventory of wells in progress remained consistent at 198 gross or 0.64 net wells compared to the 203 gross or 0.83 net wells reported as of December 31, 2022. The continued track record of well conversions and replenishment of the inventory of wells in progress, or WIP, shows the repeatability of our business strategy. Additionally, we have mineral interest under a deep inventory of approximately 2,000 gross undrilled locations that will continue to feed this WIP activity. In addition to our WIPs, we regularly monitor third-party operator rig activities in our focus areas and observed 26 rigs present on PHX Mineral acreage as of April 10. Additionally, we had 95 rigs active within 2.5 miles of PHX ownership. The number of active rigs on our mineral acreage has actually increased quarter-over-quarter despite the recent decrease in natural gas prices.

We believe this is a result of owning minerals in the core of the basins in which we focus with competitive economics across various pricing environments. In summary, we continue to see steady development on both our legacy and recently acquired mineral assets, which should lead to annually increasing royalty volumes. Now, I will turn the call to Ralph to discuss financials.

Ralph D’Amico: Thanks, Danielle, and thank you to everyone for being on the call today. As a reminder, we recently changed our fiscal year to a calendar year. So when I refer to Q1, I mean March 31, ended quarter. We will file 10-Qs for the June and September quarters, and then a 10-K for the December 31 ended period. Natural gas, oil and NGL sales revenues was decreased 20% on a sequential quarter basis to a total of $11.9 million. Breaking down this number further, royalty sales volumes decreased 4% to $10.1 million as a result of higher production volumes, but lower realized commodity prices. Working interest sales revenues decreased 60% to $1.7 million as a result of lower production volumes associated with the divestiture of the Eagle Ford and Arkoma assets as well as lower realized commodity prices.

Realized natural gas prices averaged $3.53 per Mcf, 38% lower than the prior sequential quarter. Realized oil prices averaged $0.7601 per barrel, 8% lower, and NGLs averaged $25.18 per barrel, 13% lower. Realized hedge gains for the quarter were $630,421. This number is inclusive of the off-market derivatives where we received, and we received total cash of $256,676. Note that, we do not have any remaining off-market derivatives associated with the 2020 COVID-induced contracts. So the accounting and the understanding of our hedge contracts going forward in our financials should be a lot easier for everybody to follow. For the quarter, approximately 48% of our natural gas, 45% of our oil and 0% of our NGL production volumes were hedged at average prices of $4.06 and $63.10 respectively.

Approximately 40% of our anticipated remaining calendar 2023 natural gas production has downside protection through hedge contracts at approximately $3.31 per Mcf. On the oil side, approximately 55% of our anticipated remaining 2023 production has downside protection at approximately $74.92 per barrel. Most of our natural gas hedges are structured as costless collars, which means that we also have upside in those volumes to the $6 range. Our current hedge position is available in our most recently filed 10-Q. Total transportation, gathering and marketing decreased 22% on a sequential quarter basis to $1.13 million and decreased 32% on a per unit or Mcfe basis to $0.45, primarily as a result of our non-op working interest divestitures in the Eagle Ford and Arkoma, which had much higher per unit metrics compared to our royalty assets.

These expenses are primarily tied to changes in production volumes. Production taxes decreased 6% on a sequential quarter-over-quarter basis to approximately $581,000. These expenses are primarily tied to movements in both production volumes and commodity prices. LOE associated with our legacy nonoperated working interest wells, decreased 46% on a sequential quarterly — quarter-over-quarter basis to $546,000. Note that the Eagle Ford and Arkoma asset sales, which closed on January 31, 2023, still had a full month of LOE as part of the quarterly results. Removing the LOE associated with those assets would have shown a quarterly LOE expense of approximately $350,000. Cash G&A was down 11% to $2.35 million compared to the prior sequential quarter, as the prior quarter incurred costs associated with terminating our ATM program.

Adjusted EBITDA was $7.74 million in the quarter ended March 31, 2023, as compared to $5.33 million in the December 31, 2022 quarter. Adjusted EBITDA was positively impacted by higher royalty volumes, which have much better margin than working interest volumes and a 20% decrease in total cash expenses, primarily associated with the sale of our lower-margin, non-op working interest assets, while being offset by lower commodity prices. The noncash gain on sale of $4.4 million was associated with the divestiture of the Eagle Ford working interest asset. Recall the last quarter, we had a $6.1 million impairment associated with held-for-sale accounting from our Arkoma properties. Again, note that all of these are noncash items. Net income for the quarter was $9.6 million or $0.27 per share compared to $3.3 million or $0.09 per share for the prior sequential quarter.

Note that this includes the noncash gain this quarter and impairment in the prior quarter. Adjusting for these items and the unrealized mark-to-market on the hedges, pretax net income increased approximately 100% to $4.7 million or $0.13 per share. We had total debt of $26 million as of December 31, 2022, compared to $33.3 million as of December 31, 2022, as we use a portion of the proceeds from the sale of the Eagle Ford and Arkoma working interest assets, as well as our discretionary cash flow to reduce our debt level in light of current natural gas pricing environment. Our debt to trailing 12-month EBITDA was 0.91 times at March 31st, 2023. Lastly, as part of our regularly scheduled semiannual borrowing base redetermination, our borrowing base was reduced by $5 million or 10% to $45 million.

This reduction is associated with current natural gas pricing macro environment and not a reflection of the quality of our assets. We continue to have a great relationship with our bank group and we look forward to continue to partner with them across all commodity pricing environments. Our asset retirement obligation liability or ARO associated with working interest assets stands currently at $1 million as of March 31st, 2023. We have decreased this liability by $1.8 million since September 30th, 2021 when our ARO stood at $2.8 million. This reflects again just continuous improvement on our balance sheet profile. We recorded an income tax receivable of $776,000 this quarter compared to an income tax payable of $576,000 in the previous quarter.

This change was generated by a net operating loss due to the divestiture of the Eagle Ford working interest, which we anticipate will offset all federal taxable income in 2023 and be carried forward into 2024. Lastly, our mineral only strategy has minimal capital commitments, which allows us to pivot very quickly to reallocate capital as necessary be it to reduce debt, increase or decrease the size of our acquisition program, all while maintaining excellent coverage on our dividend. With that, I’d like to turn the call over to Chad for some final remarks.

Chad Stephens: Thank you, Ralph. Before we close, I would like to highlight a couple of important points from both Danielle’s and Ralph’s comments. First, with our non-op working interest divestitures largely complete, we expect to resume growth in our corporate volumes, which will be primarily driven by our increasing royalty volumes. Secondly, despite a 20% sequential drop in our quarterly revenue, our EBITDA was 45% higher this quarter. This is the result of a favorable mix of higher royalty volumes which increased by 29% and that created a higher margin of 60% this quarter versus 40% margins the last quarter. We anticipate operating with the higher cash margins going forward. Lastly, as we have pointed out, the hedges we established at the height of COVID at the insistence of our banks have now completely rolled off.

Our current hedge book provides much better downside protection, while maintaining upside exposure. We have made remarkable progress in transforming PHX over the last three years and have achieved on the specific plans we originally established and communicated to the market. We are now positioned to grow even further using the free cash flow from our quality assets and strong financial position and look forward to keeping you updated. Deservingly, I would also like to thank our dedicated employees for their hard work and congratulate them on our achievements to-date. Additionally, I would like to thank our Board of Directors for their support and insightful wisdom they provide in executing our corporate strategy. This concludes the prepared remarks portion of the call.

Operator, please open up the queue for questions.

Q&A Session

Operator: Thank you, sir. We will now be conducting the question-and-answer session. [Operator Instructions] And the first question comes from the line of Derrick Whitfield with Stifel. Please proceed with your question.

A – Chad Stephens: Thanks, Derrick

A – Ralph D’Amico: Thanks, Derrick

A – Ralph D’Amico: Derik, it’s Ralph. Yes, I think at this point, we do. Again, if you look at the rig activity on our minerals and as Chad pointed out, right, I mean, we’ve really focused on buy minerals in the core of the core, right? So in theory, right, those have the best margins. And if you’re an operator, those would be the last assets that you — where you drop a rig from. We have followed what all the operators have stated publicly in terms of rig activity. And we think there may be some softening coming towards the third quarter of this year from a rig count standpoint, this is in the Haynesville. But I think if you’re an operator and you’re looking forward into what the 2024 curve looks like and if they have the ability to hedge those volumes, right, they’re going to be — they’re going to have to make some decisions about whether they actually drop the rigs or did they keep them operating, right, and hedge into a much stronger 2024 versus 2023.

And I also think that would offset the — any potential decline in the Haynesville as we’re seeing very strong performance on our liquids-rich assets, both in the Anadarko Basin and some other areas of the country where maybe our nets are not that high, but we still have interest in whether it be in the Bakken or in the Uinta Basin, you continue to see activity with oil prices where they are. So all of that to say is, as we sit here today, we’re still very comfortable with the guidance that we provided.

A – Chad Stephens: Yes, Derrick Hi, this is Chad. Since January, gas prices had a stunning breathtaking plunge, we’ve really seen the bid ask between sellers and buyers. The gap has widened quite a bit. So it’s real difficult for us to transact in the Haynesville, given where we think the mineral values are and what the seller’s expectations are. So our capital allocation to acquiring more minerals in the Haynesville has slowed down even though we do see deal flow, it’s hard for us to transact at seller expectations value. So we’ve slowly pivoted toward and allocating more capital in the springboard in the SCOOP/STACK area in that higher quality rock quality areas and where operators are going to be drilling more wells in the SCOOP/STACK area that are more liquids-rich, and we’re having some success there.

Operator: And the next question comes from the line of Jeff Grampp with Alliance Global Partners. Please proceed with your question.

Operator: [Operator Instructions] Our next question comes from the line of Donovan Schafer with Northland Capital Markets. Please proceed with your question.

Operator: At this time, there are no further questions. And I would like to turn the floor back over to Chad for any closing comments.

Chad Stephens: Thank you, operator. Again, I’d like to thank our employees and shareholders for their continued support. I’d also like to note that Ralph and I will continue to expand our investor marketing activities over the coming weeks and months, through a series of non-deal road shows and conference presentations aimed at expanding investor awareness. If you’d be interested in meeting, please don’t hesitate to reach out to myself, Ralph, or the folks at IR. We look forward to hosting our next quarterly call in mid-August. Thank you, and have a good day.

Operator: Thank you, everyone. This does conclude today’s conference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.