Penn Virginia Corporation (PVAC) Q2 2021 Earnings Call Transcript

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Penn Virginia Corporation (ROCC)
Q2 2021 Earnings Call
Aug 4, 2021, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Penn Virginia Corporation Second Quarter 2021 earnings conference call. [Operator Instructions]

I would now like to turn the conference over to the Company. Please go ahead.

Clay Jeansonne -- Director of Investor Relations

Thank you, and good morning, everyone. I'm Clay Jeansonne, Director of Investor Relations for Penn Virginia Corporation, and we're pleased today to discuss our second quarter 2021 operational and financial results.

With me today is Darren Henke, our President, Chief Executive Officer and Director. Also joining us and available for our Q&A session are Rusty Kelley, our Senior Vice President, Chief Financial Officer and Treasurer; and Julia Gwaltney, our Senior Vice President of Development. Before we begin, I would note that today we will discuss certain non-GAAP measures. Definitions and reconciliations of these measures to the most comparable GAAP measure are provided in the Company's second-quarter earnings presentation and press release that can be found at www.PennVirginia.com.

Our comments today will also contain forward-looking statements within the meaning of the Federal Securities law. These statements which include, but are not limited to, comments on the pending merger with Lonestar Resources and our operational guidance are subject to a number of risks and uncertainties that could cause actual results to be materially different from those forward-looking statements, including those identified in the Risk Factors in the Company's most recent Annual Report on Form 10-K and quarterly reports on Form 10-Q.

So with that, I will now hand it over to Darrin to discuss our second quarter 2021 results and recent events. Darrin?

Darrin Henke -- President, Chief Executive Officer and Director

Thank you, Clay. We appreciate everyone joining us for today's call. Wow. I couldn't be prouder of our team. This quarter has been one of the best performing quarters for Penn Virginia which could not have been achieved without the tireless efforts of our entire employee base. It's quite rare that all within one month we get to announce significantly exceeding production expectations, lowering per well capital cost, improving operating costs, as well as announce a pending transformational merger. Furthermore, we are gaining access to the high yield capital markets, expanding liquidity, and having one of our highest free cash flow quarters in recent history.

Now, let me touch on some of those achievements in a bit more detail. After raising our oil guidance last quarter, we again exceeded the high end of oil sales guidance with 20,117 barrels of oil per day. And total sales volumes of 24,844 barrels of oil equivalent per day, both for the second quarter of 2021. Adjusted EBITDAX came in at $77 million, a 64% increase from the first quarter and beating Wall Street consensus estimates. Our operations team did an outstanding job during the quarter, reducing estimated per well cost by approximately 4% compared to initial guidance estimates for wells completed in the second quarter of 2021. Likewise, our production team continued to focus on lowering costs and reducing expenses. These actions lowered operating expenses per BOE by approximately 19% as compared to the first quarter of 2021. I'm also happy to report we generated significant free cash flow for the seventh consecutive quarter which lowered our net debt by approximately $30 million to $334 million as of June 30. In mid-July, we were pleased to announce our pending all-stock acquisition of Lonestar Resources. We view the transaction as attractively valued at a purchase price of less than $30,000 per flowing BOE per day of current production, which implies a discount to PV-10 value of Lonestar's proved, developed, producing reserves. In aggregate, we expect that this strategic combination will build on our financial strength and flexibility, and be accretive on key per-share metrics.

The complementary nature of Lonestar's high-quality assets provides Penn Virginia additional scale to deliver continuous, operational, and development excellence. The result is a significant increase in free cash flow generation, supported by an estimated $20 million per year of identified tangible synergies. The combination will also materially enhance our inventory of high return drilling locations, including the opportunity for additional extended reach laterals that are typically more efficient from a capital spending perspective, driving higher rate of return well economics. Importantly, the addition of Lonestar's approximate 250 identified gross well locations results in an anticipated 50% increase in the high rate of return drilling inventory for Penn Virginia. On a combined basis and only targeting one landing zone in the lower Eagle Ford horizon, independent reserve auditors estimate we have an approximate 750-well inventory.

Two-thirds of the combined Company's future wells are estimated to average approximately 65% well level rates of return when calculated using a flat $60 per barrel price. All 750 locations are expected to have an approximate 50% well level rate of return at the same flat $60 per barrel price. Nice returns to say the least and these returns are based on third-party reserve report assumptions. To put that in context, I am pleased to report that to date, the wells we spud in 2020 are currently outperforming our independent reserve auditors type curve projections by approximately 14% on a cumulative basis, implying the returns previously mentioned are likely conservative. Beyond the 750 wells reflected in our inventory count, we believe an incremental 150 gross potential wells can be added on Penn Virginia's acreage alone as a result of the work we and industry have performed evaluating the upper Eagle Ford formation, the Austin Chalk formation, down-spacing results in selected areas, and future participation in non-operated wells.

As we integrate Lonestar, we anticipate our future well count could increase significantly. Protection of the balance sheet is core to our disciplined approach to running the business. Our pending transaction with Lonestar is expected to be significantly accretive to free cash flow and other financial metrics, and thus should facilitate Penn Virginia retaining a strong balance sheet and ample liquidity. It is anticipated the combined entity will reach its targeted leverage ratio of 1 times, early next year. And just last week, we priced an inaugural $400 million of senior unsecured notes, successfully accessing the high yield capital markets. These notes will allow us to refinance Lonestar's existing long-term debt and Penn Virginia's second-lien term loan.

Upon closing the merger, Penn Virginia's capitalization is expected to include these notes, and an upsized revolving credit facility to enhance liquidity. We believe the pending acquisition of Lonestar is the next logical step in our journey to drive further targeted consolidation in the highly fragmented Eagle Ford. The combination follows our recent Juniper transaction, which added overlapping core acreage, improved our balance sheet, and further positioned Penn Virginia as a consolidator of choice. Numerous subscale operators in the Eagle Ford create a robust set of potential acquisition candidates. As such, we look forward to evaluating additional targeted acquisitions that will further reduce per-unit costs, expand margins, enhance returns, and increased financial strength and market relevance.

So, with that, we will open up the call to questions. Operator?

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Neal Dingmann with Truist Securities. Please go ahead.

Neal Dingmann -- Truist Securities -- Analyst

Good morning, all. Two questions. One, maybe first just, Darrin, for you on -- if we go to slide 12, could you talk a bit about -- [Indecipherable] this a little bit, but again more -- I'd like to hear more about inventories. Just -- it appears on that Slide that, I guess, the two questions about inventory. Could you give color on those 500 locations? I know it does talk about details on what you think of sort of returns are on that, but I'd like to hear your thoughts on that. And again, what you've continued to sort of discover as you've been there on the inventories [Phonetic]?

Darrin Henke -- President, Chief Executive Officer and Director

Sure, Neal. Thank you for the question. So relative to those 500 locations, that is only on Penn Virginia lands, that is only one landing zone in the lower Eagle Ford horizon, and it's with a well spacing in the 450 feet to 500 feet range. So, it's a conservative approach on those 500 future well inventory for Penn Virginia.

When we look at Lonestar, they add an incremental 250 gross locations, also, only in one landing zone in the lower Eagle Ford. Beyond that, other things we're looking at on page 15, we show you some down-spacing that we've done earlier this year, where we've drilled wells offsetting parent wells as close as 315 feet. And Penn Virginia is in a unique situation where many of the parent wells were completed with a legacy, hybrid gel completions, and they weren't really very productive, and what that leaves us with is an opportunity to even space our future wells closer to those parent wells. And on these two examples on page 15, these wells are even producing a greater rate of return than our -- than what we've shown on our inventory slide, over 100% on these groups of wells that we drilled earlier this year, the Reffenshack and the Munson Ranch. And not only are those wells outperforming what we had projected from an inventory standpoint, but we actually improved the parent well production by about 30% just from the offsetting fracs and how they improved the parent wells. So yeah, it's great inventory of the combined Company, 750 wells is what our reserve auditors are showing. And we think we can add hundreds of wells beyond that as we continue to understand our rock as well as Lonestar's rock. And we're digging into that every day.

Neal Dingmann -- Truist Securities -- Analyst

Great details. Yeah, you guys have done a good job delineating that. It's really been a nice change. And then, maybe just a two-fer, Rusty, for you. Just, could you talk a little bit about, I know you've had some pretty nice hedges, both as you put them on kind of as the quarter goes and prior. So, my thought is -- or I guess my question is, one just, could you just talk overview on, you and the guys for hedges philosophy? Today, as now that, obviously, the balance sheet is much improved, and as that balance sheet even gets down, I guess, according to my math, could be down to 1 times or so, I guess, if you include Lonestar, let's say, early next year. Including Lone [Phonetic], once you get to that, could you just talk about how you'd -- would the hedging philosophy sort of stay the same, pre-and-post-leverage kind of hitting that 1-ish times?

Rusty Kelley -- Senior Vice President and CFO

Sure. So taking notes, kind of in reverse, I would like to emphasize that 1 times leverage is the goal here and we're very fixated on making sure that we get there as quickly as possible. Part of that is the use of our capital to be very disciplined in line with what we talked about. And as commodity prices have increased, we've really used that excess free cash flow to pay down debt and just get to that 1 times quicker, so we're very focused on that. Part of that strategy though also is our hedge program, which is the question you asked. So, we continue to have a similar strategy currently, and will likely have a very similar strategy, even when we get to 1 times, which is to protect the capital invested as we invest it, so what you've seen is, as we roll, we continue to have a strategy of 70% to 80% of anticipated production, hedged in the near term, which we've defined as six months to 12 months. You have seen us inside of that. The difference that we've done is we have widened out some of those callers, just given the inflationary risk. But in today's environment, have been able to put the floors of those recent hedges, even though you see the averages here on the slides, we've got a lot of near term hedges with swaps with seven handles and floors on those collars with six handles, giving us upside into the sevens.

As we grow out further into the curve, we tend to hedge out to 18 months to 24 months, but we have widened those collars and we're really protecting that 55 floor, which in today's market gives us substantial upside up to what we're seeing kind of at today's spot rates. But we don't anticipate that to change materially, other than to make sure that we continue to protect the balance sheet from a binary position. And as we have lower leverage, we may continue to look at wider and more upside opportunities such as $55 puts that we've utilized or wider collars. But that's the only change we anticipate.

Neal Dingmann -- Truist Securities -- Analyst

All right, great. Thanks, guys. Great quarter.

Operator

And our next question today comes from Charles Meade with Johnson Rice. Please go ahead.

Charles Meade -- Johnson Rice -- Analyst

Yes. Good morning, guys. I wanted to -- or is -- guys and girls not, you're ladies and gentlemen. I wondered, Darrin, we could go back to those -- the question on the inventory, but slightly from a different angle. Your Slide 13 and Slide 14, it -- to me, it seems the -- to me, it seems that that southwest extension of your acreages is more derisked in the industry sense down there. And that the -- that the -- the greater rate of change on your inventory depth or quality is probably more likely in that northeast extension. But I wonder if you -- how you might agree or disagree with that perception and give us a little bit of a timeline on when we might learn a little bit more about these big five wells?

Darrin Henke -- President, Chief Executive Officer and Director

Yes. So I think relative to the northeast acreage, as you head Northeast off of this map on page 13, we certainly see more clay enter this system, and there is a point out there where the results aren't as good. And so, you could add a lot more sticks on this acreage than what we did, than just the 100 that we're reflecting in our inventory here on Slide 13. But the results are really impressive. If you look at the Svatek well, 12-month Cum. 155,000 barrels of oil from a 6,500 foot lateral. And I want to be clear that's oil, that's not equivalent, that is -- that is actual oil Cum. for that well. And then we brought on the Matocha with the Penn Virginia completion early this year, about 1,250 barrels a day, IP 30.

We are finishing up fracs today on the big five pad and a coiled tubing rig will be there to drill those wells out. So, we'll initiate flow back on those wells here in the immediate future. And certainly, excited about the productivity that we'll see out of those wells. When you back on page 12, relative to our, excuse me, I meant to go to page 14. Answering your questions around the southwest acreage, I do think it is more delineated. There is -- EOG has drilled a lot of wells in this area as well. We're showing the wells on the map that either Penn Virginia or Lonestar has drilled since 2018. And so, there is a number of EOG wells right in the middle of -- between the Penn Virginia acreage in yellow and the Lonestar in blue. And it's definitely a focus area for them and they've made a lot of really strong wells in this area right off our lease lines. And they're helping us put together our type curves. But you look at our recent Emerald well performance there, longer laterals, different completion design, and different flowback strategy. Those wells are triple the IP-30 versus Penn Virginia's last attempt in this area a couple of years back. So, we've made some material step change improvements in how we drill and complete those wells.

And Lonestar's drilled some really attractive wells down on their acreage which are reflected on a different slide, their results. So excited about that area. I do think it is a little more proven relative to all the acreage versus the northeast acreage. But as we continue to develop the northeast acreage, there could be a lot more than just the 100 wells that we're reflecting at this time in our inventory.

Charles Meade -- Johnson Rice -- Analyst

Yeah, it sounds more like an elevator trip rather than a step change down there. But if I could go back to Rusty, the comment you made about the target for the 1 times net debt or debt to EBITDA, is there a oil price or a set of commodity prices that you have in mind, when you put that target, or is it -- does it float up and down as the as the outlook changes [Phonetic]?

Rusty Kelley -- Senior Vice President and CFO

Obviously, commodity -- the higher the commodity price, the more free cash flow that can be generated. But when we've made those statements, I believe, what we used was a strip pricing, but the comment made about early 2022 was kind of the $60 and up type of pricing when we budgeted those numbers.

Charles Meade -- Johnson Rice -- Analyst

Got it. Thank you. That's it from me. Appreciate it.

Darrin Henke -- President, Chief Executive Officer and Director

Thank you, Charles.

Operator

[Operator Instructions] Our next question comes from Davis Petros with RBC Capital Markets. Please go ahead.

Davis Petros -- RBC Capital Markets -- Analyst

Good morning, all. Thanks for taking my question. I guess the first one is kind of a two-parter. One, is there a kind of an update on what you're seeing on the service, or in the raw materials cost inflation side of the equation? And then, secondly, you all have made good strides in reducing your well costs. I'm just wondering what additional levels -- levers are you guys seeing to kind of grind those lower over time and maybe offset some inflation in the next year?

Rusty Kelley -- Senior Vice President and CFO

Yeah, so inflation, year-to-date, we certainly have seen inflationary pressures. We see it first and foremost, probably the largest percentage on anything made of steel, seeing significant pressure there. And then, we've seen pressure on trucking, the drilling rigs, and then the frac fleets. And year-to-date, first half of the year, I'm really proud of how the teams performed. We've been able to overcome those inflationary pressures through operational execution and efficiencies. We set a couple of drilling records this year for the Company, we drilled about 7,400 feet on one well in 19.5 hours. We cut a mile in one well in a little over 12 hours, and those are great progress by our drilling team to reduce time and time is money in our business, of course. And then on the frac side, we are getting more efficient, getting more sand and water in the ground each and every day. We also did some simul-fracking in the second quarter where we're fracking two wells simultaneously and saw some efficiencies there. So, that's -- really proud of the team and how they've overcome inflationary pressures and actually came in in the second quarter, 4% under our expectations from a cost standpoint, on a per well basis.

As we look forward to the second half of the year, we're continuing to see inflationary pressures. And I -- we're going to attack them the same way. We're consistently looking for opportunities to do better tomorrow, what we're doing today. And figuring out is to everyday strive for improving the results and how we do it. So, that's really how we intend to overcome additional inflationary pressures that we'll see in the second half of the year as well.

Davis Petros -- RBC Capital Markets -- Analyst

Got it. Good to hear. And kind of my second question and building on that last part. I know, it's probably too early for kind of formal 2022 plans, but just high level as you kind of approach next year's budgeting process, is there kind of any inflation level you guys are baking into your estimates as well as kind of accounting for the loan store activity? Is there maybe a general idea on the amount of TILs or activity you guys are planning for next year?

Darrin Henke -- President, Chief Executive Officer and Director

Yeah, we haven't had any guidance for '22 at this point. We anticipate closing the acquisition in the fourth quarter, and we're looking at a lot of different budget cases for next year. Lonestar has been running a rig, Penn Virginia has been running two rigs. So, obviously, a logical case would be to look at a three-rig program. And we'll be looking at other pace of development as well.

Relative to inflation going forward, we are constantly updating our cost models on what our wells will cost, including changes we see on the horizon relative to inflationary pressures and we model those accordingly.

Davis Petros -- RBC Capital Markets -- Analyst

Got it. Thanks.

Darrin Henke -- President, Chief Executive Officer and Director

Yes, sir.

Operator

And ladies and gentlemen, our next question today comes from Nicholas Pope with Seaport Global. Please go ahead.

Nicholas Pope -- Seaport Global -- Analyst

Morning.

Darrin Henke -- President, Chief Executive Officer and Director

Good morning.

Rusty Kelley -- Senior Vice President and CFO

Good morning, Nick.

Nicholas Pope -- Seaport Global -- Analyst

How would you talk a little bit -- with the recent debt issuance, when that comes out of escrow, like how are you prioritizing I guess what -- I guess what the post-merger, what pay down would look like and what the priority is of kind of on the balance sheet, what you guys have, and kind of where the focus will be on the term loans, and the credit facility? And how you think about the priorities for pay down whenever that comes through?

Rusty Kelley -- Senior Vice President and CFO

Sure. So the high yield proceeds, when they're released from escrow was noted in the offering memorandum, will fully repay and refinance the Lonestar current long-term debt, both their revolver as well as the term loan that they have. We will also fully refinance the term loan, the second lien term loan at Penn Virginia. And then, any additional proceeds or differences will be made up by our revolver. And then, future pay downs from free cash flow will then be again directed toward our existing revolver, allowing us to get down to that 1 times. So, the pro forma capitalized structure would just leave us on a combined basis with a high yield, unsecured notes as well as a conforming bar -- RBL.

Nicholas Pope -- Seaport Global -- Analyst

Got it. That's helpful. And moving over to operating cost. Just looking at the, kind of, quarter-to-quarter moves on a unit basis, operating costs, gathering costs were down in 2Q a fair amount from 1Q. Guidance is kind of back toward the more into the range where they've been at the last -- the previous two quarters. And just, can you talk a little bit about the cadence of that, what's kind of causing that movement in operating and gathering costs there?

Julia Gwaltney -- Senior Vice President of Development

Thanks for the question. This is Julia. So on our actual run rate, it was fairly flat, just slightly down. On a unit cost basis, obviously, it was down to the production beat to guidance that we had. So what we're seeing going forward is just an ongoing continual run rate, pretty flat to what we have always been seeing, maintaining workover expenses at the same levels that we've had before. So, that's why you're seeing the -- a slight reduction to match to the overall year run rate. But going forward, pretty flat.

Nicholas Pope -- Seaport Global -- Analyst

Yeah. That's helpful. That's all I had. Thank you.

Rusty Kelley -- Senior Vice President and CFO

Thank you, Nicholas.

Operator

Ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to the management team for final remarks.

Darrin Henke -- President, Chief Executive Officer and Director

Well, thanks, everyone, for participating in the call today. Really good questions. You know, it's really a privilege to announce everything that we've done this quarter that we had a beat and raise in the first quarter, and then we beat production again in the second quarter. The wells we're drilling this year were outperforming the inventory projections that we've shown. Great rate of returns. I really appreciate the questions around our inventory. I think that Penn Virginia's inventory and then combine that with Lonestar, we've got an incredible 12-year to 15-year inventory going forward, just in one landing zone, in the lower Eagle Ford. So a lot of neat things to come. I look forward to learning from the Lonestar assets and how they operate their wells, and applying those learnings to Penn Virginia and vice versa. There'll be some synergies there that we can share and improve the Lonestar operations as well. So thanks again for calling in and we look forward to talking to you soon.

Operator

[Operator Closing Remarks]

Duration: 28 minutes

Call participants:

Clay Jeansonne -- Director of Investor Relations

Darrin Henke -- President, Chief Executive Officer and Director

Rusty Kelley -- Senior Vice President and CFO

Julia Gwaltney -- Senior Vice President of Development

Neal Dingmann -- Truist Securities -- Analyst

Charles Meade -- Johnson Rice -- Analyst

Davis Petros -- RBC Capital Markets -- Analyst

Nicholas Pope -- Seaport Global -- Analyst

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