Centennial Resource Development, Inc.

Good morning and welcome to the Centennial Resource Development conference call to discuss its second quarter 2022 earnings. Today's call is being recorded. A replay of the call will be accessible until August 11, 2022 by dialing 877-344-7529 and entering the replay access code or by visiting Centennial's website at www.cdevinc.com. At this time, I will turn the call over to Hayes Mabry, Centennial's Senior Director of Investor Relations, for some opening remarks. Please go ahead, sir.

Thanks, Chris, and thank you all for joining us on the company's second quarter earnings call. Presenting on the call today are Sean Smith, our Chief Executive Officer, George Glyphos, our Chief Financial Officer, and Matt Garrison, our Chief Operating Officer. Yesterday, August 3rd, we filed a Form 8K with an earnings release reporting second quarter earnings as well as operational results for the company. We also posted an earnings presentation to our website that we will reference during today's call. You can find the presentation on our website homepage or under presentations at www.cdevinc.com. I'd like to note that many of the comments during this earnings call are forward-looking statements that involve risk and uncertainties. They could affect our actual results and plans. Many of these risks are beyond our control. and are discussed in more detail in the risk factors and forward-looking statement sections of our filings with the SEC, including our quarterly report on Form 10-Q for the quarter ended June 30th, 2022, which is expected to be filed with the SEC later on this afternoon. Although we believe the expectations expressed are based on reasonable assumptions, they are not guarantees of future performance. and actual results or developments may differ materially. We may also refer to non-GAAP financial measures that help facilitate comparisons across periods and with our peers. For any non-GAAP measure we use, a reconciliation to the nearest corresponding GAAP measure can be found in our earnings release or presentation, which are both available on our website. With that, I will turn the call over to Sean Smith, our CEO. Thank you, Hayes.

Good morning and welcome to Centennial's second quarter earnings call. During the quarter, the company generated very strong operational and financial results with a significant increase in production levels, strong pricing realizations, record-free cash flow, a substantial amount of cash on the balance sheet, and a low leverage profile. Before George covers the quarterly results in more detail, I'd like to provide a brief update on our pending merger with Colgate Energy. Overall, I'm very pleased with the tremendous progress that's been made since the announcement. As you've likely seen from last week's definitive proxy filing, the shareholder vote is scheduled for Monday, August 29th, and we expect to close shortly thereafter. Both the Centennial and Colgate teams have made significant progress on the merger integration so that the new company will hit the ground running on day one. With all of that said, for the purposes of today's call, that will be the extent of my remarks related to the Centennial Colgate merger. Around the time of closing, senior management will provide a fulsome company update, which will include forward guidance, anticipated drilling and completion activity, and details on the return of capital program, amongst other things. Now, I'll turn it over to George to cover the results for the second quarter.

Thank you, Sean. Turning to our financial and operational results, which can be referenced on slides 4 and 10 of the earnings presentation, Q2 results were quite strong as a significant increase in production levels and higher commodity prices drove record free cash flow and a material decrease in leverage. Net oil production for the second quarter was approximately 36,700 barrels per day, which was a 12% increase relative to Q1. Average net equivalent production increased 14% compared to Q1 and totaled 70,240 barrels per day. Total revenues increased by 36% to approximately $473 million, with a 33% increase in oil revenues, a notable 74% increase in natural gas revenues, and a 21% increase in NGL revenues. Unit costs for the quarter benefited from the increase in total production, in addition to continued cost control in the field. Compared to Q1, Q2 LOE of $4.52 per barrel declined 13%, and cash G&A of $1.95 per barrel was down approximately 8%. GP&T was up slightly at $4.03 per barrel, primarily as a result of strength in natural gas prices. The company generated approximately $137 million of free cash flow during the quarter, which was inclusive of 5.7 million of merger-related expenses. This represented a 55% increase in free cash flow compared to Q1. Adjusted EBITDAX totaled 297 million, which was up approximately 37% from Q1. Lastly, net income for Q2 totaled approximately 192 million. Turning to CapEx, During Q2, Centennial incurred approximately $141 million of total capital expenditures. We spud 19 wells during the quarter, which was six more wells than were spud in Q1. Additionally, we completed 13 wells during the quarter and also incurred capital from additional wells that were ultimately completed in early July. Overall, capital levels increased on a quarter-over-quarter basis as a result of higher drilling activity tied to the temporary usage of sputter rigs, a 17% increase in the average completed lateral length, and general OFS inflation. On slide five, we summarize our capital structure, leverage, and liquidity. As of June 30th, we had approximately $200 million of cash on hand and no borrowings on the revolving credit facility. As a result, total net debt was approximately $615 million, and net debt to LTM EBITDAX declined to 0.7 times compared to 1.1 times at the end of Q1. Finally, I wanted to note that Centennial has been unable to repurchase any company stock due to restrictions related to the pending Colgate merger. We look forward to communicating the new company shareholder return program around the time of closing. With that, I'll turn the call over to Matt to review operations.

Thank you, George. Q2 was another solid quarter for the operations group, turning online some strong wells while sustaining our operational efficiencies gained to date on the drilling and completion side. More specifically, our completions crew continues to impress, as we believe it is one of the most efficient zipper crews in the Delaware Basin. Overall, our fleet has averaged approximately 2,000 feet of lateral stimulated per day for the first half of the year, which compares to 1,700 feet per day in 2021. This nearly 20% increase in footage per day is another example of Centennial Operations driving additional efficiencies in the field and informed our decision to implement a sputter rig program for the portion of the quarter to assist with the drilling of the first and second intermediate sections. As a result, we spud 19 wells during the quarter which represents a 58% increase versus our quarterly average for 2021. Turning to well results, our operations team brought online some outstanding wells in the second quarter, including four out of our top 10 wells in company history. Located in Lee County, the Tostada and Gordita package was a five well grouping targeting the third bone spring sand. This development averaged just shy of 10,000 foot lateral lengths. The IP30s for the package were approximately 3,000 BOE per day, which is 84% oil, or 2,500 barrels of oil per day per well. Additionally, the Tostada 602 saw single-day production numbers that exceeded 5,400 barrels of oil per day, while the Tostada Statecom 601 and Gordita State Comm 602 and 603 each boasted single-day production numbers exceeding 4,100 barrels of oil per day per well. These are fantastic wells, and I'm extremely proud of our operations and asset teams for delivering these results. A little further south in New Mexico, the Airstream wells were drilled as a three-well pad. also targeting the third bone spring sand interval, with approximately 9,800 foot lateral lengths on average. Like the Tostada and Gordita package, production numbers were strong, posting IP30 numbers of almost 2,300 BOE per day, or 1,900 barrels of oil per day. Overall, our team did a tremendous job during the first quarter, bringing online some strong wells and puts us on our front foot heading into the merger. Turning now to ESG on slide 6, we recently released our second annual Corporate Sustainability Report, which covers 2021 performance and is available on our website. I am extremely proud of our employees and the ownership they have taken relative to our ESG initiatives. In this year's report, we introduced our alignment with the Task Force on Climate-Related Disclosures Framework. expanded our emissions reporting to include Scope 2 disclosures, and expressed our commitment to the World Bank's initiative to end routine flaring by 2030, which we have already implemented in our operations. With regard to performance, we reduced our 2021 Scope 1 greenhouse gas intensity rate by almost 30% year over year, lowered our flaring rate to 1.2% compared to 4.4% in 2020, and increased our recycled water usage by 17% year-over-year. These are just a few of the highlights from this year's annual report, and I encourage everyone to review it further at your convenience. Also in Q2, we completed the build-out of our Merchant Water Recycling Facility in Lee County, New Mexico. This facility is capable of recycling one million barrels of water each time it is filled up to capacity. For wells within the operational area of this recycling facility, we believe our recycling efforts will save on average approximately $100,000 in completions-related costs per well, not to mention the additional LOE savings associated with the project. It is our goal for future wells in this area to utilize 90 to 100 percent recycled water going forward. This water recycling facility is just another example of our operations team's pursuit to generating cost savings opportunities across every discipline. To wrap up, I'd like to make a couple of comments about my thoughts relative to the future of the combined company. After spending time with both the Colgate and Centennial teams, one thing has stood out to me, and that is the quality of the employees in both companies. Upon closing, I believe that we will have one of the highest caliber employee bases in the industry, and I am proud to lead the operations and technical teams in the next phase of this company's history. With that, I'll turn the call back over to Sean for closing remarks.

Thank you, Matt. The Centennial team is performing at a very high level. Turning back to slide four, you can see that during the quarter, we increased oil production volumes by 12%, delivered almost $300 million of EBITDAX, generated record-free cash flow of approximately $137 million, reduced total net debt by $150 million, and lowered our leverage to 0.7 times. Combined, this provides us with very strong operational and financial momentum headed into the combination with Colgate Energy. In closing, I am truly excited for the company's next chapter, and I couldn't be more grateful for our employees' hard work and dedication over the years and during the integration period. Upon closing, the combined company will have a high-margin, low-cost asset base with an extensive portfolio of long-dated, high-return inventory capable of delivering significant shareholder returns. We look forward to closing the transaction shortly after the shareholder meeting, which is scheduled for later this month. Before we go into Q&A, I'd like to remind everyone to please hold your questions related to the pro forma company as we expect to provide more details on the combined company at closing. Thanks for listening, and now we'll go to Q&A.

Thank you. The question and answer session will be conducted electronically. If you would like to ask a question, please do so by pressing star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. Today's first question comes from Scott Hanold with RBC. Please proceed.

Thanks. Good morning. Just curious on the well that you drilled this quarter, or the second quarter, seemed like you had a number of them that, as you put it, were company records. Can you talk about what's going on there? Is that more geology? Are they techniques that you're tweaking? And then also, if you can add a little bit of color on the cost savings you get for using the sputter rig and obviously drilling the longer laterals.

Sure. I'll go ahead and kick that one off with some of those well results. Those wells, the Tostada and Gordita wells, are located in our northern prior block, which is kind of the big central block in our Lee County acreage. And it's been an area that traditionally we've been developing across multiple different horizons. Second bone spring is more of the historical well result that we've been talking about. These new wells are now in the third bone spring below the second bone spring, and they represent kind of our best practices to date, right? You know, with regard to targeting and well spacing and our most modern and up-to-date completions designs that we've been looking at over the past several years. So we believe, you know, the well results themselves are the reflection of our ability to develop multiple zones as well as the larger packages of wells, which I think historically we've done, you know, prior to 2022, you know, our average pad size were in the range of two to three well pads. These are much more robust development packages, so we're seeing a lot more better ratios of parent-type performance of these wells as we start to really develop larger packages of wells. And our infrastructure setup in New Mexico at this point is able to accommodate those larger packages of wells as we've grown into that asset and been able to make sure that we've got the ability to do these large packages of wells. So we think it's kind of the culmination of a bunch of different things, geology on the forefront, And then our operations ability to execute larger packages of wells and flow them back the way we've been doing it. But very good results, I would say. It's not really surprising to us. We always view that acreage as top tier. And so we think that these results are in line and exceeding even some of our internal expectations. But that bar is high. Maybe turning to the sputter rig now. I'll address some of that. The reason the sputter rig program was set up is because our completions efficiencies have skyrocketed this year. We're very pleased with the average cycle times of our completions crew. At 2,000 feet a day, average treated lateral lengths. That really forced us to consider, with the size of our program, the ability to balance that increased pace on the completion side with our drilling cadence. And so the way we see that sputter rig is it really further compresses our cycle times and it allows us to run still with the two-rig primary program and the single frac spread and balance those two schedules out together just fundamentally as the completions cadence has significantly upticked this year.

Okay, that makes sense. And, you know, I appreciate the fact, you know, you don't want to get too much into the pro forma, you know, look for the merge companies. But maybe if I could ask a question on just how are you seeing inflation? How are you all set up with inflation, you know, from here going into 2023? And, you know, when you think about the combination of Colgate and Centennial, how does that sort of, you know, potentially mitigate some inflationary pressures in your view?

I can start with that and then I'll pass it around the room if anybody needs. This is Matt again. One of the things we've really sought to do between the two companies is look towards the size and scale component as a way to avoid having to do things like, for example, the sputter rig as a whole. In the new company where there's more rig activity, more acreage positions, There's opportunities for us to do things on a larger scale with regard to rig and fleet activity. I would think some of that may be in the form of different vendor companies, third parties, and we have to still kind of work through some of that. As it pertains to things that we can control, we have done our best to lock in pricing on some of the tangible elements like steel and casing and as well as sand contracts and things like that, those have been done both independently by the companies heading into the merger. And we're pleased with how both companies have managed those independent of one another. So we believe we're in a very good place heading into the new company to be able to mitigate and address a lot of those inflationary concerns. And frankly, we see a lot of opportunities here. to bring our cycle time reductions and our completions cycle times over, over in the new company that just is going to keep the pressure on those costs heading in the right direction.

So, so like, what do you think the leading edge inflationary is, you know, pressures are into 2023? Would you, you have, do you have an opinion on that yet?

You know, Scott, I'll take that. You know, it's, We're still working through some of those things, obviously, with the combined company, and we're looking for operational best practices as well as syncing up rig cadences and things like that. So there's a lot to work on on the capital side. Obviously, we think there is going to be pressure if prices remain high where they are today, although my guess is that it's starting to level off. Some prices have backed off from their previous highs. So I think we've seen a lot of the major inflationary items already hit, and they're already priced into our current budget. So Without giving you too much more specific, I would say look forward to releasing kind of forward-looking capital guidance and rig cadence after we close the deal.

Understood. Thanks.

Thanks, Scott. The next question comes from John Annis with Stiefel. Please proceed.

Hey, good morning. For my first question, I wanted to touch on the Inflation Reduction Act and specifically the minimum tax and methane fee components. Could you speak to the expected implications for Centennial?

Sure, I'll take a look at that. I'll take a first shot at that, and George can chime in if he needs to. We certainly are aware of that and have been monitoring that as it comes along and understand what is at least initially being proposed. Obviously, there's a lot of legislation that still has to take place for that to get passed and we'll see what form that takes. You know, there are certain limits that they are proposing on the size of company based on amount of income that you generate, and so we'll see how all that comes together and how we need to forecast that for the pro forma company. But as of right now, it's just kind of a wait and see and monitor mode, and we are certainly on top of that from a regulatory and government relations point of view and making sure it gets forecast if should it become legislation when it gets voted upon.

Got it. And then building off of Scott's question on the Tostada and Gordita package, was there anything specific in the geology or development approach of those wells that strengthens your view on the implied value of Colgate's acreage, or is the geology somewhat different between those two areas?

The geology is quite different between the two areas, but I've also seen their well results in the Eddy County assets, and they're extremely economic in different ways. I mean, the shallower drilling costs, the lower cost overall of completions, and then the steady and solid production that comes from the Eddy County assets, both in the second and the third bone spring sands, are very, very comparable in terms of asset quality and just the sheer size and scalability of that asset in Eddy County. But the geology is very different from one area to the other, with the exception of the formation names. I mean, the formation names are common, but the quality of the rocks are very different. And so the way we will execute the Eddy County assets is going to be different than the way we execute the Lee County assets.

Makes sense. Thanks for taking my questions.

Thank you.

As a reminder, if you do have a question, please press star, then one.

Our next question comes from Danny Pukin with Truist. Please proceed.

Hi, good morning. I was wondering if you could talk about some of the operating efficiency specifically, you all continue to highlight extended laterals. So I'm wondering how much higher returns do you all assume the longer lateral has?

Without giving specifics on that, you know, I think that, you know, we continue to push where we can on extending laterals. Longer laterals tend to be better from an efficiency point of view and and generate higher returns. We average, it was 8,000 or so lateral feet this quarter. Anywhere we can push that, we will. That's one of the interesting things about the combination with Colgate. We think there are some opportunities there to continue to extend laterals. That being said, it's not a brand new thing for us. We have been doing this for a few years now and just look for any opportunity we can to drill longer laterals. Our average well going forward is typically, it leans towards a two-mile lateral. And so that's how we think we'll be developing the assets on a go-forward basis and think it's the most efficient way going forward.

Okay, great. Thank you very much. And then my second question is on pad size. How large of a well package should we think about in the near term?

Yeah, it's a good question there, Danny. You know, what we've been working on over the past couple of years is building out pad sizes from smaller incremental numbers in the past, historically two wells and three wells, to more robust three, four, and five well packages on average. I would say, you know, that... answer varies by the asset in which we're developing. Some of the assets just have different well spacing assumptions, and so more packages of wells in more of a stacked component can be what you might expect to see. In some areas like the Lee County assets or even some of the assets in Reeves County, those may be different on the order of threes, fours, and five wells. I think the opportunities to put more wells on the pads, they really emerge across areas where there's mature infrastructure in place where we know we have the flow capacity to take that kind of volume relative to the initial flow backs. But I wouldn't be surprised if you continued to see well packages that vary between three and six on average with the occasional increase higher-sized pad being thrown in just by virtue of proximity to known infrastructures and things like that.

Okay, great. Thank you. That's it for me.

Thank you. Thanks, Jenny.

At this time, there are no further questions in the queue, and this concludes our question-and-answer session as well as our conference. Thank you for attending today's presentation, and you may now disconnect.