Callon Petroleum Company

Ladies and gentlemen, thank you for standing by and welcome to the Cow and Petroleum first quarter 2022 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question, you'll need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require operator assistance at any time, please press star 0. I would now like to hand the conference over to your speaker today, Kevin Smith, Director of Investor Relations. Please go ahead, sir.

Thank you, Julian. Good morning, and thank you for taking the time to join our conference call. With me on today's call are Joe Gatto, President and Chief Executive Officer, Dr. Jeff Balmer, SVP and Chief Operating Officer, and Kevin Haggard, SVP, Chief Financial Officer. During our prepared remarks, we may reference the earnings results presentation and our first quarter earnings press release. both of which are available on our website. So I encourage everyone to download both documents if you have not done so already. You can find the slides on our events and presentations page and the press release under the new settings, both of which are located within the investor section of our website at www.cowen.com. Before we begin, I would like to remind everyone to review our cautionary statements, disclaimers, and important disclosures included on slide two of the presentation. We will make some forward-looking statements during today's call that refer to estimates and plans. Actual results could differ materially due to the factors noted on these slides and in our periodic SEC filings. We will also refer to some non-GAAP financial measures today, which we believe help to facilitate comparisons across periods and with our peers. For any non-GAAP measures we reference, we provide a reconciliation to the nearest corresponding GAAP measure. You may find these reconciliations in the appendix to the earnings presentation slides and in our earnings press release, both of which are available on our website. Following our prepared remarks, we'll open the call for Q&A. And with that, I'd like to turn the call over to Joe about it. Joe? Thank you, Kevin, and good morning to everyone on the call. As always, I encourage you to review the earnings presentation on our website as background for our commentary. I will start with a review of our first quarter results. We got off to a great start to the year with operating and financial results exceeding both guidance and consensus expectations. For the quarter, total production came in above the top end of guidance at over 102,000 barrels of oil equivalent per day, carrying oil cut of 63% and a total liquids content of 82%. Part of the outperformance was driven by well productivity from the initial round of larger scale projects in our new Delaware South area that was better than forecast in both the Wolf Camp A and Wolf Camp B formations. Just as impactful, we made meaningful progress lowering operating costs despite inflationary pressures in the field. We were able to reduce absolute lease operating costs by $6.2 million and gathering and transportation expense by $1.3 million, both on a sequential basis. As Jeff will discuss in his prepared remarks, we are taking additional steps to further decrease operating costs over the course of the year. Strong oil and natural gas price realizations experienced during the quarter, combined with cost structure improvements, resulted in a second consecutive increase in quarterly operating margins, driving a leading operating margin exceeding $58 per BOE in the first quarter. Switching to the capital program, Our disciplined reinvestment rate of just over 45% drove another quarterly increase in free cash flow, while also setting us up for efficient production growth in the second half of the year. During the quarter, we increased our drilled but uncompleted backlog by 15 to a total of 42 wells. With our duct backlog at a more normalized level, we are now positioned to start increasing our completion pace. This uptick in activity will drive a projected 10% increase in daily oil production by the fourth quarter, as previously outlined in our 2022 operational plan in February. Town's operational capital spending for the first quarter was $157 million, below our guidance of between $175 and $185 million. The savings was driven by a deferral of a portion of our permian infrastructure spend, which we now expect to occur in the second quarter, in addition to realized capital efficiencies. As we've all heard this starting season from energy companies across the value chain, inflationary cost pressures have continued to build in the labor, materials, and equipment markets. As a reminder, we factored in an average price escalator of 10% for our 2022 capital budget at the beginning of the year to account for inflation estimates at that time. This outlook also gave consideration to capital efficiencies from longer laterals and expected integration synergies related to Delaware South. Given the rapid increase in oil prices and resulting market tightness, we have been proactive in recent months entering into new or modified agreements that provide a certainty of key services to ensure execution of our program with top-tier service and materials providers. I'm pleased to say that we have secured all of our needs for completion crews, drilling rings, sand, and steel casing for 2022, and for some of these categories into 2023. In addition to reliable access, these agreements come with a varying level of price certainty. For example, the agreement for one of our completion crews provides a full year of firm pricing in 2022. However, in other agreements, we are exposed to price reopening discussions over the course of the year, which is typical for these types of industry agreements. Given the rapidly developing dynamics of the service market and recent industry data points, we are evaluating several scenarios for incremental headline inflation impacts on our capital program for 2022. Depending on the outcomes of upcoming pricing discussions and the overall pace of oil and field price increases as the year continues to unfold, Some scenarios show service inflation impacts moving into the mid to upper single digits. However, as evidenced by our first quarter capital spend in a rising price environment, we will continue to drive initiatives that increase our operating efficiency to help mitigate potential drilling and completion-related price increases in the coming quarters. Importantly, our operational program remains intact. and remain confident in achieving our targeted leverage metric of between 1 to 1.25 times EBITDA by year end 2022 if price is well below the current strip. This outlook covers a wide range of outcomes from our vendor pricing discussions and benefits from both having four months of the year behind us and the cost certainty embedded in some of our existing service agreements extending into the year end. We also remain focused on lease operating expense to preserve our differentiated cash margins. Good progress has been made to offset inflationary cost pressures, with first quarter results serving as a good example. We delivered a sequential decrease in absolute LOE spend, in large part from synergies we have realized in the Delaware South area. Lastly, thanks to the strong start to the year, we continue to pay down debt and strengthen our balance sheet at a faster than anticipated pace. After generating over $180 million in free cash flow in the first quarter, which was our eighth consecutive quarter generating free cash flow and third consecutive quarterly increase, we are on pace to achieve our goals of exiting this year with a leverage ratio nearing one times EBITDA and absolute debt approaching $2 billion. As we turn to the second quarter outlook, we recently accelerated the timing of a portion of our 2022 Eagleford program to navigate potential Permian bottlenecks that we saw earlier in the year and mitigate some pricing pressures. Looking at our second quarter production profile, we expect volumes to be relatively flat with the first quarter of 2022, while momentum builds from increased completion activity into the second half of the year. The number of wells drilled will be relatively similar in the second quarter versus the first quarter, but our placed on production wells are expected to rebound to over 30 net wells. With the meaningful uptick in activity, Our operational capital spending is forecast to be between $225 and $240 million on an accrual basis, including a catch-up on some deferred spending from the first quarter. I will now turn it over to Jeff to discuss operations. Thank you, Joe, and good morning, everyone. As Joe mentioned, we had a great start to the year. Operationally, we exceeded our production forecast, as well as results in the Delaware and Midland Basins never beat our expectations. And despite the ongoing inflationary environment, we maintain discipline, with our capital costs coming in below forecast. Lastly, I'm proud to report that we are successfully implementing our strategy to reduce operating expenses on our Delaware South assets. Partly in response to the increase in oil and natural gas prices, during the quarter, we elected to add a workover rig and increase the company's workover activities by approximately $3 million sequentially. Workovers and re-completion activity are some of the highest rate of return projects in our portfolio, with payback periods of less than two months. And during the three-month period, we elected to increase the pace of installation of electric submersible pumps, or ESPs, installing some of these ESPs after only two months of initial production versus the normal four months. Specifically at our Elk Alley and Nibbets wells, we realized average production increases of 40% within days of installing the downhole pumps. We remain extremely focused on overall operating expenses in all of our areas. We've had an excellent start to 2022 and a large part of offset many of the inflationary pressures by increased operational efficiencies, such as improvements in overall artificial good strategy, Compression advancements and sourcing cheaper supplies like chemicals. And I'm also very excited to mention that our efforts to reduce our methane intensity remain on track as our program to change out pneumatics has had a great start. Now I'd like to provide you with an update on each of our operating areas. So starting with the Eagleford. During the quarter, we drilled nine wells on three paths as part of our ongoing five-panel 26-well 2022 Eagleford Development Program. We commenced completion operations on the first of these paths in early April and plan to complete the remaining paths in the second and third quarters. As we discussed last quarter, as part of this program, we will be drilling and completing an Alcantara test well, and we plan to complete this well in the third quarter. Shipping to the Midland Basin, we continue to have success with our multi-bench development and our life appeal development philosophy. One example of this are two four-well pads that we placed on production in our sidewinder area that were completed at year-end. The eight 9,500-foot lateral wells were completed targeting multi-bench development in the well camp A and B and lower spray drain formations and had an average 30-day production rate of 1,150 BOP per day with 84% oil. During the quarter, we had two rigs running in the basin and drilled nine wells with completion operations commencing at the beginning of April. We plan to keep a two-rig drilling program on the Midland acreage through the second quarter and then drop down to one rig for the remainder of the year. Moving to the Delaware, all of our completion activity in the first quarter was focused on our Delaware acreage. And during the quarter, we completed 16 wells and brought on 9-11. The 11 wells were completed targeting multi-bench development in the Well Camp A and Well Camp B formations. Two pads that I'd like to highlight are the 6-well Kesey unit and the 5-well Campbell unit pads, both on our Delaware South acreage. These 9,000-plus-foot laterals achieved strong production results, with the Keseys generating a peak average 30-day rate of 13.12 BLE per day, and the Campbell wells with an average 30-day rate of $11.99 per day and around 80% in wealth. By increasing the parent size from two to three wells to five and six, respectively, we were able to realize cost benefits. Given the lower cost and the strong production profile, we expect these wells to pay out in as little as six to seven months, further boosting our capacity to generate free cash flow. Besides the strong Delaware well results, we've made strides in lowering our operating costs on our Delaware South asset. During the quarter, we switched service providers on items like chemicals to enter into more favorable pricing. This helped reduce our LOE per BOE on our Delaware South asset by 23% sequentially. We've scheduled some facility upgrades for the asset later in the year, which should also provide the opportunity to increase efficiency rates and further lower our feature costs. Before turning the call over to Kevin, I'd like to discuss the current service price environment and the steps that we've taken to contract our service needs and mitigate price volatility. Over the last several quarters, we've felt inflationary cost pressures on many different service items, such as the labor materials like fuel, steel, sand, and also equipment. Our multi-basin asset base provides flexibility as the service market is not as tight in Eagleford as it is in the Fernies Basin, which provided us the opportunity to flex our program as we've done in the second quarter. Additionally, we've used our scale and steady development base to enter into service contracts that reduce price volatility and provide greater service assurance. We entered the year operating seven rigs with stagnant maturities locked in for most of 2022. And in keeping with our original plan, we'll be dropping one grid next month. On the completion side, we're utilizing two crews. We entered into a long-term contract for one of the completion crews in the fourth quarter of 2021 that is renewable on an annual basis for two additional years with embedded performance incentives. We also restructured our locally sourced sand supply contractor in the quarter to lock in our sand requirements for our two completion crew program for the remainder of the year. We've contracted Steel Hasing to meet our drilling program needs for 2022. Therefore, we feel really good about the steps we've taken to provide service assurance while maintaining our focus on margin improvement. And with that, I'll now turn it over to Kevin to handle the financials. Thank you, Jeff. It's a great way to start the year generating financial results like those we achieved this quarter. We increased our operating margin by 20% sequentially, and our adjusted EBITDA was up 16% sequentially. The strong free cash flow generation of the quarter resulted in continued debt reduction. I am happy to be able to point out our LTM net debt to EBITDA metric now starts with a one handle at 1.97 times. Now let's go through the details. Our tier-leading operating margin once again increased, driven by a 23% increase in oil price realizations on a per unit of production basis. On the cost side, the actions that Jeff discussed helped lower lease operating expenses compared to last quarter. We also realized a total dollar increase in our gathering, processing, and transportation costs. However, both LOE and GT&T increased on a per-unit basis due to the sequential reduction of production volumes. Our top-tier margins helped us generate an adjusted EBITDA of $394 million in the first quarter. The increase in adjusted EBITDA, combined with the reduction in interest expense and continued capital conservatism, drove a significant sequential increase in adjusted free cash flow. During the first quarter, Cal generated adjusted free cash flow of approximately $183 million. This is a good place also to remind you that our 2022 oil hedges are more weighted to the first half of the year, and in particular, the first quarter was our highest hedged quarter of the year. Our near-term plan continues to be to use our free cash flow to pay down debt. During the quarter, we paid down our bank debt by approximately $73 million, exiting the quarter with just over $700 million drawn on the facility. For a further look at the second quarter, using current strip prices, we would end Q2 with less than $600 million drawn on our credit facility, continuing the debt paydown. As part of our work to optimize the balance sheet and increase cash flow, we will look to retire some of our high-cost term debt this year. As mentioned on the last call, we expect to retire the 9% second-lead notes when they are callable on October 1st. We also have a small portion of 8.25 bonds that are callable at reasonable premiums as well. Thankfully, with the free cash flow we are anticipating generating this year, we have many options to further reduce our overall debt balance and continue our process of extending our maturities while at the same time lowering our weighted average interest rate. We laid out one of these options on page 10 of our first quarter earnings slide deck. Turning to hedging, our hedging program for 2022 is essentially complete with approximately 45% of our oil production hedged for the balance of the year. As we look to 2023, we have positioned the portfolio with a good base layer of hedges. With strength in the oil and natural gas futures curves, we will look to opportunistically add 2023 hedges over the remainder of this year. However, we will note as our leverage continues to decline and our balance sheet strengthens, we expect to hedge less volumes, or said another way, a lower percentage of production than we have historically. Finally, I want to head off the likely questions from our Q&A session regarding the timing of shareholder returns. At current commodity prices, we are targeting using free cash flow to repay debt until we achieve a net debt to EBITDA ratio of one times and are below $2 billion in total debt. In addition, we would like the flexibility and time to do some balance sheet cleanup and optimization this year, including the second-game redemption I discussed earlier. Before starting to return capital to shareholders, we want to make sure we have a balance sheet that can support a full range of commodity prices, including a mid-cycle oil price and a downside case with WTI as low as $40. While we work to continue to achieve these leverage objectives, we will also be working internally to evaluate our financial capacity to offer sustainable shareholder returns. And as I mentioned on our last call, it is important for us to retain corporate flexibility to invest in our business, which ultimately allows us to deliver sustainable long-term returns to our shareholders through all phases of the commodity cycle. And with that, I'm going to turn things back over to Joe before we move to Q&A. Thanks, Kevin. Just to wrap up, we entered the second quarter having consistently exceeded our commitments to leverage reduction and operational performance. Our LTM net debt to EBITDA ratio is now below two times and free cash flow generation has been repeatable and rising. Importantly, Calendars is one of the deepest inventory of top tier projects amongst our peer group, putting us in an enviable position for a critical component of the free cash flow discussion, that being sustainability over time. This longer term visibility will provide numerous capital allocation options for shareholder value, including further debt reduction, return to capital, and reinvestment in the business. Operator, you may now open the lines for Q&A.

Thank you. If you would like to ask a question, please press star followed by the number one on your telephone keypad. To withdraw your question, please press star one again. We'll pause for just a moment to compile the Q&A roster. Our first question comes from Neil Dingman from Truist Securities. Please go ahead. Your line is open.

Morning all, Joe and team. My first question is on operations. Joe, maybe for you or Jeff, just specifically, could you all talk a bit more on, I'd really like to hear more on that build-out of the duck inventory in the new Delaware South Acreage. I'm just really wondering around that, what will this do to sort of future developments and results? I like that you all, unlike some others, are really building this out, doing a larger full-scale development. But then when I heard about the duck inventory as well, curious to know what you think the upside will be around this.

So this is Joe. I'll start off. I mean, Jeff wants to chime in on the back end. But if you recall, we stepped into the position that the historical operator was really doing one, two well types of paths. That's not our philosophy, as you know, from field development, co-development mindset. So in order to create flexibility to move to larger projects, we had to build out a duct inventory system. over the last couple of quarters. And by the first quarter, we started getting after it with a five-well pad and a six-well pad. So we're sort of steady state now, but it was really a one-time event to get that area ready for the type of operational development that we deploy. Yeah, and just one other thing to add is we've got a nice, close to development program throughout that acreage. So each of the different areas that we have taken over. We're putting some pads in across the entire south acreage, testing the entire stack, what the wealth can't be. And the wells have performed extremely well so far. Very, very happy with that acquisition.

Great details, both. And then maybe, so just to follow up again for you, Jeff, just one more, and this one on logistics specifically. You guys continue to do a nice job of, you know, Again, I know everybody else has seen or everybody's sort of seen inflation out there. My concern is more about potential logistical issues that I'm sure you're facing each day. You know, what are you guys doing to sort of overcome that? It doesn't appear you have any potential upcoming shortages, whether that be pipe casing, crack spreads, et cetera. So just love to hear more about what you do to sort of stay in front of this, because it really does seem like you guys are doing a great job.

Yeah, thank you very much. It's a compliment to the team as a whole that we've been able to work effectively in the current environment. We've got outstanding partners and we took advantage of the foresight of what 2022 might look like by entering into agreements for 22 relatively early in 2021. And then when things started changing relative to the profit margins for our partners, We just sat down and got together and figured out things that were going to work that would allow us security for delivery of pipe in particular to Big One Sand, of course. The labor market and other items are a little more of a gray area because they're so dependent upon that individual discipline or supplier. But in large part, also to our benefit, having the multi-basin asset base When things did pop up, we could just shift and do a little more Eagleford work or give some folks some relief in some of the sourcing supplies. And that generally tends to be a win-win situation for both of the partners. So we feel very good about our ability to effectively put 2022's program into the ground and have some continued discussions ongoing about what we'd like to do for 2023. Very good. Thanks for the details, guys. Thank you.

Our next question comes from Derry Whitfield from Stiefel. Please go ahead. Your line is open.

Thanks. And that's Derry Whitfield. And good morning, all, and certainly congrats on your quarter and operational progress. Thanks, Derry. With my first question, I wanted to focus on your capital plan and build on Neil's question if I could. As the majority of the sector has announced, CapEx increases are firmly messaging inflationary pressures. I wanted to first, again, compliment you on the progress you've made on holding the line on CapEx. And secondly, ask if you've quantified or could quantify the degree of self-help or operational efficiency you're effectively achieving in your capital budget.

Yeah, I guess, Derek, to start that off, we had baked some of that in at the beginning of the year with our – operational plan at that time so i'd say headline inflation at that point was in that 12 to 15 percent or so that we saw across the sector incorporating some of the what you called self-help whether it be uh you know increased efficiencies we continue to deliver over time get wells down faster over time and then maybe a little bit unique to us being able to reach some synergies from the the primex acquisition you know when we were close to the 10 percent uh at that point so hopefully i could get a sense of what kind of you know a few percentage points that we saw self-help delivering to us and on the operational side we made some modifications in particular on the completion design and the delta basin south assets where we lowered some of the the fuel of the uh water loading um it still was in the same amount of sand changed the completion design from the perforation scheme etc And so you save money going into the well on some of the upfront water costs. The larger pads work out a little bit better from the distribution of the upfront costs. And then just overall operational efficiencies on having very effective completion crews and knocking out the wells on a regular basis consistently. So that's all been kind of a standard, what Cowan has always tried to do, and so far so good in the first part of 2022.

That's great. And again, congrats to you guys on those measures. And as my follow-up, I wanted to ask a Delaware Ops question focusing on the operating cost side. Referencing slide 8, could you perhaps quantify the absolute gross volume improvement from the installation of ESPs and speak to the amount of well-maintenance projects you have planned for the balance of the year?

Well, it's a good question. It's kind of an ongoing effort because all the wells don't necessarily react the same. So the wells that we've quoted here were a little bit heavier on the water side. And so we proactively came in and put in ESPs to give that. It's a density issue, oil being lighter than water. So if you have a little more water, the lifting mechanisms from the natural process are worse. the initial pullback period. And so what we're going to do is systematically look at all the wells that we have in our portfolio that are not on lift and then determine when the best time is to put those on. Normally what you see, if you look at a long-term projection of a well over 18 months, for instance, that usually has the component of an artificial lift installation being done to it at some point in time. and so what we don't expect necessarily every single well to have an immediate 40 uplift you generally speaking do see some of those uplifts initially these happen to be consistent and are going to be sustainable the other ones just tend to be kind of part of the normal process for the well life and you wouldn't necessarily achieve a greater EUR, for instance, by having ESP installed. These roles, I do believe, are overall going to be benefited from these installations.

That's great, Keller, Jeff, and great update. Thanks again for your time. Thank you. Thank you.

As a reminder, if you would like to ask a question, please press star followed by the number one on your telephone keypad. Our next question comes from Davis Petros from RBC Capital Markets. Please go ahead. Your line is open.

Hey, all. Thanks for taking my questions. Just kind of a first one, and I realize kind of debt reduction until you work towards that one-times leverage, and $2 billion aggregate at that level remains the focus for now. But is there an update on when you think kind of discussions around a shareholder return strategy can start? I mean, do those targets need to be met, or can those start kind of a quarter or two ahead of time?

Yeah, so let me take this one. I think all I want to say on this is we're heading towards these numbers at the end of 2022. So the focus this year is taking that free cash flow and helping get our balance sheet in a position where we can weather future commodity cycles. So all I want to say is we're heading towards those numbers in 2022. We're going to be cleaning up some of the high-cost debt and at the same time doing our homework on shareholder returns. And this homework includes sensitivity work on our cash flows, to ensure that whatever we decide on is sustainable through cycles, gives us corporate flexibility, and then, frankly, meets the needs of shareholders. So I don't want to put a specific timing out there at this point other than we're going to get close to these numbers at the end of 2022.

Got it. Makes sense. And I guess just kind of as a follow-up, one of your peers recently announced kind of a bolt-on acquisition right in your backyard in Ward County. I'm wondering if there's any updated thoughts kind of on Callan's role in industry consolidation kind of moving forward, as well as kind of how you're seeing the M&A market today.

Yeah, that's a good question, and we've seen a little bit of an uptick in activity, although in the volatile markets, sometimes that's a little bit more challenging to get things done. I'd say, you know, for us, it's a very high bar on the acquisition front. Certainly, anything that we're going to focus on of any size will have to be accretive to our asset quality, but more importantly, advance the balance sheet. Just like, you know, Primex was a great example of that. Jeff talked about results on that property, just as we had thought, you know, this is going to compete well and attract capital. Effectively, we were able to finance it with 75% equity and be accretive to free cash flow per share, so we checked a lot of boxes. We'll certainly continue to evaluate opportunities like that, but I think it's a very high bar. In terms of the overall M&A market, I think there's a lot of hope coming out of the gate this year. There'll be a lot of assets moving, private sellers trying to monetize their positions. Again, the run-up, I think the bid-ask becomes pretty tough at this point. But again, there's nothing for us to chase right now. We've got a deep inventory, as I talked about. If an opportunity comes along to check all those boxes, we'll certainly take a look.

Got it. Okay, and just one last one, if I can squeeze it in, kind of building off that prior question regarding the short cycle projects you all are doing. Can you remind me kind of how exactly those flow through the financials? Would that be kind of a capital cost or is that a work over LOE cost?

It'll be a mix depending on the type of project. I don't have an exact breakdown, but some fall into capital work over summer expense. Got it. Appreciate the time.

We have no further questions in queue. I'd like to turn the call over to Joe Gatto for any closing remarks.

That's great. Thank you. Thanks, everyone, for joining. Before we go, I'd like to take a quick moment to pass along a big thank you on behalf of all of us at Cal and to Larry McVeigh, who will be retiring from our board at our upcoming annual meeting. Larry's contributions to the board over the last 15 years have nothing short of invaluable, and we wish Larry and his family all the best in the future. Again, thanks, everyone, for dialing in today, and we'll look forward to talking to you next quarter. Thank you.

Thank you for joining us on this call and for your continued interest in Callan. We look forward to speaking with you again next quarter. This concludes today's conference call. You may now disconnect.