Callon Petroleum Company

Ladies and gentlemen, thank you for standing by and welcome to the Kellan Petroleum fourth quarter and full year 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. Please note that each caller will be limited to one question and one follow-up question. To ask a question, simply press star, then the number one on your telephone keypad. To withdraw your question, press star one again. Please be advised that today's conference is being recorded. 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, Regina. 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 Ballmer, SVP and Chief Operating Officer, and Kevin Haggard, SVP and Chief Financial Officer. During our prepared remarks, we may reference our fourth quarter and full year earnings press release, our 2023 outlook news release, and our supplemental slides, all of which are available on our website at www.calend.com. Today's call will include forward-looking statements that refer to estimates and plans. Actual results could differ materially due to risk factors noted in our presentation and in our periodic SEC pilots. We will also refer to some non-GAAP financial measures which we believe helps 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 will open the call for Q&A. I would now like to turn the call over to Joe Gatta. Joe?

Thank you, Kevin. Good morning and welcome, everyone. We have a lot of good news to share with you and are excited about our plans to unlock the tremendous value we see in Calend today. By now, I trust you have had a chance to review our two press releases issued last night, one detailing our Q4 results and the other, our 2023 outlook. These are accompanied by other supplemental disclosure slides on our website. We will reference a few of these slides in today's call, but encourage you to review the entire package to provide background for questions. As demonstrated in our fourth quarter and full year 2022 results, we had a strong finish to the year on the production front, despite periods of adverse weather conditions, and we're right on the mark with our capital spending forecast. Looking forward, our 2023 business plan is designed to capture capital efficiencies through larger-scale projects that we expect to deliver solid returns and help offset industry-wide inflation, ultimately creating value for our shareholders through reinvestment in our high-quality inventory. We are eager to address your questions, so we plan to keep the prepared remarks relatively brief today. The call today will be divided into three buckets. First, I will outline our key objectives for 2023. We are confident that our 2023 development plan will drive significant free cash flow, clearly demonstrate improved efficiencies through continued application of our life of field co-development model, and enable us to further reduce debt balances. We'll move to a brief summary of our fourth quarter and full year 2022 financial and operational highlights. And lastly, I'll discuss our capital allocation framework and some important updates on our path to returns of capital. Let's get started. Our top priorities in 2023 are pretty simple. Invest in our premier assets to generate free cash flow and pay down debt. To the last point, our track record of strengthening the balance sheet has been outstanding. Since the first quarter of 2021, We've improved our leverage ratio by more than three turns, or over 70%. Overall, we anticipate investing approximately $1 billion this year, with more than 80% of our DNC activity allocated to high-return Permian Basin projects, which are expected to generate average IRRs of approximately 70% and average payouts of less than two years. Callen has a premier asset base with an inventory of over 1,500 risk locations and core zones, representing over 10 years of locations that are economic at $60 per barrel or lower, and that's assuming current service costs. We are fortunate to be positioned with the quality asset base we possess today, which is the result of many years of important decisions related to building our team and the development strategy we have employed on our multi-zone asset base over time. Our life of field co-development model has been a key tenant of Callen's operations going back several years as we built our position in the Midland Basin, and that philosophy carried with us into the Delaware Basin upon our initial entry in 2017. While co-development is not unique to Callen, we are part of a select group that has adhered to this strategy over time. This is a critical point. The power of the model comes from the cumulative impact of consistent application over time, ultimately creating an inventory with more consistent quality into the future and maximizing the MPV of the resource base. Focusing on one element of our development model, will continue to increase the average number of wells targeted within our projects this year co-developing multiple zones to mitigate risks associated with parent-child well interactions and balancing today's well productivity with tomorrow's value proposition in addition to the subsurface optimization there are also economies of scale that translate into dnc savings in 2023 our average project size will increase by over 20 percent importantly As our development program has achieved critical mass and we've established a solid ongoing duck inventory, we can increase the use of simultaneous operations to reduce our cycle times. We estimate that our simultaneous D&C activities will reduce cycle times by approximately 20%, which significantly improves capital efficiency, even as larger project sizes are used. On the cost savings front, Our scale program has been instrumental in limiting the inflationary increase in our DMC cost per foot to roughly 10% year over year. I ask you to now take a look at slide 10. This is a powerful chart that really captures the perspective impact of our life of field focus and the implications for sustainable pre-cash flow generation. Over the next five years, we expect that our annual capital efficiency metrics, as measured by total capital invested divided by total average daily production will be consistent and directly improve on average under the development scenarios captured. This dynamic is underpinned by a couple key drivers. In terms of wedge production from new drilling activity, which is the production that is incremental to established base production, we expect to benefit from the relatively consistent return profiles of new co-development projects, as discussed earlier, improve project cycle times from the ongoing use of simultaneous operations and optimization of project sizes over time, and leveraging of past facilities investments as we return to previously developed areas. In addition, capital efficiency will benefit from the maturing of our corporate P2P decline profile over time. Clearly, this type of analysis represents a point-in-time outlook with several underlying assumptions and resulting outputs, but I want to make sure there's one key takeaway. The capital efficiency profile embedded in our current inventory provides differentiated flexibility for meaningful capital allocation to what we envision as the three key drivers of shareholder value going forward. Disciplined investment and a high return inventory, ongoing debt reduction, and an impactful return of capital program. Let me switch gears and cover our fourth quarter and full year 2022 financial and operating results. For the fourth quarter, Total production averaged 106,000 barrels of oil equivalent per day, and oil sales averaged just over 66,000 barrels per day. Both were in line with expectations, despite weather impacts we experienced from winter storms around year end. For the year, our 2022 production increased by about 9% over 2021. We generated $412 million in adjusted EBITDA and posted adjusted net income for diluted share of $3.36 during the fourth quarter. Our results were driven by strong well performance and the continued strength of both oil and natural gas realizations. We realized 102% of NYMEX WTI during the fourth quarter, owing to our close proximity to premium Gulf Coast markets and contracts tied to Waterborne and international pricing. Of particular importance, 2022 marked the third consecutive year that we posted improvements in EBITDA margins. Our work-to-control costs through supply chain efficiencies, LOE reductions from the Primex acquisition, and strong price realizations has helped us enhance margins and mitigate industry-wide inflation. Overall, our cash operating costs during the fourth quarter were in line with expectations, with LOE per BOE down 2% sequentially and cash G&A in line with the previous quarter. Proved reserves at year-end were approximately $480 million BOE, of which 57% were oil and 85% weighted to the Permian, with an associated PV10 value of $10.5 billion. During 2022, we added 68 million BOE from extensions and discoveries, which represented 180% of 2022 production. As a result, approved developed reserve volumes grew by 7% over 2022 to approximately 295 million BOE, with an associated PV10 value of $7.1 billion. Said another way, The PV-10 value of just our approved developed reserves represents over $75 per share in equity value after deducting debt balances. We get a lot of questions from shareholders regarding our capital return strategy. Our answer has been consistent. Let's make sure that we have addressed the balance sheet first and not declare a victory too soon. We made tremendous progress on this front, which was recognized in credit rating upgrades from all three agencies in 2022. We reduced our debt by $462 million last year and by more than $715 million since the start of the first quarter of 2021. In sum, the balance sheet is very close to being in a position for us to implement a return of capital program. But before I address this further, let's take a step back and start with a few points on the broader allocation of the cash flow generated from operations. Callen has a deep and robust inventory development projects, and an outlook for improving capital efficiencies as evidenced by the stats around our 2023 capital program. Reinvestment in our assets is the cornerstone of our strategy and discipline capital allocation into an asset base with consistent return profile that provides confidence in our ability to generate sustainable free cash flow. Given the high returns and quick payouts on our portfolio of investments, we expect to generate a significant amount of free cash flow for allocation to an expanded set of shareholder value initiatives. Based on the assumptions detailed in the presentation, we expect to generate more than $2.75 billion of free cash flow over the next five years under our baseline development scenarios. As a frame of reference, this amount of free cash flow represents approximately 125% of our equity market cap and over 60% of our total enterprise value today. The next logical question is how will we deploy this free cash flow? We expect to achieve our key $2 billion debt milestone later this year. which is now our only gating financial metric to achieve before adding a return of capital program. So this element will now squarely be part of our broader capital allocation framework. And as to the form of this program, based on our equity value today and our desire to retain financial flexibility, we believe the highest return proposition for execution of a capital return framework for shareholders is a stock repurchase program. In addition to capturing the value arbitrage between our public market valuation and our internal view of intrinsic value, share repurchases will enhance production growth per share beyond our organic potential and also increase per share exposure to our strong inventory position. And to front run the question, we will be detailing elements of this program as we get closer to formal initiation. I want to make one last point here and refer you to page eight of the materials and the checklist on the left-hand side of the page. Just to be clear, even when we reach $2 billion in debt and commence capital return initiatives, debt reduction will continue to be a key priority for our free cash flow deployment with an eye towards achieving less than $1.5 billion of gross debt and a leverage ratio of less than one times. Before taking your questions, I'll summarize what we believe are the key ingredients for Calend to warrant a premium valuation. A deep and high-quality inventory that contributes to an improving capital efficiency profile over the next five years of development. Our life-of-field co-development model that has been consistently followed over the past several years differentiates our longer-term asset value proposition. A solid plan to attain our $2 billion debt milestone and commence the return of capital to shareholders later this year that will complement further debt reduction. And a successful integration of ESG initiatives and targets across the business which tie to compensation to incentivize right behaviors. Overall, we are confident that the execution of our plan will close the significant valuation gap we see in our equity today. This concludes our prepared remarks, and we are now happy to take your questions. Operator, we'll turn it back to you.

As a reminder, to ask a question, simply press star 1 on your telephone keypad. Our first question will come from the line of Neil Dingman with Truist Securities. Please go ahead.

Morning, all. Thanks for the time. First, my first question is on the operating plan. Really, Joe, for you and the guys, just wondering, how sensitive is this plan would you consider to the volatile energy tape? Or maybe asked another way, you know, what would it take to add or drop, you know, one or two of those current, I think, seven rigs you have?

Yeah, look, Neil, I think we're pretty well dialed in on this program with a large-scale program. There's a lot of planning that goes into that. And, you know, we're We've got to stay very well advanced of our plan. So, you know, we'll see how the commodity shapes up. Obviously, alongside that, we've got to see how service costs react because it's not about any one headline price. I'd say that as we look at the landscape here, we look at our program and how we're setting up for next year, that We see optionality for additional activity into 2024 would probably be where we stand today, but 2023 is pretty locked in. On the flip side of that, if we see things pull back into the low 60s, probably time to revisit our plans moving forward. But for right now, we think this is a resilient plan. Obviously, with the return profiles that we've shown for 2023, there's a lot of economics to go around and weather the ups and downs.

Yeah, great to hear. And then that's kind of what I thought too. And then just lastly, could you talk about, I know you're getting much closer to sort of hitting those optimal leverage debt levels. Could you talk about, you know, would you get any, do you have to wait until you actually get there or what, you know, maybe just talk about the timeline if you could. Thank you.

Yeah, Neil, why don't I take that? This is Kevin. We've been asked this question before. Our answer remains the same. When we hit those debt targets, we'll be ready to go with an announcement, period.

Thanks to you. Thanks, Dale.

Your next question will come from the line of Phillips Johnson with Capital One. Please go ahead.

Hey, guys. Thanks. Joe, on the third quarter call, you guys highlighted a 20% improvement in the Midland Basin well productivity just in terms of the 22 vintage wells relative to the average for the prior three years. Just wondering if you have an update on how the productivity is trending there.

I think we're similarly in line with that, just because we didn't have a huge body of work there in terms of extended performance. We didn't provide an update here, but you can expect that as we move forward to keep supplementing that. Jeff, is there anything you want to?

Yeah, the Midland Basin continues to be a very strong opportunity area, extremely good capital efficiency metrics across the board.

Okay, sounds good.

And then on the LOE guide, it looks like it's picking up a little bit, kind of an 8 to 850 range from sort of the high 7s or so for 22. Just wondering what the drivers might be there.

Yeah, the primary ones are just some modest inflationary costs that we're seeing. We're hoping to obviously trim that back. One area that I would point out as a strong success is the significant improvement in the Delaware Basin South, where the Primex acquisition occurred. Those have come down quite a bit, despite the fact that inflation has continued, of course, through 2022 and the beginning of 2023. But that's the primary headwind, is still a little bit of inflationary pressure that we hopefully, again, anticipate nibbling away at that.

Great. Thanks so much. Thank you.

Your next question will come from the line of Paul Diamond with Citi. Please go ahead.

Good morning, y'all. Thanks for taking my time. Thanks for taking the time. I was wondering if you guys could just kind of walk through kind of the rationale of shifting the kind of those gating targets more towards the asset debt leverage and kind of away from the leverage ratio. Is that more of a comment on your perspective see disconnect in the equity value, which is why you're focusing on a share or may focus on a share buyback. Kind of just walk through the thought process there.

Yeah, this is Kevin again. I think what you're asking is what happens to the one-time leverage target. And I would say in our discussions with debt and equity investors based on our analyses internally, we realized that the absolute debt target is the key one here to help us get through any commodity price volatility. So for us, Achieving that $2 billion milestone is going to represent a strong balance sheet. And I would say also that $2 billion is just the first stop. So we're going to look to continue to reduce debt and want to reach what we call an optimal level. And that optimal level is less than a billion and a half and less than one times debt to EBITDA. And we say optimal because of these levels of debt we'd feel very comfortable with what our leverage metrics would look like down to a low $40 WTI price for a prolonged period of time. Does that help?

Yeah, understood. Perfect. Just one quick follow-up on kind of just more of the macroinflationary environment. Through your conversations, are you seeing anything of, I guess, particular bright or dark spots across the complex? Is there anything that – the conversations that are going well versus those that are going poorly, kind of how you see those wrapping out over the, you know, when we get down to the micro.

Sure.

Very relevant question. I'm very happy with how we've addressed our 2023 needs earlier in the year in 2022. And so I feel like we have a very strong foundation from a contracting standpoint. We're not in the market to get any new equipment right now relative to the, you know, the drill bit and the completion side, which are our primary spends. But we are very foundationally solid relative to the pricing. If we see some break over in items like tubulars and casing, chemicals, some of the ancillary service items, we should be able to realize some cost savings of those things going forward into 2023.

So that's kind of where we sit. Understood. Thanks, Isaiah.

Your next question will come from the line of John Anis with Staple. Please go ahead.

Hey, good morning, all, and thanks for taking my questions. Referencing slide 11, I wanted to ask what, in your view, is driving the out-period productivity in the Delaware? Is it better fracture, conductivity, rock quality? Any color would be much appreciated.

Sure. It's one of the strong foundational items of CALEN, I would suggest. If you look at the inventory and then the very thoughtful development programs that we put in place in the Delaware, those multiple year thoughtful life appeal development decisions that we've made have yielded what we see here on page 11 as far as the co-development philosophy. And it's fairly complicated, of course, and it adds in a number of items, the correct spacing and stacking, understanding the geology and the geologic barriers, the existing natural fracture systems that you have in the area, the faulting systems that you have, and then also how we propagate the frac systems based upon existing wells, so the parent-child relationships, et cetera. And CALEN has really been able to flex its muscles on its knowledge base. PRIMEX was a great example where that group had a tremendous subsurface data set that we were able to leverage on everything from seismic all the way up to induced fracture propagation. So that whole aggregate set of disciplines, when you put that all together, that's what's needed in order to really put together a strong development program over multiple years not just one year at a time um so it's a little bit of a broad answer with some some discipline specific items that roll into that but but we see the delaware basin has a strong competitive advantage for calendar and i i just add there i think that really well sums up our life of field development a little bit more detail we saw the power of that overlaying the model on primex and also what you'll see you know

Life of Field is not something you just cookie-cutter overlay on something. There's things that we continue to tweak, like completion designs that we've tested some larger profit loadings there last year, which have a nice impact. We've sort of optimized some of our artificial lift programs over time with ESPs. So, you know, the Life Field model is very powerful, but we continue to look for ways to continuously improve that.

Tariq Maizena- terrific terrific I appreciate the color then shifting to the mid lane you show some sticks on the map on slide 21 plan for 2023 that are in or close to dawson county. Tariq Maizena- That appears to be the most northern wells drilled today, could you share any color on pre drill expectations, based on your subsurface work or industry activity.

Sure. They should be pretty much in line. There are some geologic changes as you go up into the northwest in that area. We feel, again, we're a very experienced Midland Basin operator, and we've taken advantage of being thoughtful about how we progressed our development programs in those areas. So we've seen very, very good well results in the center portion of that. and feel good about expanding that up into the Northwest.

Perfect. That's it for me. Thanks for taking my questions. Thanks.

Again, for any questions, press star 1. Your next question will come from the line of Tim Rosman with KeyBank. Please go ahead.

Good morning, everybody, and thank you for taking my question. I'd like to start with the, I guess, the five-year free cash flow plan. I know it's a volatile oil tape. You know, that plan is predicated on $80 oil below that. And, you know, we get continued, you know, bearish macro statistics. So I'm just curious, have you sort of stress tested this model? Is this something that will hold in a $50 to $60 kind of environment? And, you know, if we are in a sort of lower for longer environment, and you mentioned earlier, you could pull back rigs in a low 60s world. What is that free cash flow like? you know, program kind of look like longer term? And is this sort of set in stone for better or for worse, longer term?

Yeah, no, clarification. I guess I want to emphasize, you know, those were scenarios based on, as you pointed out, the assumptions of $80 oil. So this is not set in stone. They're really meant to be scenarios. And as much as we're trying to provide a five-year outlook, I think the key point to take away from that is that capital efficiency profile, which really highlights the ongoing efficiencies within our inventory program that are relatively consistent over time, that we don't see any periods we're going to hit a cliff on capital efficiency because we've co-developed our asset base over time. That's the biggest takeaway, Tim. So don't take away from that. Say, all right, well, they're locked and loaded. You know, damn the torpedoes. This is what we're going to do. But if you look at that capital efficiency, it gives us a lot of flexibility through ups and downs and tweaking the program to continue to deliver free cash flow. And that's going to be used for debt reduction and returns of capital. But the key point there is really just looking at that profile of capital efficiency. We think over time is going to be differentiated. It might, you know, that exact claim might not come to pass. But given that the tools that we have to work with gives us a lot of flexibility for the right outcomes on free cash flow.

Okay, that makes a lot of sense. That's pretty helpful. And then I just want to circle back, Joe. You mentioned kind of repurchases earlier. I wasn't clear on what you were sort of referring to. I know there's a pretty clear arbitrage, and that's sort of underscoring everything you're doing here with the long-term strategy. But I guess I know you can't talk about the plan, but I think the concern would be if you implement it before a one times leverage target, that the intensity could have negative effects of oil decline. So can you talk about the repurchases, what you're referring to, and I guess how you're thinking about the intensity of capital returns if you initiate something with leverage over one times?

Yeah, so this is Kevin again. I think there's a couple of questions there. One, you're kind of asking what does the shareholder return return program going to look like? And that is the repurchases, right? With the compelling value of our equity today, we think that the share buyback program is the first initiative, and we will definitely evaluate other potential methods in over time. And I would say this, we don't have specifics as approved by the board in terms of size, but we do believe a multi-year share repurchase authorization is going to allow us the most flexibility. Does that provide you Enough guidance?

Yeah, that's helpful. I just think boxing yourself in with something rigorous could have negative effects. That makes a lot of sense. That's all I was trying to understand.

Overall, we've talked about this over time with investors and we've had the chance to watch other programs get released over the last year plus, see how those age over time. What was really clear to us was we wanted to maintain Flexibility, that was the number one priority for us. So getting locked into things that were overly formulaic or, you know, maybe fixed in nature at this juncture, I don't think are appropriate for Callen because as a SMICAP company and the opportunities that we have, we want flexibility to be nimble. And pinning us down, especially with, you know, leverage not exactly where we want to be long term yet, keeping flexibility as capital return program while still delivering on something in the near term that was our really guiding post on this.

Okay. Yeah, I appreciate the color. It certainly shows, you know, conviction and the resource base, which I think, you know, people are looking for. So thanks for the comments.

Thanks, Tim.

We have no further questions at this time. I'll hand the call back over to Joe Gatto for closing remarks.

Thank you, and thanks again for joining. Hopefully everyone enjoyed this call, and obviously, please feel free to reach out to the team here with any questions, and we'll look forward to talking to you next quarter. Thank you.

Ladies and gentlemen, that will conclude today's meeting. Thank you all for joining. You may now disconnect.