Callon Petroleum Company

Ladies and gentlemen, welcome to the Callen Petroleum first quarter 2023 earnings conference call. Currently, all participants are in a listen-only mode. After the company's prepared remarks, there will be a question and answer session. Please note that each caller will be limited to one question and one follow-up question. Just a reminder, today's conference call is being recorded. To ask a question during the Q&A session, press star 1 on your telephone keypad. To withdraw your question, press star 1 again. I will turn the call over to Callan's Head of Investor and Relations, Kevin Smith. Please go ahead, sir.

Thank you, Mallory, and good morning, everyone. I am joined by our CEO, Joe Gatto, our COO, Jeff Ballmer, and our CFO, Kevin Haggard. During our prepared remarks today, we will reference our release on the first quarter and our recently announced Permian Eagle for transactions, as well as supplemental slide decks related to both. All these materials are available on our website at www.callan.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 SEC filing. We will also refer to some non-GAAP financial measures that help facilitate comparisons across periods and with our peers. For any non-GAAP measures referenced, we provide a reconciliation to the nearest corresponding GAAP measure in the appendix to our slide deck 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. I will now turn the call over to Joe Gatto.

Thank you, Kevin. Good morning, everyone. We are thrilled to have you with us today on this very exciting day for Callen. We delivered another strong quarter performance, highlighted by improved Permian cycle times and continued debt reduction. I'll cover the first quarter highlights later in my remarks, but we are off to a great start in 2023. I'll spend most of my time today discussing our creative and transformative transaction in the Delaware basin. Simply put, this deal is a great fit for us. It solidifies our focus and positions us as a leading operator in the Permian with more than 145,000 net acres and 107,000 BOA per day of production. It's contiguous with and complements our existing Delaware position where we have proven history of adding value. And these high quality assets will be seamlessly integrated into our development model and will immediately compete for capital within Callen's broader Permian portfolio. The cash portion of the transaction, totaling approximately $265 million, will be funded with the sale of our Eagle Ford position for $655 million in upfront cash. The transactions will be accretive to our absolute leverage and credit metrics. Our strengthened balance sheet achieves our initial debt reduction milestone, allowing us to launch a share buyback program upon closing. Let's take through some more of the deal highlights. We are adding 18,000 net acres and about 14,000 barrel of oil equivalent per day of production from oil assets that sit contiguous to our core Delaware acreage. We are gaining a larger footprint in the Permian and increasing the critical mass of our operations. This will create opportunities for further capital efficiency improvements and economies of scale. This deal extends our decade-long Permian inventory of high-return, oil-weighted drilling locations. We are adding 70 operated long lateral locations of which 90% have a positive PV10 at $45 oil. These locations are in the well-established third bone shale, Wolf Camp A and Wolf Camp B intervals with additional potential in both shallower and deeper zones. This contiguous acre position with stacked pay horizons sets up perfectly for the application of our proven life of field co-development model. Today's earnings deck highlights sustained well productivity benefits across our asset base in both the Delaware and Midland basins that are driven by this model. These transactions will improve our operating margins due to a similar proforma oil weighting and lower LOE per BOE. We have also identified more than $10 million in annual G&A savings and are confident that we will find other cost-saving opportunities through the integration of the assets. This deal is priced right at 2.5 times EBITDA and provides an efficient way for us to exit the Eagle Ford. And it's highly accretive to key financial metrics, including a 15% uplift to adjusted free cash flow in 2023 and a 55% increase in 2024 at recent strip commodity prices. It also improves free cash flow per share by 10% in 2023. And after a full year of integration and synergies, 40% in 2024. Per-share metric accretion has the opportunity to further improve, even before share repurchases, since the number of shares issued to the selling parties decreases to the extent that Callen's 20-day VWAP is above $32.50 at closing. And importantly, we will focus 100% of our capital and operational teams on the Permian. This will yield stronger well-level economics, enhance flexibility in project scheduling, and improve cycle times. Together, this will reduce our reinvestment rates and increase the conversion of EBITDAX into free cash flow. The bottom line, we will generate more free cash flow with our investment dollars through significant capital efficiency gains and cost savings as a focused Permian company. From our forecast, you'll see that 2023 production will be relatively unchanged with the lower capital spend, despite the fact that we are selling more current production than we are buying. Looking to 2024, we expect production to grow at a low single digit rate year over year as contributions from the newly acquired assets increase. The final point I'll make is the culmination of everything that I've covered on this call and perhaps the most important. As you know from recent conversations, reducing debt and initiating a shareholder return program are our top objectives for 2023. These transactions get us there on both counts. Upon closing, our debt will be reduced by more than $300 million to approximately $1.9 billion, below our $2 billion initial debt milestone. We will continue to focus on deleveraging and see substantial progress in 2024 towards our optimal debt target of less than $1.5 billion and leverage below one times. Subject to closing, our board has approved a $300 million share buyback that we plan to execute over a two-year period. We believe that Callan's intrinsic value proposition which will be significantly improved by these accretive transactions, is not reflected in the public market valuation, creating a very compelling case for a repurchase program moving forward. Before taking your questions, let me quickly give you the main takeaways from the first quarter. First, we are executing extremely well. Our first quarter financial and operating results were in line or better across all key metrics. This gives us high confidence in our ability to deliver on our 2023 business plan. We are also maintaining our focus on capital discipline and balance sheet strength. We generated $7 million in adjusted free cash flow for the quarter, allowing us to realize our 11th straight quarter of debt reduction. Second, our life of field co-development model is differentiating Callen from the pack. We provided a great deal of insight into this model last quarter and had discussions with many of you on the road over the last few months. We've implemented this model consistently over the last five plus years, and it underpins our longer-term asset value proposition. Third, we are seeing significant operational improvements. These gains are owed to scale, larger project sizes, and deep knowledge and experience within our teams. We are drilling wells faster, pumping more completion stages per day, and using multiple rigs and completion crews on single projects. Increased DNC efficiencies, combined with our focus on simultaneous drilling and completion operations, are rapidly reducing cycle times and increasing capital efficiency. All these factors contribute to strong momentum for our production outlook. We forecast that our second quarter production will be up over 5% to 105 to 108,000 VOE per day. We've updated our 2Q guidance in today's materials and have also provided updated guidance for 2023 that assumes six months of impact from the transactions. In closing, know that our results year-to-date are strong and in line with our top priorities of investing in premier assets, generating free cash flow, and reducing debt. Today's transaction fits us perfectly, both financially and operationally. Financially, it allows us to achieve our near-term debt milestone and launch a share buyback program this year. Operationally, it solidifies our focus on the Permian Basin. Similar to past acquisitions, we are highly confident that our life of field co-development model will allow us to add significant value on our new acreage in the Permian and enhance our cost structure and capital efficiency outlook. And finally, I'd like to personally thank our talented Eagle Ford employees for their commitment and hard work. They have done an exceptional job operating safely and efficiently and have consistently made valued contributions to Calum. This concludes our prepared remarks. We're now happy to take your questions.

Mallory, take.

At this time, I would like to remind everyone in order to ask a question, press star then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from Zach Parham with JP Morgan.

Hey, guys. Thanks for taking my question. Joe, first one for you. You mentioned 55% higher 2024 free cash flow and 40% higher free cash flow per share following the transactions. Could you just walk us through some of the underlying assumptions, particularly on pro forma CapEx and production volumes that underwrite that number?

Yeah. You know, what we've talked about, you saw in the release, we're moving over the course of this year from seven rigs down to five. I would expect similar type of cadence going into 24 we'll fill in some more details going ahead but obviously with the efficiencies we pick up with just operating the permian go go a long way on that front uh underlying assumptions of strip pricing as of a couple uh days ago are going to go into that and production growth now this is compared to a higher baseline in 23 because we had six months of higher eagle for production the first half but we see on top of that higher baseline

know that low single digits of production growth into 24. got it thanks joe um and then maybe one just on on well productivity and kind of your expectations from percussion um you know the 70 locations that you're acquiring how do you think about the timing of developing those you know in your prepared remarks you mentioned they'd be immediately or they would immediately compete for capital But maybe just any thoughts on how those returns compare with your current Delaware-based drilling program.

Yeah, look, we think that they squarely compete for capital. They talked about similar to what we've done with acquisitions. We'll fill out some completion activity on their asset base over the coming months and then get going with our overlay of our model over the next 12 months and really start seeing some more of an impact in 24. You know, I guess with this asset base in particular, you know, it's always worth going back and explaining how these asset bases have come to where they are. And the Southern Delaware Basin is about learnings, right? And we have as much learnings as anybody in this part of the world to overlay our model. So, you know, previous operators, we've seen pretty tight spacing, 7 to 10 wells per section, a couple zones, and under stimulation on completion designs. That's evolved with the current operator. It took over just under two years ago. They started moving to wider spacing, some increased completion design intensity. We've seen some progress there. They've also started very recently moving to what we've done over the last couple years on artificial lift and removing gas lift and just going straight to ESPs. We see a lot of opportunities to overlay our model, just like we've done with Primex, and see the benefits over time. So you put that all together with, you know, Great Rock that's here. This is going to be an asset that's squarely competing for capital going forward.

Thanks, Joe and team. Congrats on the deal. Thank you.

Your next question comes from Neil Dingman, which is Securities.

Morning, guys. Thanks for the time. Joe, again, congrats. I think the deals look good. My first question is maybe just comments around the creativeness of the deal. Can you walk through how maybe you and Kevin think about the future fee cash of the new deal versus the existing that you're selling? And also, I assume part of that plays into the large amount of future fee that you now have to be drilled on this new acreage as well, if you could maybe hit both of those.

Yeah, let me make sure I'm answering the right thing there, Neil. Could you just quickly run me through that one more time? We are having a little bit of a hard time here.

Oh, I'm sorry. Yeah, just on the deal. I mean, you know, there's always with existing assets, existing free cash flow that, you know, you're selling with those Eagleford assets. And, you know, just how that compares with, you know, when you look at the free cash flow with the new deal, I mean, knowing that it doesn't have uh, given production. Um, and then where I was, where I was going with that second part of that is knowing that the deal also has a large amount of undeveloped inventory that's, uh, with more feet to be drilled. So I'm just wondering if you could maybe hit both the free cashflow of the two, how those compare and, um, you know, the deal being sold, the deal being bought, and then the future feet being drilled.

Yeah, I guess. Got it. Um, couple things that i'll address there one is like you look at the assets just sort of in a vacuum right in terms of their profile uh what's what's great about this asset we're acquiring typically with private equity back type of companies you know we will see a lot of drilling and maybe some steeper declines this is not the case here uh we see pdp declines around low 30 percent uh which is you know depending on what point in time you you look at our eagle for similar, maybe even a little bit better, depending on the timing there. So you have that nice base of PDP production helping you out on the free cash flow side. Obviously, both assets in the Eagle Ford or with this new position in the Delaware, they have attractive inventory to develop, so they get their share of development dollars. So from a free cash flow standpoint, they're somewhat similar on the baseline PDP, but we're going to have more opportunities for development on a longer-term basis than this new Delaware asset, just because our Eagleford inventory was getting a little bit short. But that's, you know, in a vacuum. So if you move to putting this asset base into our model, right, in a more consolidated critical mass of Permian activity, there's just – there's efficiencies that we're going to get and improve free cash flow from being able to do that on a more streamlined basis going forward. So there's some pickups in terms of synergies that add to that baseline of shallower declines on the PDP.

Yeah, great caller. And then I really appreciate that. And then my second question just on Cheryl's return. I know early in the plan, you know, my question, Joe, for you or Kevin, I know you're always purely looking to keep your, you know, your options open, but just any thoughts on how large you believe the shareholder return maybe should initially be or how that should grow. Again, I don't want to pin you down yet, but maybe just your or Kevin's thoughts on how you're thinking about what would make sense.

Yeah, thanks, Kevin. So at this point, we have a two-year period of time authorized once this deal closes. So that would run through the second quarter of 2025, and that's a $300 million program. We haven't set quarterly targets for percentage of free cash flow or allocation percentages. The magnitude of the time in each quarter is going to depend on free cash flow, commodity prices, stock price, et cetera. So we're trying to retain some optionality here to create shareholder value the best way we see to use that free cash flow. I would give you some additional guidelines here. We expect to pursue the additional $400 million of debt pay down to reach that $1.5 billion number. do that side by side with that two-year $300 million share repurchase program. I guess I'd offer one other point of data here. I would say in the mid to low 70s WTIO price, there's more than enough cash flow to cover both the share repurchase objectives and the debt pay down over that two-year period of time.

No, love the optionality. Thanks, Kevin. Thanks, Joe. Congrats, Ken.

Thanks, Dan.

Your next question comes from Derek Whitfield from Cycle.

Thanks. Good morning, all, and congrats on your transformative transactions. Thanks, Derek. With regard to the acquisition, could you speak, I think you referenced earlier some degree of activity, but could you maybe outline current activity on the asset today and your plans to integrate it within the portfolio and the degree of synergies you see with the acquisition?

Yeah, so today we'll be stepping in. We're going to do some completions as the year rolls on. They've moved, they've taken down their rigs. There's not going to be current activities as we step in, which is good, right? So it allows us to direct activity in our development model the way we want. A lot of times that's not the case. So, you know, we're starting with a bit of a clean slate, but we are going to have a chance to employ our completion designs on some of the activity that we're stepping into. You know, moving forward, it's hard to just discreetly point out where the synergies are. Like, again, it goes with a broader model as we go in and really try to optimize the combined development program. But I think you get a sense of that certainly from the free cash flow per share and absolute pickup going forward. But, you know, the flexibility in scheduling employing our learnings and models does go a long way. And I think we've shown those synergies to a large degree with the Primex transaction over the last couple of years.

Terrific. And then with regard to the acquisition, could you just speak to how it came together and if it was your or the seller's preference for Calendstock?

Yeah, you know, a lot of these deals come together over many, many months. Certainly when you have two pieces of the puzzle, it takes a lot of time. So that's a whole other sidebar conversation. But these are assets that we've kept an eye on for a long period of time, going back to when they originally were sold by Ford. So we know this area quite well. And then we have been thinking about what is the best way to approach an acquisition as Callen today. and achieve all of our objectives that we talked about on the financial side and start thinking about the Eagle Ford and how that fits into the mix. So this has been something we've been percolating on for quite some time and took a long time to get here, but it's great that we're here. And yeah, on the equity side, it was a clear ask out of the sellers that they wanted some upside here. They have other opportunities to sell for all cash, but it was clear. You know, it took some time for her to get her head around that, just given where we were trading. But given the accretion we saw on this transaction and also overlaying this mechanism that, you know, we hope that the stock performs well between now and closing, we'll be able to claw back some of those shares as well.

That's terrific. Great update, guys. Thanks for your time. Thanks, sir.

Your next question comes from Philip Johnston with Capital One.

Hey guys, thanks and congrats. Just one for me. Looks like the rate count on the percussion properties has trended down from around three or so at this time last year to one as of a few months ago. And the production does seem to have kind of leveled off over the last six to nine months or so. So I'm guessing that PDP decline rate on the properties isn't super high, but can you maybe talk about how these two transactions will affect your company-wide 12-month PDP decline rate?

Yeah, you're right. The activity has been coming down, and it has helped to shallow out the PDP decline profile right now, somewhere in the low 30s, which is somewhat where we are as a company, maybe even a little bit better. So overall, it's neutral to maybe a slight benefit to overall corporate decline.

All right. Perfect. Thank you.

Your next question comes from Paul Diamond with Citi.

Good morning, all. Thanks for taking my time, and congratulations on the transaction. I just want to touch base quickly on some of the efficiency gains you've seen in your drilling program over the course of the last 18, 24 months. How does the, I guess, how does the kind of repositioning away from Eagle Ford into, or primarily into Permian

know do you see any kind of step change in that trend or should we expect that to kind of continue on path yeah generally speaking that it's been absolutely outstanding performance both on the drilling and completion side um you know the teams are never satisfied so what we do is we take a look at what we call the the perfect well so we apply a limiter theory where we break down each individual component of the drilling and completions everything from starting and moving the equipment in to how we turn the wells online and connect into the facilities and the flow line. So we anticipate that this new acreage that we have coming in, which has been developed very nicely, will integrate extremely well into the things that we do well. So we would anticipate, I can't stand here hand on heart and say we'll see another 20% in the next six months, but we're extremely proud of the performance that we've had and the results speak for themselves.

Understood. Thanks for the clarity. And just a quick kind of housekeeping one. As far as your hedging strategy, does this transaction really shift any of that, you know, kind of 30,000-foot strategy, or should we expect that to really continue on path?

Yeah. So, thanks. That's a good question. Our strategy hasn't changed, which is really we kind of are targeting around a 30% WTI hedging over the next 12 months on a rolling basis. uh right now we did uh we did inherit or will inherit some hedges uh from their book uh which will take us closer to i-20s uh on a hedge basis for the back half of the year and we are currently in the 17 18 19 range on that edging so we gained some incremental hedges from from them but it doesn't take us over the level we view as our strategy which is that 30 of next 12 months wti

Understood. Thanks for the clarity. Congratulations again.

Thanks, Paul.

Your next question comes from Fernando Zavala with Pickering Energy Partners.

Hey, guys. Good morning. Just a quick one for me. So, pro forma for the deals, do you see any material changes to your cash tax status heading forward?

Yeah, it's a good question, and the answer is we're still sticking with our original guidance for cash taxes for 2023, and that is $5 to $15 million guidance, which we offered on the Q4 call. No change from either of these two transactions. No additional limitations on NOLs or et cetera.

Okay, great. Thanks. And then just another one, a follow-up on your comments around the low single-digit production growth. Is that similar on oil and equivalent, or is it weighted to one or the other?

Pretty similar. You know, we're stepping into asset base with 70-plus percent oil, which is relatively similar to Eagleford, so no meaningful changes there.

Great. Thanks.

Your next question comes from Tin Resvin with KeyBank.

good morning everybody thanks for taking my my question um first one maybe for kevin um when we think about the the net cash proceeds i guess it's 390 million is there any tax leakage we should be baking in is it or anything else that would affect that that net balance sorry uh so i i think i heard you say it's 300 about 310 million dollars uh of kind of net cash that will be applicable to to paying off the rbl as a result of this transaction

and no cash tax leakage here.

Okay. $310 has been that amount. Okay. Yeah, after purchase price adjustment. Yeah. Okay. Okay. And then my follow-up, I guess more for Joe. You know, in the past in our discussions with investors, some of the hesitancy from buying Callen shares kind of stem from the frequency and size of acquisitions that you've undergone. And as you think about coming up on the close on this in July, I guess what's the new message to investors about the willingness or appetite for future deals now that you've transformed the portfolio like you have?

Look, I think we've shown over the last couple of years, we are very focused on our financial objectives. And this is a very important step that we're taking here. We've figured out creative ways to, number one, find assets that are going to compete for capital and benefit from our overall methodology. We'll continue to look for opportunities to overlay our model and add value to asset bases paying reasonable prices. I think every company should be looking for opportunities like that. I think it will ultimately add value, but You know, we have to be realistic and we're going to be very selective just given the quality of the inventory we have. It's a high bar to find assets like that. And then certainly, you know, how do we finance these items? I mean, this is a pretty unique situation in terms of having the Eagle Ford be a source of proceeds here. So we don't have another Eagle Ford position. I guess it's a long way of saying, you know, we'll be very smart about it. We're obviously laser focused on continued debt reduction. now share returns but you know we're in the business of you know looking for opportunities to step into positions and add value as an operator that's done that in the past okay okay i appreciate that and congratulations on the deal it's really a pretty impressive transformation thanks thanks

There are no further questions at this time. I would now like to turn the call back over to Joe for closing remarks.

Thank you, everyone, for joining. Hopefully we've been able to provide you a lot of detail on a transaction that we're very excited about here. I think checks all the boxes for what we've been talking about with you all over the last couple of years, frankly, to get to this point. So we're all excited. I'm sure we'll be talking more. going forward. And as always, please let us know if you have any more questions. Thanks again.

This concludes today's conference call. You may now disconnect.