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spk02: good morning my name is emma and i will be your conference operator today at this time i would like to welcome everyone to the sm energy third quarter 2022 financial and operating results q a all lines have been placed on mute to prevent any background noise after the speaker's remarks there will be a question and answer session if you would like to ask a question during this time simply press star followed by the number one on your telephone keypad if you would like to withdraw your question Again, press the star 1. Thank you. Jennifer Samuels, Vice President of Investor Relations, you may begin.
spk01: Good morning, and thank you for joining us. To answer your questions today, we have our President and CEO, Herb Vogel, and CFO, Wade Purcell. As usual, before we get started, our discussion today may include forward-looking statements and discussion of non-GAAP measures. I direct you to slide 2 of the accompanying slide deck, page 5 of the accompanying earnings release, and the risk factors section of our most recently filed 10-K and 10-Q, which describe risks associated with forward-looking statements that could cause actual results to differ. We may also refer to non-GAAP measures. Please see the slide deck appendix and earnings release for definitions and reconciliations of non-GAAP measures to the most directly comparable GAAP measures and discussion of forward-looking non-GAAP measures. Also, look for our third quarter 10-Q filed this morning. And with that, I will turn it over to Herc for brief opening commentary.
spk05: Thank you, Jennifer. Good morning. Thank you for your interest in SM Energy and joining us this morning. We've reached a really exciting time for our business, and I would like to reiterate that we are very pleased to initiate our return of capital program ahead of expectations. Our initiation of share repurchases in September was earlier than expected, and our first increased fixed dividend gets paid next week. We designed our sustainable dividend program, assuming $60 oil and $3 gas, which gives us upside flexibility in a stronger commodity price environment, including acceleration of buybacks. With that, let me now turn it to Emma to open the line for questions. Emma?
spk02: Thank you. As a reminder, if you would like to ask a question, press star followed by the number 1 on your telephone keypad. We do ask today that you limit yourself to one question and one follow-up. Thank you. First question today comes from the line of Parham Lin with JP Morgan. Your line is now open.
spk05: Hey guys, this is Zach Horham from JP Morgan. First, just wanted to ask on the oil cut, which moved a little lower in the 4Q guide. Can you just talk about the drivers of that oil cut moving lower and how you expect the oil cut to trend as we move into 2023? Yeah, Zach, that's a question we hear quite a bit and it's really just driven by how many completions come on in Midland versus how many completions come on in South Texas. We kind of look at it longer term, and the quarterly variations in that oil cut really don't make a difference. We just know it's ultimately going to be driven by the capital allocation between South Texas and Permian. But the returns are what are important, and those returns are very comparable between the two areas.
spk08: Got it.
spk05: And then just shifting over to cash return, particularly on the buyback, you all did about $20 million in buybacks. in September. Can you talk about the pace of that buyback going forward, and is that going to be systematic or purely opportunistic and utilized when you're not blacked out?
spk04: That's a great question. This is Wade.
spk03: I would say it'll be somewhat systematic and methodical, but also very opportunistic. We'll certainly take harder looks on down days, I would say that. But it'll be done over time, and we'll do some each quarter, and that's just the way we'll play it. We always have a view of NAV, and we certainly believe we're trading below that right now. That makes it easy.
spk05: Just one quick follow-up. Are you planning on putting in a 10B51 plan so that you can buy back stock consistently when you're in blackout periods?
spk03: We have not done that, and I would say right now that's not the plan, but that could change, but currently not.
spk08: Thanks for taking my question. You bet.
spk02: Your next question comes from the line of Timothy Resvin with KeyBank. Your line is now open.
spk07: Good morning, everybody. In your press release, you mentioned three high-performing wells that proved up the western flank of Sweetie Peck. And I was curious if you could provide some more details on the zones or what essentially you proved up and why you felt the need to call that out in the release.
spk05: Tim, great question. Yeah, those three wells were a one mile step out to the West from our closest producers and they were in three different zones and we were quite pleased with the outcome of the wells. So that's why we called those out.
spk07: OK, do you have any information on the zones you tested and how much acreage maybe that de-risks for your well?
spk05: So one's middle spray bay, one's lower spray bay, and the other's wealth camp A. And it just moves to the proved category, an area that would have been in probable or possible previously. So it's more or less what we've been doing, which is at the same time we're concentrating on development in the core parts, we're also extending our boundaries. And that's a great example of doing that.
spk07: Okay, thank you for the caller. And my follow-up, I wanted to touch on a big topic in the Midland Basin on well degradation. A lot of operators are talking about it. You all seem to have been kind of less impacted looking at your results over time. So I'm just curious kind of how you think you've sort of sidestepped this issue and how you're thinking about that going forward.
spk05: Yeah, Tim, that is an excellent question. So I think if you look in our deck, that's really the whole latter part of the deck is how much time we spend on modeling the fracks and the wells to get the well spacing tuned to each DSU driven by how much oil is in place in each zone, the vertical and horizontal interference. And that's where I think we really stand out with our ability with the proprietary tools we've developed. And we have that one slide where we show the cloud of all the potential completion designs and where we are compared to kind of the competitors in the Midland Basin. So that's why we view ourselves as really having predictable wells. For us, it's very easy to predict them. The performance is spot on always with what we expect on a per lateral foot basis and on a per well basis if we've got the lateral length fully delivered. That's really what drives it.
spk07: Okay. And then if I could just follow up on that, your spacing assumptions over the last couple of years versus how you're thinking about the next two years, are those consistent or have you made any upspacing changes?
spk05: We have basically lined out by DSU, and after all these years of tuning, there's less and less tuning going on each year. So I think we're pretty much right on. We have done really well with the Dean wells. Those have really outperformed. And so we modified some when we saw zones that performed particularly well. We've done minor modifications, but in the entirety, it's pretty much the same.
spk08: Thank you. I appreciate the comments. You bet.
spk02: Your next question comes from the line of Gabriel Dowd with Cowen & Company. Your line is now open.
spk06: Hey, guys. Gabe here. Thanks for all the prepared remarks last night.
spk05: I was curious if we could maybe just get an update on some of the supply chain issues that were referenced in the pre-release about a month ago or a couple weeks ago, and then also the offset frack issue. I guess how long Do you think these issues could linger? And just given all the wells that were anticipated to come on and maybe pushed to the right of it, should we expect a pretty nice start to the year in 2023? Yeah, great question. We put that early release out to cover the production differences from our expectations. And that was really about 60% from delays and turning wells in line and about 40% from offset activity. The supply chain difficulties really is where we've got a really finely tuned instrument out there, especially when we're simulfracking or even when we're zipper fracking. And if the provider has to wait for parts, that slows us down. If there's slowdowns and trucking whether that is spare parts or other materials required on the site that can slow us down and then For the service sector finding and keeping experienced folks labor on the job that that's another challenge so those sorts of things with the activity at the highest level it's been in a Several years now. That's what's really driving that in overall The number of completions in the Midland Basin, we completed 14, but some came on later in the quarter than expected. And then South Texas, we brought online four fewer, and two of those are already online now, but two more are yet to come. So our base production looks great, but it's just a matter of what the uplift timing is. That's really the story on that one. On the offset activity, it's kind of funny actually that we've been accused of being conservative in our forecasts, and it's kind of funny that three quarters in a row we were accused of conservative. Well, that offset activity was lower than we expected, and then this quarter the offset activity was higher, and that's then what we had baked into our estimates. So that will happen at times, and not much really we can do about it. Okay, got it. Thank you. That's a great caller and very helpful. Now, just on the buyback maybe, just curious, what do you have to see to get comfortable with either accelerating it or even raising it? You noted it's on a pretty conservative price deck and calendar 23 TI is showing $84 or so. How long does that have to be sustained or is it something on the debt side? Obviously, you're pretty close to or about to exceed your target.
spk06: Maybe just help us think about upside to that program and what you guys need to see. Thank you.
spk04: Sure. Great question.
spk03: You know, as you mentioned, we are kind of right at our target on the leverage side of well below one times and right around the billion of net debt. And all I can say right now is that we'll move forward. We will deliver on our commitment to return the levels to the shareholders that we've talked about. And as you mentioned, we built that in pretty conservatively to make sure that would happen. So we used 60 and 3. As we move forward into finalizing our plans for 23 and looking at other opportunities we might have and seeing how stable the commodity prices end up being, that'll just be part of the decision-making as we move forward. Can't give you any metrics to watch for right now. The more comfortable we get with the stability of the commodity and the free cash flow we're generating, there's obviously an opportunity and a possibility that we'll increase the levels on the return to the shareholder side, but too early to indicate any of that yet.
spk08: Okay. Understood. Thanks, Wade. Thanks, guys. You bet.
spk02: Your next question comes from the line, of Oliver Huang with TPH. Your line is now open.
spk00: Good morning, everyone, and thanks for taking my questions. I just wanted to follow back up on the Q4 guide, just, I guess, compared to prior to initial expectations of having encountered the offset frac and supply chain issues in Q3. Does that 60-40 mix that you just kind of referenced for Q3 also hold for Q4, or does it lean a bit heavier one way or the other?
spk05: Yeah, Oliver, for 4Q, all we'd say is, you know, there's been delays in when we can turn some weld in line. Offset activity is something that's really hard to forecast. So what we did for 4Q was just more or less delay the turning lines somewhat. And then for the offset activity, we basically just use our offset activity model where we know our own offset activity and then We know what offset operators will do. Sometimes they'll change their schedule. Sometimes we'll have a delay. But there's nothing specific that I would say pinned to on percentages of one versus the other, kind of all grouped together.
spk00: Okay, thanks. That makes sense. And for a second question, I know you all historically bake in some risking for us at right downtown, but just kind of given the strong commodity prices, more players and activity in the basin, just kind of wondering if you all are expecting a more elevated impact relative to historical norms when thinking about 2023, just based on conversations that other operators have kind of communicated with you in the planning phase for next year at this point in time.
spk05: Not really. It's something that, you know, every month we'll get an update on things, that sort of thing. So it's really... It's hard to forecast exactly what the rig count will be in Howard County. You know, that's one proxy. Just look at the rig count in Howard County when it's way up. You know, there's going to be more activity in the area. So South Texas is different because we've got quite a bit of, it's only our own wells, really.
spk08: Very few places where we've got offset activity directly off us. Perfect. Thanks for the time.
spk02: As a reminder, if you would like to ask a question, press star, then the number one on your telephone keypad. Your next question comes from the line of Greg Brody with Bank of America. Your line is now open.
spk09: Good morning, guys. Just to follow up in terms of the debt side, clearly you're below your leverage target and you've paid down your revolver, so you've still got another $600 million or so to reduce debt. in terms of debt from the bond side to try to get to your billion dollar target. Just talk to us about how you're planning on approaching that. Should we think about you just calling on the first maturities as they come due, or are you thinking about it in a different way? Yeah, thanks, Greg. Good question.
spk03: You know how we operate typically by maturity. So you can assume that when we're ready to reduce the absolute debt, numbers to get down to that billion. As you mentioned, we have a lot of cash right now. That's why we can say net debt's close to a billion. It would probably be the 25s would be the first target, although we watch the trading levels of the others as well. But that's just generally speaking how we would do that. We tapped the brakes a little bit on that, just given the uncertainty with inflation and interest rates. It feels like a good time in this time of uncertainty and rising rates to have cash. So that's kind of the way we're running things right now. As we move forward and build more cash, then that will, you know, we'll make those decisions as we move forward. But that's kind of the general thinking.
spk09: That's helpful. And then you had some comments in your pre-call that I just wanted to clarify to make sure I understand them. So I think when you were talking about inflation, you talked about how this year you modeled for 22, you averaged in 25 to 30%. And I think you said that you expected the exit rate to be above that number, so implying 2023 inflation is higher than 25% to 30%. Did I understand that correctly? And just how does that translate potentially for your capital budget when we think about what you may have locked in from this year already and maybe how you're approaching contracting? Are you thinking about having longer-duration contracts to try to address some of the inflation?
spk03: Yeah, I'll respond to your comment on my prepared remarks. They let Herb add any color he wants, but you did hear it correctly, 25-30, and that we're seeing an exit rate out of 22 higher, and we listed the things that are still going up. Too early to give any specifics on 23 in those areas, though.
spk05: Yeah, the only thing I'll Greg, the only thing I'll add on that is that, you know, we have not done the 2023 budget. We're watching things really closely. We've, you know, done as much as we can to lock in the supply chain for next year. But there's no doubt there's inflation going on and, you know, we don't know when it'll top out.
spk09: Are you considering smaller duration contracts now with some of your providers? It's also addressing the supply chain issues that occurred this quarter.
spk05: Yeah, it's a mix of the contracts themselves, getting the steel, making sure we've got the steel, that we can drill the wells. That's a critical starting point. And then on the frack service providers, making sure we're set there. We're really good. Sand supply, we're in great shape because we do lock that in a bit longer term. We really work that hard is the way I'd sum it up.
spk09: Great. Thanks for your time, guys. I appreciate it.
spk08: You bet.
spk02: Your next question comes from the line of Daniel John with Daniel's Energy Partners. Your line is now open.
spk06: Hey, guys. Thank you for including me. I got a quick question on just the supply chain. If the industry activity stabilizes from here, Do you think the industry sees these headaches ease in 23? But what happens, in your view, if we see another 5% to 10% activity across the board? What's the duration of the headaches, if you will?
spk05: Yeah, John, you know, thanks for the question. You probably know better than anyone on what it looks like. There's areas that are quite tight, and if there were the hypothetical of increasing activity, those tight areas will obviously have more inflation. I think there's quite a bit of discipline on the E&P side and the service side. Yeah. But I'm not, you know, I think the thing is if you're going to forecast, forecast often. I don't think we're ready to forecast. We're going to put a budget together with our expectations in the November through January timeframe, and we'll go with that, and then we'll see where things come. But we are focused on our relationships with those key suppliers and service providers and materials. So that's just what I'd say on that.
spk06: Fair enough. I've got a dumb guy question for you now. Where are we on the evolution of well completion designs? Any big picture thoughts on that? Like how often are you testing new designs?
spk05: So, John, you know, I'm going to point you to one slide in our deck. I don't know if you've looked at it, but it really just shows.
spk06: I'm driving in my truck, sorry. I haven't had you look.
spk05: I'm going to point you to slide 13, and you can see how we've moved our completion design to add value. And in some cases, it does take additional capital, but the performance, that incremental return for that additional capital is phenomenal. We're going to continue to do that. You're going to continue to see us get better, and you're going to see our competitors moving towards our designs over time. I think we're right at the cutting edge on that, and it's a place we want to be. Awesome.
spk06: I really appreciate you guys letting me ask some questions.
spk08: Thank you. You bet, John.
spk02: This concludes today's Q&A. I now turn the call back to Herb Vogel, Vice President and CEO.
spk05: Thank you, Emma, and thank you all for your interest in SM Energy.
spk08: Thank you.
spk02: That concludes today's call. Thank you for attending. You may now disconnect.
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