Sitio Royalties Corp.

Hello everyone and welcome to the City of Royalty's fourth quarter 2022 earnings call. My name is Nadia and I'll be coordinating the call today. If you would like to ask a question at the end of the presentation, please press star followed by one on your telephone keypad. I will now hand over to your host, Ross Wong, Vice President of Finance and Investor Relations to begin. Ross, please go ahead.

Thanks operator and good morning everyone. Welcome to the City of Royalty's fourth quarter and full year 2022 earnings call. If you don't already have a copy of our recent press release and updated investor presentation, please visit our website at www.cidio.com, where you will find them in our investor relations section. With me today to discuss fourth quarter and full year 2022 financial and operating results is Chris Conocenti, our chief executive officer, Kerry Osika, our chief financial officer, and other members of our executive leadership team. Before we start, I'd like to remind you that our discussion today may contain forward-looking statements and non-GAAP measures. Please refer to our earnings press release, investor presentation, and publicly filed documents for additional information regarding such forward-looking statements and non-GAAP measures. And with that, I will turn the call over to Chris.

Thanks, Ross. Good morning, everyone, and thank you for joining CTO's fourth quarter and full year 2022 earnings call. We had a tremendous 2022 and demonstrated strong execution on our large scale minerals consolidation strategy through a series of transactions that transformed us from a private company with approximately 106,000 net royalty acres in the Permian Basin at the beginning of the year to one of the largest publicly traded oil and gas mineral and royalty companies in the U.S. upon completion of the Brigham merger in December. Closing two corporate mergers and two large cash acquisitions within a calendar year is an impressive feat, and I would like to thank the CITIO team and our board members for their dedication and hard work to get us to this point. We now own 260,000 net royalty acres across seven of the premier oil and gas basins in the country and have exposure to over 170 operators of horizontally drilled wells based on fourth quarter 2022 production. The oil and gas minerals and royalty sector remains highly fragmented, and we're well positioned to be the natural consolidator with our proven returns-focused and large-scale consolidation strategy. In addition to meaningfully scaling our business, impressive returns were generated for investors. All shareholders, regardless of whether they originally owned Falcon or Brigham, experienced total returns in 2022 in excess of 60%. Now, turning to our fourth quarter results. Due to lower commodity prices, CTO's average realized unhedged revenue per barrel of oil equivalent was down 17% from $65.71 per BOE in the third quarter to $54.68 per BOE in the fourth quarter. This was partially offset by a quarterly increase in average daily production of 935 barrels of oil equivalent per day. which generated an incremental $5.8 million in revenues in the fourth quarter. CTO generated adjusted EBITDA of $93.1 million and discretionary cash flow of $77.5 million in the fourth quarter, which both included three days of contribution from the Brigham assets since that transaction closed on December 29th. Quarterly adjusted EBITDA was down sequentially by 12%, primarily due to lower commodity prices. Quarterly discretionary cash flow was down sequentially by 17% as a result of weaker commodity prices and increased cash interest, partially offset by a reduction in cash taxes. Cash interest expense was higher by $4.1 million compared to the third quarter due to higher debt levels from refinancing the $425 million bridge loan with $450 million of senior unsecured notes and higher interest rates on all of our debt because of the rising SOFR curve. Our cash taxes paid decreased by $1.4 million relative to the third quarter. However, some of this was due to timing because a tax payment for the fourth quarter of approximately half a million dollars was made in January of this year. For the fourth quarter, we are declaring a dividend of 60 cents per share. This is based on a full quarter of discretionary cash flow from Citio and Brigham of $144.3 million. assuming the Brigham transaction had closed on October 1st, 2022. This dividend per share amount is down 12 cents or nearly 17% from our third quarter dividend per share of 72 cents. So I wanted to provide some color to help explain that change. On a standalone basis, as if the Brigham merger had never occurred and at our standard 65% payout ratio, CTO's fourth quarter dividend would have been 58 cents per share. Lower commodity prices accounted for a $0.12 per share decrease. Higher interest expense, lower lease bonus activity, and higher severance and ad valorem taxes accounted for a $0.05 per share decrease. Lower cash G&A, lower cash taxes, and hedge impacts accounted for a $0.03 per share increase in the fourth quarter dividend. Outperformance of the Brigham assets. created a $0.02 per share accretion versus Citio on a standalone basis, increasing the fourth quarter declared dividend to $0.60 per share. Our business generates an incredible amount of cash, and assuming that Citio and Brigham had been combined since July 1 of 2022, we have declared or distributed approximately $200 million in aggregate dividend for the second half of 2022, which is more than any other U.S. publicly traded minerals company over this time period. This aggregate dividend amount is also competitive with exploration and production companies, with only three publicly traded ENPs in the US that have declared more aggregate dividends over the same period and have a market cap of less than $20 billion. To make things simple, all metrics I refer to from here on will be on a pro forma basis as if Citio and Brigham were combined for the entire fourth quarter, because we believe it is most relevant for investors, particularly This is how results will be reported in future quarters. Operators remained active on the acreage underlying our minerals, turning in line 1,200 gross wells normalized to 5,000-foot laterals, which equated to 7.3 net normalized wells. Fourth quarter net production volumes of 34,424 BOEs per day outperformed our expectations and were above the top end of the range of our combined company guidance. partly due to approximately 16,000 BOEs per day from the Brigham asset, which continued to outperform what we underwrote for the merger. Now that the Brigham merger is behind us and the 2022 books are closed, we have issued full year 2023 guidance. Our line of site inventory of 47.9 net normalized spud and permitted wells, which on average typically come online within 12 months, remains near record high levels and provides visibility into near-term production growth, particularly when compared to the 128.1 net normalized wells that were turned in line on our acreage over the past four years combined. The Delaware, Midland, and DJ basins continue to be the most meaningful and active areas in our portfolio, accounting for 94% of net wells turned in line during the fourth quarter and 92% of our net line-of-sight wells at year-end. We expect these three basins to have higher near-term growth than the other geographies in our portfolio due to the mix of operators, resilient well economics, and robust levels of remaining inventory. Our 2023 guidance includes a production guidance range of 34,000 to 37,000 DOEs per day, with a range of 49% to 51% for oil as a percent of production. The midpoint of this production guidance range is up by 6% relative to the midpoint of the previous guidance issued in November for the 12 months ending June 30, 2023. We also provided an annual cash G&A guidance range of $25 to $27 million, which implies cash G&A of $2.01 per BOE, a $0.26 per BOE reduction versus CITIO on a standalone basis for the fourth quarter of 2022. The rest of our full year 2023 guidance metrics are relatively in line with our prior guidance. Now, transitioning to the balance sheet, we inherited Brigham's revolving credit facility when we closed the merger, resulting in us having both Citio's revolver and Brigham's revolver on our balance sheet at year end. In January, we launched a syndication for a new revolving credit facility, which closed and became effective on February 3rd with elected commitments of $750 million from a 15-member bank group. I would like to thank all of the banks who supported us throughout this process and helped syndicate one of the largest revolvers in the oil and gas, minerals and royalty sector, providing the company with additional liquidity and financial flexibility to help run our business efficiently. As of March 3rd, we had $407 million drawn on our newly syndicated revolving credit facility, down from $510 million in credit facility debt at December 31st. At the end of December, we made our first quarterly amortization payment at par of $11.25 million on our senior unsecured notes, reducing the outstanding principal from $450 million to $438.75 million. The senior unsecured notes prohibit us from making stock repurchases, which we would like to be able to opportunistically do with the 35% of our discretionary cash flow that we don't distribute as a quarterly dividend. We are monitoring market conditions for an opportunity to refinance these notes, either after the first call date on September 21st of this year, or sooner if warranted to provide our company the appropriate amount of capital allocation flexibility. Regarding our outlook for additional large-scale acquisitions, we remain focused on our underwriting discipline and believe that there will be fewer opportunities that meet our returns criteria in 2023 compared to 2022. There is still a large opportunity set of high-quality and sizable minerals positions to consolidate, and we have made several offers to acquire additional mineral assets this year, but the bid-ask spread has been too wide. If attractive consolidation opportunities do not materialize, we will continue to focus on strengthening the balance sheet by paying down our prepayable debt and building liquidity for when market conditions normalize. In 2023, we will also be acutely focused on gaining additional efficiencies and implementing new technologies to help us continue to scale and provide competitive advantages that will allow us to replace less effective third-party vendors. Professional management of oil and gas minerals is still a relatively new concept, and we believe there is a large opportunity to transform the industry, which currently uses many outdated methods and tools. Technological advances geared specifically for the challenges of an independent mineral owner are in their very early stages of development, and we are piloting a number of new efficiency tools. We also see a large opportunity to fundamentally improve the relationship between operators and mineral owners while saving money and time on both sides and eliminating inefficiencies in the system from duplicative work done by hundreds of operators and tens of thousands of mineral owners. That concludes my prepared remarks. Operator, please open up the call for questions.

Of course, if you would like to ask a question today, please press star followed by one on your telephone keypad. If you choose to withdraw your question, please press star followed by two. When preparing to ask your question, please ensure your phone is unmuted locally. We'll pause for just a moment. Our first question today goes to Tim Redson of KeyBank Capital Markets. Tim, please go ahead. Your line is open.

Okay, thanks, Dan. Good morning, everybody. Appreciate you taking my questions. First question, I guess, Chris, you gave line-of-sight information, 47.9 wells at year-end. We're now almost 10 weeks into the year. There's a lot of concerns on a potential slowdown in industry-wide activity. Can you give any insight on what that line-of-sight information is now, or just generally, can you talk about the pace of activity you've seen year-to-date?

Good morning, Tim. Thanks for the question. So given data lag, it's hard to give real-time updates on exactly what is happening at this moment. But what we have seen over the past several months has been a trend of increasing spud activity and plateauing permitting activity on a gross basis. It's had a somewhat different effect on a net basis, too, as there's different interest wells drilled within those. But a similar trend of increasing net spud activity and a flat-ish profile for the net permitting activity. But again, that's maybe current as of January. It's not really up to date as of March 9th.

Okay, I appreciate that. Then if I could switch, I don't know if this is for Carrie or for you. As CDO works to get leverage down to or below sort of that target one times goal, How do you think about the value of your non-permian minerals? And I asked in light of another public minerals company announced a sale of non-permian minerals acreage a couple weeks ago. Is that something you're considering or is it more of a low likelihood event?

Well, it's something that we didn't have the luxury to consider this time last year because we had a 100% permian portfolio. But now that we have a broader set of assets, those are the types of portfolio management opportunities that we do consider. Now, in order to be value additive for the company, it would have to be a pretty compelling valuation. So it's one of those circumstances where we're in the business of aggregating and consolidating this business, and we have to see the compelling use of the capital deployed elsewhere to consider selling some of our assets today. That said, there's places that we look at and we think they're challenged from a growth perspective, and a good example is Appalachia. When you look at Appalachia, it's unlikely that we're going to see additional long-haul pipelines built out of Appalachia in my career, just given the political landscape up there. And so that basin is effectively capped in terms of production growth. So when we look at minerals there, as a mineral owner, what you really hope to see is rapid paper development, healthy operators, good infrastructure, and a stable regulatory environment. And unfortunately, we just don't have all of that in Appalachia. So that's just one example. It's a small segment of our assets. We're not actively considering selling anything at the moment, but those are the types of criteria we look at when we consider selling assets.

Okay. Thanks. And then if I could just sneak one last one in. In your prepared comments, Chris, you talked about in September there's the one-year anniversary of the senior notes, and you could look to refi. You did mention maybe refinancing earlier. Can you just kind of – any details on what the terms would be? Is there some sort of premium if you were to refi earlier? Would that be in theory like – related to some sort of compelling acquisition that you wanted to make and reset the capital structure. Just trying to understand that comment. And that's all I have. Thanks.

Sure, Tim. So at September 21st, there is a call premium of 103. And then there's a make hole on top of that to do it prior to September 21st. So it becomes a pretty NPV negative trade to do something a lot sooner than September 21st at today's market conditions. Now that can always change, but as we analyze it today, it's not a compelling trade. But you're right, one of the things that could factor into our decision making could be a compelling cash acquisition and us looking for additional liquidity. We're going to continue to watch it and look for the flexibility that this company needs. These notes were put into place at a much different time in our company's lifecycle. We were smaller. The capital markets were in a much different position than they're in today. And so I think the overall terms would be much more favorable for our company. So there's other factors than just the NPV that go into it. But right now, it's a fairly NPV-negative trade.

Okay. That makes sense. Thank you. Thank you.

Thank you. The next question goes to Janine Way of Barclays. Janine, please go ahead. Your line is open.

Hi. Good morning, everyone. Thanks for taking our questions. Good morning, Janine. Our first question is on productivity, I guess. Good morning. Our first question on productivity, the press release cited near record level line of site wells, which is great. That's a tailwind in 23. but continued capital discipline from public EMP operators as a headwind. So on the discipline side, is it your sense that companies, that they continue to high-grade activity within their acreage positions? There's been a lot of attention on year-over-year oil productivity, with one large-cap EMP actually saying that flat productivity at this point would be a win, and 23 considering just the natural maturation of the industry. I guess, you know, any comments on what you're seeing from your end regarding oil productivity trends and is, you know, it's kind of in direct conflict with some of the trends that we're seeing from the EMP operators of doing more co-development or exploring more deeper zones. So, any commentary you have would be very helpful. Thank you.

Sure. Thanks for the questions, Janine. So, we are seeing people look around for leases on deeper horizons, not in great volumes, but here and there. Anecdotally, we are seeing that. And we are seeing wells here and there testing different zones. But again, it's not the lion's share of activity. The lion's share of activity is still in the most productive and highest IRR known zone. So not a lot of deviation from past activity there. We did take a look at some of the performance data on some of the operators that did report some of those productivity differences versus prior wells. As a mineral owner, we sit here and one of our goals is to maximize resource recovery from a drilling unit. So it's probably less sensitive than an operator is to single well economics because they're the ones that have to deploy the capital and bear the burden of that capital expense. For us, what we're hoping to achieve is maximum drainage from any unit. So yes, single well economics are important, but more important to us is actual maximizing of drainage from a given unit. So that's the area we're more focused on.

Okay, great. Another structural advantage for minerals. We like it. Our second question may be just going to the deal environment. The commentary in the press release indicated that the current environment is looking to have similarities to 2019 and 2020 with, I think it cited single-digit rates of return. So just wondering if you could provide a little more color what you're seeing and what level of returns do you consider to be acceptable considering that you can hedge some of the commodity price risk? Thank you.

Our expectations for rates of return haven't wavered since we were a private company with private equity capital and those types of return requirements. So we still look for mid to high teens to low 20s IRRs over the life of the assets. And we value these assets at strip pricing. And when strip pricing is above what we consider mid-cycle, which is in today's terms $50 to $75 by our math, then we'll hedge. So our underwriting standards haven't changed. But we're in a time period right now, much like we were in 2020, where commodity prices were much higher not too long ago. And when that pattern exists, you see sellers look for commodity pricing or valuations that reflect prior pricing, not current pricing, and prior levels of activity, not current levels of activity. So these things move in cycles, and we're patient and disciplined, so we'll be here when the cycle normalizes, and we're just going to build liquidity in the meantime.

Great. Thank you. Thank you. As a reminder, if you would like to ask a question, please press star followed by one on your telephone keypad. And our next question goes to Noel Parks of Tuohy Brothers. Noel, please go ahead. Your line is open.

Hi, good morning. Morning, Noel. Just a couple of things. One thing I noticed is that actually the proof reserve figures came in higher than sort of my back of the envelope estimate. And I wondered, was there anything notable that came from your process of sort of rationalizing the old Desert Peak and then Falcon and then Brigham's different reserve policies? I seem to recall there's some differences as far as PUD bookings and also the different accounting method change with RIGM, I believe.

Yeah, Noel, thanks for the question. Nothing notable in terms of evolution of reserves beyond what we were expecting. You are correct. There were some nuances in how each of the companies philosophically approached PUD bookings. I would say ours is on the more conservative end of the spectrum where we only book wells that have been thud as thud wells. So that's where you may be seeing some differences versus legacy companies in the acquisitions.

Okay, good enough. And you mentioned right at the end of your remarks that you were piloting a number of new efficiency tools. You were talking in general about professional management of minerals is still relatively new. I'm just curious about some of the things you're experimenting with.

We're really excited about a couple of the initiatives we have starting this year. We sit here in a pretty unique position where we view ourselves as the permanent owners of these assets. We're buying assets from people who maybe aren't necessarily the permanent owners, and that's why they're selling them to us. And as the permanent owners, we're going to manage them differently, meaning we're going to make sure we're getting paid timely on every well every month, making sure that the decimals on which we're paid match the decimals on which we believe we own. And we track these things monthly. We prioritize the missing payments that we believe we're owed, and we pursue them with operators. And to do that on a business of our scale with 5,000 leases over 25,000 wells, it takes a lot of technology and data management to do it efficiently. And so we are developing tools on our own just because there's no suite of software that effectively manages a minerals business. So we've spent a lot of time in 2020 building out our data warehouse and data management system, and that has allowed us to scale up the way that we have. And now we're working on ways to make our team more efficient by having them touch fewer of the data points and just automatically process some of the data points. So things like revenue or division orders are just begging for efficiency measures. So we're working on those things this year.

Okay, great. And just one housekeeping item. In the release, the one-time transaction costs were broken out, which was helpful. And is the fourth quarter amount sort of the bulk of what we'll see, or do you expect there'll still be some remaining items in first quarter or second quarter?

There were a couple of lingering invoices in January, but that's it.

Okay. Okay, great. Thanks a lot.

Thank you.

Thank you. As a final reminder, if you would like to ask a question, please press star followed by one on your telephone keypad. And we have a follow-up from Janine Way of Barclays. Janine, please go ahead. Your line is open.

Hi. Thanks for getting me back in the queue. Just a question from us, maybe following up on something that Noel just asked in terms of new things that you're thinking about doing. So you also mentioned in your prepared remarks doing certain things to improve the relationships between operators and mineral owners. And we found that really intriguing. And, you know, we know that you're kind of trailblazing some of the minerals business model here with large scale. So just any commentary or color on what you meant by improving the relationships and how that'll translate into, you know, tangible improvement?

Sure. So if you think about the construct we live under today, We deal with publicly released information, so information that comes through regulatory bodies like the Railroad Commission in Texas and check data that we receive from operators. But all this data comes to us on a lagged basis. It'd be nice when we're more relevant and at a larger scale with operators to have a more direct line of communication because we think that that can save the operators time and money and also improve the quality of data we receive from them. Right now, that data filters through third-party providers and often mistakes are made by those third-party providers and we find ourselves having to correct them or work with the operators. Again, it just consumes time and resources on both sides. And so just having a more direct line of communication, more standardized output of information, those types of things will go a long way to reducing costs for operators and for mineral owners.

Okay, great and then just one quick one on potential buybacks in the future, once you take out those old notes. We heard some commentary on the EMP earnings calls that you know they just think that their variable distributions aren't getting enough credit in the market we've heard this from a couple of operators actually and so. One of them was moving more towards buybacks in a meaningful way. Another operator said they were going to go back to their shareholders and kind of pick their brains on that. So I think for you guys, buybacks has always been part of a broader conversation. Just wondering if, you know, there's been a change in any of your conversations with your own investors about what they really want you to do on capital allocation of that distribution. Thank you.

We haven't heard any change or seen any change from our shareholders and what they're looking for. As we look at our options here, we still remain committed to our at least 65% payout ratio as a percentage of our discretionary cash flow. And the current thinking is that if we were to institute a buyback program once we get support authorization and once we refinance these existing unsecured notes, for a more flexible piece of capital. The thinking now is that the share repurchases will be done out of the 35% of retained cash flow, and so we remain committed to that 65% on the dividend payout. That's the current thinking that could always change, but we'll continue to reevaluate that at the time that we have the flexibility to make the repurchases.

Thank you for the time.

Thank you.

Thank you. And as a final reminder, if you would like to ask a question, please press star followed by one on your telephone keypads now. We'll pause for just a moment. Thank you. It appears we have no further questions. This now concludes today's call. Thank you so much for joining. You may now disconnect your lines.