Texas Pacific Land Corporation

Greetings and welcome to the Texas Pacific Land Corporation third quarter 2021 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce Sean Amini, Vice President of Finance and Investor Relations Thank you. You may begin.

Good morning. Thank you for joining us today for Texas Pacific Land Corporation's third quarter 2021 earnings conference call. Yesterday afternoon, the company released its financial results and filed its Form 10-Q with the Securities and Exchange Commission. These documents are available on the investor section of the company's website at www.texaspacific.com. As a reminder, remarks made on today's conference call may include forward-looking statements. forward-looking statements are subject to risk and uncertainties that may cause actual results to differ materially from those discussed today. We do not undertake any obligation to update our forward-looking statements in light of new information or future events. For a more detailed discussion of the factors that may affect the company's results, please refer to our earnings release for this quarter and to our most recent SEC filings. During this call, we will also be discussing certain non-GAAP financial measures. More information and reconciliations about these non-GAAP financial measures are contained in our earnings release and SEC filings. We may at times refer to our company by its stock ticker, TPL. This morning's conference call is hosted by TPL's Chief Executive Officer, Ty Glover, and Chief Financial Officer, Chris Stedham. Management will make some prepared comments, after which we will open the call for questions. Now, I will turn the call over to Ty.

Thank you, Sean, and good morning, everyone. Third quarter 2021 was a tremendous quarter. TPL set quarterly records for consolidated adjusted EBITDA and royalty production. This was our second best quarter for revenues in our water business, and what a difference a year makes. Compared to the same quarter last year, our total consolidated revenues are up 66%, royalty daily production is up 24%, total water revenues are up 51%, and total consolidated free cash flow is up 60%. Although the past 18 months have been among the toughest we've seen in the industry, TPL's vertically integrated business model, high margin cash flows, and strong balance sheet allowed us to successfully navigate through the downturn. One metric we focus on and prioritize and I think demonstrates the resiliency and quality of our overall business, is our consolidated adjusted EBITDA margin. For the first half of 2021, our adjusted EBITDA margin was 83%. Amongst members of the S&P Oil and Gas Exploration and Production Index, which includes TPL, our first half 2021 adjusted EBITDA margin was the highest of the group. If TPL were a member of the S&P 500, our adjusted EBITDA margin would have been in the top 10 for the same period. For this most recent quarter, our adjusted EBITDA margin has improved even further to 87%. Today, with higher commodity prices and continued growth in the Permian Basin, combined with years of hard work by the TPL team in developing and executing our vertically integrated business model, We're pleased to be in a position to fully capture the value from our asset base. Our active management approach has taken our legacy asset base, which was both ideally situated, yet raw and underdeveloped, and created multiple high-quality cash flow streams. To this point, today I want to highlight and elaborate on our water business. Our water business is a clear example of the benefits of our active management approach. Prior to active management, TPL had minimal revenues outside of its legacy production royalty interest, despite owning close to a million surface acres in the Permian. As drilling and completion techniques continued to improve over the last decade, the vast resource potential underlying our royalty assets became increasingly viable. However, development here is not without challenges, especially in the western part of the Permian, generally known as the Delaware Basin. where a majority of our high-interest royalties reside. On the Delaware side of the Permian, the geography tends to be much more arid and just generally inhospitable compared to the eastern flank of the basin. In fact, Loving County in Texas, which is considered to be part of the core of the Delaware Basin, is the least populated county in the contiguous United States. Reeves and Culberson counties sit to the west of Loving, and these counties are no less desolate and arguably even more arid than Loving. These geographical features are relevant because water is scarce in this part of the Delaware, and well development would be impossible without tremendous amounts of water. Completing a horizontal well, otherwise known as fracking, requires approximately half a million barrels of water. This lack of water availability was a major reason development in the Delaware Basin initially lagged behind the development in the Midland Basin. That's why in 2017 we formed Texas Pacific Water Resources. This represented a departure from the legacy way of doing business at TPL, which up to that point was mostly passively run with just a handful of employees. We went out and hired a talented and experienced team of professionals from some of the best companies in the industry to execute our plan. From there, we developed two general sides to our new water business, the first being source water and the second being produced water. Starting with source water, this is where we provide brackish groundwater and, to a lesser extent, treated produce water to oil and gas operators for use in their well development activities. As surface owners, TPL has the unique right to water aquifers on our land and across our 880,000 surface acres. We have a handful of locations with productive aquifers. Over the last few years, we've invested approximately $105 million in developing aquifer wells, laying transfer pipelines and pumps, and constructing frack water storage ponds. We strategically selected and developed this water infrastructure throughout our acreage footprint to efficiently service the greatest number of oil and gas wells across the Permian Basin. In order to maximize capital efficiency and margins, we generally require producers to come to our frack water ponds to take delivery of our water. From there, the operators take responsibility for developing the infrastructure and managing the logistics, transferring water from our frack ponds to their well pads. It's worth noting that today, operators generally develop multiple wells simultaneously on a single development pad. Operators have also become more efficient in completing multiple frack stages for multiple wells in an increasingly condensed amount of time. Laterals are also getting much longer. Thus, operators often need millions of barrels of water delivered over a course of just a few days, which is no easy task if you're trying to source water from multiple small sources. At TPL, we've sized and developed our source water infrastructure to accommodate the needs of the most demanding producers. The outcome of this very deliberate effort is that our source water business was instrumental in enabling and incentivizing production on our royalty acreage in the Delaware. Although development in the overall Delaware has grown tremendously over the last five years, production on our acreage has grown even more. Additionally, we often sell water for wells that may not be located on our acreage, so our water has been vital for well development in the Delaware even outside of our footprint. And this also drives additional surface revenue for TPL. During this most recent quarter, over 70% of our source water sales were for wells that were located off of TPL's surface, which is directly attributable to the industry relationships our team has. Historically, we estimate that our market share has been approximately 30% of Northern Delaware source water volumes. We have capability to deliver over 800,000 barrels of water per day without meaningful additional capital expenditures. This past quarter, we delivered 42 million barrels of water to our customers. I'm confident that without our source water business, oil and gas production in the Delaware overall and production on TPL's royalty specifically would be meaningfully less than what it is today. Our water is vital for Permian producers to develop their acreage, and we actively leverage our source water and our surface rights to drive more production onto TPL's royalty acreage. Today, we have an extremely talented group of people that focus exclusively on serving our customers, to encourage production on our land, and to make sure that we are a reliable partner in delivering water. That's worth noting because our source water is an operated business, and as such, our cash flow margins are understandably lower than our oil and gas royalties business. Our source water assets still generate strong cash flow margins and profitability, and our investment in the water business has generated meaningful free cash flow. Later on, the additional impact of using our water to incentivize development onto TPL's royalty acreage and our source water business has generated tremendous value for our shareholders. The other side of the water business is referred to as produced water royalties or also referred to as saltwater disposal royalties. This is where we charge a fee for water from a producing oil and gas well that is disposed of on or crosses our land. As many are already aware, oil and gas wells in the Delaware are unique in that these wells produce a disproportionately high amount of water along with the oil and natural gas volumes compared to other basins. This associated water is referred to as produced water. And generally, the water must either be injected into a saltwater disposal well or treated for reuse elsewhere. Unlike our source water business, our produced water business requires no capital investment from us. Whereas we operate our source water assets so that we can control our own destiny towards incentivizing development, our produced water royalties leverage our expansive checkerboarded surface footprint to create value. Our customers are generally either operators that own their own infrastructure or water midstream companies that specialize in handling produced water on behalf of operators. Because we don't develop, own, or operate saltwater disposal wells or the logistics pipelines, our produced water royalties are high margin, fee-based cash flows that require no capital expenditures. And because producing wells are almost never shut in outside of rare circumstances, the volumes are very stable. 2020 was a great example of the resiliency of this business. Despite one of the worst down cycles this industry has ever seen, And with severely depressed commodity prices, our produce water revenues in 2020 were 30% higher than in 2019. Again, our produce water business is a testament to our active management approach. Prior to active management, our produce water royalty cash flows were minimal and little time and effort was spent on maximizing its value. Today, TPL's management and water teams dedicate a tremendous amount of time and effort in forcing our surface rights negotiating fees at fair value, and monitoring compliance. In summary, over the last 12 months alone, our water business has generated approximately $113 million in revenues and $50 million in net income. And since 2017, when we started the business, we've generated over $445 million in revenues and $210 million of net income. The water business generates robust free cash flow and requires relatively modest amounts of maintenance capital, approximately $10 million annually. Our investment in people and capital has been a highly profitable endeavor, and we expect our investment to continue generating strong free cash flow and value for our shareholders. We're extremely proud of the business we have built. We're focused on making it better and more profitable every day, and we're glad that our shareholders have reaped those rewards. With that, I'll turn the call over to Chris.