Texas Pacific Land Corporation

Good morning and welcome to Texas Pacific Land Corporation's fourth quarter 2021 earnings conference call. This conference call is being recorded, and at this time I'd like to introduce your host for today's call, Sean Amini, Vice President, Finance and Investor Relations. Sir, please go ahead.

Good morning. Thank you for joining us today for Texas Pacific Land Corporation's fourth quarter 2021 earnings conference call. Yesterday afternoon, the company released its financial results and filed its Form 10-K with the Securities and Exchange Commission. These documents are available on the Investors section of the company's website at www.texaspecific.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 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. Please also note we at many times refer to our company by its stock ticker, TTL. This morning's conference call is hosted by TTL's Chief Executive Officer, Ty Glover, and Chief Financial Officer, Chris Tettum. Management will make some prepared comments, after which we will open the call for questions. Now, I will turn the call over to Ty.

I'm pleased to report that TPL finished 2021 in record fashion. The upward momentum we saw last quarter continued into the fourth quarter with consolidated adjusted EBITDA of $130 million and daily royalty production of 22,000 barrels of oil equivalent. Likewise, for full year 2021, this was the best year in our company history by almost any measure. Reflecting back on 2021, the year began with a lot of uncertainty on how the pandemic would turn out. Domestic and global demand for oil products were still far below pre-pandemic levels. Oil prices were below $50 and natural gas under $250, levels I'm not sure anyone in the industry was excited about. The TPL had navigated through the worst of the volatility of 2020, and so we entered 2021 hopeful for a better year. As the year progressed, the global economy and commodity markets did experience some volatility, but overall they continued an upward trend. By mid-year, we had $70 oil and $4 natural gas, and the industry, particularly in the Permian, seemed to find some solid footing. Our source water sales, which are a leading indicator of activity, started to noticeably pick up. You can see rig counts and frack crews also tick up week by week, and our regular discussions with operators reaffirmed that activity would be supportive of permanent production. While the first half of 2021 could be characterized as slow but steady, the second half of the year is when activity started to ramp up, especially on DPL acreage, propelling full-year 2021 royalty production growth 15% compared to full-year 2020 production. Commodity prices also steadily improved throughout 2021, with TPL's full year 2021 all-in average commodity price realization over 80% higher than 2020 realization. Because TPL was completely unhedged for the entirety of the year, we were able to fully benefit from higher commodity prices. The combined impact of higher production and higher commodity prices resulted in TPL's oil and gas royalties more than doubling in 2021 compared to the prior year. Our non-oil and gas royalty revenue stream also saw meaningful growth in 2021. Sourced water and produced water royalties had year-over-year revenue growth of 24 and 15%, respectively. Our easements and surface-related income was down modestly year-over-year as producers continued to focus development around existing infrastructure and continued to draw down ducts. In aggregate, our non-oil and gas royalty activities generated $164 million of revenue during 2021. In summary, TPL's consolidated 2021 revenues of $451 million were 49% higher than the prior year. Our 2021 total operating expenses only increased by 4% versus 2020, and as a result, the majority of revenue growth dropped to our bottom line. Looking ahead, we hope to carry the momentum from the second half of 2021 into 2022. current commodity prices at levels that we haven't seen in nearly a decade, we see continued strong permian development activity, including strong completion numbers on our gassy-loving northern reeves and Culberson acreage. We've also seen strong permitting, drilling, and completion activities on our Midland Basin footprint. In particular, the Midland royalty interest that we've acquired over the last few years are seeing strong operator activity. gross well completions on acquired royalty interest exceeding PPL's legacy mid-lending PRIs. In the Delaware, overall operator development seems to be a bit more skewed towards the New Mexico side, so activity on our Texas Northern Delaware footprint remains solid. For source water, the strong sales volumes we saw through the second half of 2021 have persisted into 2022. Operators continue to drill longer laterals and are deploying more simulfracs and zipperfracs. These accelerated completion techniques require millions of barrels of water delivered over the course of just a few days. These types of completion methods benefit TPL as our extensive source water infrastructure can accommodate the most demanding operators. On the produced water side, we continue to generate high margin and stable revenue streams. Our produce water volumes have moderated somewhat recently as we see producers focus heavily on the New Mexico side of the northern Delaware. We expect produce water volumes to grow as we are still seeing healthy development activity across both our Delaware and Midland surface acreage. Turning to surface leases, easements, and materials, which we refer to as SLIM, part of the business has been the slowest to recover from pre-pandemic levels as producers continue to draw down doves, focused development around existing infrastructure which has reduced surface revenue opportunities we continue to see duct drawdowns at a pretty healthy clip as producers continue to add more rigs and as pad development extends beyond existing infrastructure revenue opportunities for slim should increase we also continue to work hard on next-gen opportunities This past January, we executed an agreement with Texas A&M AgriLife Extension to begin assessing and eventually implementing soil carbon sequestration opportunities across a few land plots spanning approximately 20,000 acres. Our goal with this project is to generate authenticated carbon credit we can then use to offset our own Scope 1 and Scope 2 emissions or also potentially monetize. We continue to work on many other next-gen opportunities, and we hope to share more updates in the near future. On capital allocation, our board raised our base dividend by a quarter to $3 per share. More broadly, our capital allocation priorities are still predicated on long-term value creation, and we continue to see attractive acquisition opportunities in the market. There are a number of structural factors that are motivating sellers, which include upstream public valuations and significant discounts to historic levels, institutional capital drying up for legacy oil and gas assets, and zero mandates driving asset portfolio reduction, and increasing legislative and regulatory uncertainty and complexity. With our exceptional legacy asset base, our ability to manage royalties and surface, our strong balance sheet, and attractive cost of capital, we're in a uniquely advantaged position to purchase assets at attractive prices. All that said, we won't be underwriting acquisitions with a near-term or long-term $90 rollback. We remain disciplined and focused. We are trying to grow for the sake of growth itself. Rather, we want to add more royalty production, more free cash flow, more surface, more next-gen cash flows on a per-share basis, on a near-term and long-term basis. Our stock price continues to be dislocated while underlying fundamentals remain strong, and DPL retains a lot of flexibility to execute buybacks, dividends, and possibly special dividends. A capital allocation strategy is agnostic across methods. We will pursue those strategies that will add the most long-term value for shareholders. So if that means buying back stock, then we will buy back a lot of stock. If that means increasing our dividend, we can increase our regular dividend and issue special dividends. Finally, I wanted to spend some time talking about the seismicity issues in the Permian and recent regulatory action. As many are aware, Texas and New Mexico regulators have established certain seismic response areas, or otherwise referred to as SRAs, to outline regions experiencing an increase in seismic activity. Seismic activity in these areas has been attributed in part to saltwater disposal wells, otherwise known as SWDs. In short, it's generally understood that disposing of produced water in deep subsurface zones along pre-existing faults is likely instigating seismic activity. Thus, the primary attention for regulators and the industry is to try and limit SWD injection rates within these sensitive areas. So far, there have been two SRAs in Midland and one in the Delaware imposed by the Texas Railroad Commission. Only the Delaware SRA that spans northern Culberson and Reeves Counties overlaps with TPL surface acreage. Regulators here have requested that operators limit daily downhole injection volumes, and operators have generally been able to accommodate these limits without much disruption to ongoing development and production activities. Specific to TPL, the Culberson Reeves SRA covers a fraction of the SWDs located on TPL surface. Over the years, we've been deliberate in spacing SWDs throughout our surface footprint As a reminder, PPL does not own or operate disposal wells or related SWD infrastructure. Rather, our produced water royalties are derived and governed by previously negotiated long-term contracts. Most of these contracts are acreage dedications covering around 450,000 acres where PPL generates a fee for produced water that is stored directly on or travels across our land. Even if a specific disposal well on or near TPL surface gets shut down, as long as that diverted water crosses our checkerboarded surface footprint to another well on or off the TPL surface, we will continue to generate a royalty fee. With this contract structure, no matter what happens to produce water, whether it's stored, transported across, treated, or reused, TPL will generate a fee. It was clear to us years ago that Delaware's high water cuts would likely necessitate multiple solutions as development increased, and our contracts were designed specifically with this in mind, allowing TPL to participate in the value chain regardless of outcome. Longer term, if SWDs or areas adjacent to our surface footprint get shut down or restricted from accepting incremental produce water volumes, water that ends up crossing TPL's surface to access nearby disposal wells or infrastructure will have to pay us a fee. We believe that longer term our produced water royalties will ultimately benefit given that we can provide logistical solution flexibility across a vast surface footprint. We've already held many discussions with upstream and midstream operators on this issue and I can assure you that the industry is committed to finding a sustainable resolution We're not just seeking ways to deal with current produce water volumes, either much of the efforts are also focused on how to proactively implement longer-term best practices to accommodate future development. Though it's still early, solutions are likely to entail a mix of options, such as perhaps storing produce water in shallower geologic zones, taking greater care to space SWDs further apart, and more recycling. We're also actively looking at options beyond just downhole injection that would involve new technologies geared towards reuse and repurposing. Fortunately for us, our surface footprint and vertically integrated model allows us to explore every available option, and we can help facilitate and execute on those solutions for the benefit of all stakeholders. With that, I'll turn the call over to Chris to discuss our 2021 fourth quarter and year-end financial results.

Beginning with our operating results, total revenue for the fourth quarter of 2021 was $147.2 million compared to $74.3 million for the same quarter last year, a 98% year-over-year increase. The increase in revenues is primarily from higher royalty production, higher commodity prices, higher source water sales volumes, and higher produced water volumes. We were able to fully benefit from rising commodity prices as we were completely unhedged during the quarter and we remain unhedged today. For the fourth quarter of 2021, we had net income of $79 million for $10.21 per share. This compares to $44.8 million of net income for $5.77 per share in the same quarter of the prior year. Adjusted EBITDA was $130.3 million compared to $61.2 million for the same period last year. Oil and gas royalty production volumes were approximately 22,000 VOE per day in the fourth quarter of 2021 compared to 17,000 VOE per day for the fourth quarter of 2020. Production this quarter benefited from increased activity on our royalty acreage and from production associated with periods prior to the beginning of the most recent quarter. At the end of the fourth quarter 2021, PPL's Royalty Acreage had 7.2 net well permits, 6.6 net drilled but uncompleted wells, 2.5 net completed wells, and 48.1 net producing wells. Moving to the expense side, our operating expenses were $21.3 million for the fourth quarter of 2021, up from $19.1 million in the fourth quarter of 2020. Turning to our balance sheet, at the end of the fourth quarter, we had $428 million of cash and cash equivalents, and we continued to carry no debt. In the fourth quarter of 2021, capital expenditures were $4.9 million, which was primarily spent on electrifying our water sourcing infrastructure and investments in corporate assets. On February 11, 2022, our board declared a cash dividend of $3 per common share payable on March 15, to shareholders of record as of March 8th. This represents a 25 cent increase from our most recent regular dividend. During the fourth quarter of 2021, we bought back 6,979 shares of stock at an average per share price of $1,248. With that operator, we will now take questions.

Ladies and gentlemen, at this time we'll begin the question and answer session. In order to ask a question, please press star and then one using a touch-tone telephone. To withdraw your questions, you may press star and two. If you are using a speakerphone, we do ask that you please pick up the handset to ensure the best sound quality. Once again, that is star and then one to join the question queue. Our first question today comes from Derek Whitfield from Stiefel. Please go ahead with your question.

Sure. Good morning, all, and congrats on a strong year end.

Thanks, Derek. Good morning.

With my first question, I wanted to focus on your views on return of capital in light of the health of your business and your balance sheet. Could you share with us your thoughts on where the best opportunities lie as you balance your growth versus return of capital priorities over the next few quarters? And more specifically, on return of capital, What do you perceive is the best mechanism to affect return of capital in light of your stock performance?

Yeah, look, I would say, you know, like I said in my prepared remarks, as far as return on capital or return of capital, you know, if our stock price, continues to remain dislocated for a period of time, then we'll look at increasing buybacks. You know, we just raised our regular dividend. And, you know, so I think we've got a lot of flexibility there. And, you know, at the end of the day, we're a rate of return driven organization. So just wherever we feel like we can get the best return.

All right. Certainly fair. And then with my follow-up, I wanted to focus on corporate governance. It's a topic that's likely received undue attention as a result of your soccer performance. More specifically, I wanted to ask if you guys could speak to the process the board is following to evaluate the Dana McGinnis resignation and the vote from last year's annual meeting to de-stagger the board and perhaps provide reasonable timeline for the progression of these developments?

Yeah, so that process is being handled by the nomination governance committee. As we announced after the voting results were released, that process is being handled by that committee, which consists of three independent directors. I would just say one of those directors is our largest shareholder. And the process for both is definitely a priority. It's something that they're working on. And I certainly wouldn't take a lack of public disclosure as an indication of lack of progress. There's a 90-day time frame there where the board has to make that decision and publicly disclose that. Right now we're waiting on the non-gov committee to make a recommendation to the board.

Appreciate that, Ty. And then if I could ask another follow-up or two. I wanted to see if you could broadly speak to your business outlook over the next six to 12 months. As we think about the considerable increase in industry activity we've observed in Chevron and ExxonMobil disclosures, it would seem to us that you guys are positioned for relatively strong double-digit growth. Is that a fair statement?

Hey, Derek, this is Chris. I'll maybe field that one. You know, when we look around, I guess you're correct. You've got a couple operators out there, like the two you mentioned, who are definitely, you know, steering people towards pretty strong growth. One thing I would just keep in mind when you think about us and you look at Chevron and Exxon as examples, they are still a meaningful piece of TPL's production profile, water sales, and disposal. But each of those tends to hover kind of around the 10% zip code. And so although those two are talking about strong growth, when we look across the broader portfolio, I think we also tend to see that being offset by some of the other operators who are kind of more single-digit to flat profiles. And when I couple that and I look at kind of our near-term inventory, right, so looking at like the current duck count, we've definitely seen a drawdown that's been occurring over the course of the last year. And the current rate, you know, of drilling, I'm not sure that there's been a replenishment. And so although we certainly have enough ducks and kind of wells that are in the completed category about to come online to produce some growth, I'm not sure if we feel comfortable saying, you know, robust double-digit growth. I think the robust growth we saw last year included a couple quarters of incredibly strong completion activity, like over three net wells. And, you know, as we look in the fourth quarter, You know, all the data is not in, but I would suspect we'll be just over two net wells that were completed in the fourth quarter. And so it feels like there may have been a little bit of a slowdown from what was an incredibly fast pace kind of in the middle of 2021. And so when we think about those activity levels, right now I wouldn't say that we see the same levels as we saw in 2021. But I still think it's going to be a strong year. We've got a nice backlog of inventory, and so we certainly will expect to see some continued growth.

Thanks, Chris. And then lastly, Ty, thanks for your commentary on seismicity and taking that head on during the call. With the understanding that you guys have tight controls around the density of SFED wells, could you speak to your projected near and long-term business impacts, if any?

Yeah, so I would just say, you know, in the SRA that, you know, affects our property, the RRC has just implemented recommendations that operators, you know, reduce capacity in some of the wells. But I will say that, you know, the way that we've contracted that side of the business as far as, you know, acreage dedications and big AMIs and the royalty on a lot of the pipelines instead of the wells, As water is diverted from one well to another, it doesn't really affect our business because of the way those contracts are structured. And that royalty is either on the pipeline or it's on an AMI. So water can move around within the development area, and we will still get that royalty fee. I think some of the issues could be beneficial, just because of the structure of those contracts, we could see some water come to us through some of this increased regulation. So we're in constant communication with our operators, with midstream companies, and with the RRC to stay ahead of the issue and be a part of the solution because the last thing we want is for it to hold up development. And so I feel like... you know, with our involvement and the action that the industry is taking, that, you know, we will be in a good place and we'll find a good solution for the problem.

That's great, guys. Thanks for your time and thoughtful responses.

Thanks, Derek. Thanks, Derek.

Our next question comes from Hamad Korsan from BWS Financial. Please go ahead with your question.

Hey, good morning. Would you be able to provide some details as to the misstatement on your taxes and how you've justified it going forward as far as the corrections you've made.

Yeah, hey Ahmed, this is Chris. Let me give you just a little bit of background and color. As I've come in and one of the things that both myself and Stephanie Buffington, our CAO, wanted to do was take a look at some of our advisors. And so you guys have probably seen we engaged Deloitte as our new auditor this year, and we also went and engaged the new tax advisor. And, you know, as we worked with that tax advisor, looking at both our current taxes and some historical periods, they came to the conclusion that the depletion that had been taken in the past was more than was allowed. And so we really diligenced that and wanted to make sure that that that conclusion was correct, and the team came to the same conclusion as our tax advisor, that it had been incorrectly done in the past. And so what that misstatement is, is it's a correction of that past depletion amount from 2018 through 2020. And so I think to put it in perspective, you're talking about just over $10 million, you know, $12, $13 million over the course of three years, you know, against billions of dollars worth of, you know, a billion dollars worth of revenue. And so in terms of the materiality, you know, it was a fairly immaterial adjustment. And that's why, you know, it didn't require a full restatement of financials. And so, you know, we're looking to put in place a lot of controls now to make sure that something like that won't occur in the future. But I think we're glad that we were able to find it, make the correction, and move forward. And so I think that's kind of where it stands. That's a little bit of background on what that is. And we've definitely got a plan in place to get it all fixed in the future.

OK, great. And then the other question I had was, just given where the price of oil is, producers just focusing on the ducks they already have. Is there any, you know, actions or strategies you're looking to undertake that, you know, take advantage of your land that's not being accessed right now, be it either through, you know, using your balance sheet to finance producers or anything like that, just given that there's not a lot of drilling or new drilling occurring?

I would say, you know, We're not considering any options as far as financing an operator's drilling program. We have seen a big drawdown in ducts, which means operators are probably going to need to add some rigs this year. So we're just making sure that we can do everything we can to make it easier for them to to access and develop our land versus the acreage next door. And so that's what we focused on in the past, making sure they have the appropriate easements and infrastructure in place, making sure they have a sustainable source of water for completions, making sure they have somewhere to go with that produced water so that we can get wells turned online quicker and reduce costs and time lags for the operators. So that's where our focus is. you know, just using our assets to make it easier for those guys to develop.

Okay, my last question was, just given the amount of shares you've bought back this past year, is there a timing or any intention to announce a new stock buyback program, and would it be bigger than what you implemented in 21?

Hey, Matt, I think as Ty said, I mean, we're probably not going to give guidance on on that, but it's certainly something, you know, clearly with where the price is right now that we're going to consider and take a look at. And at the end of the day, that is a board-level decision, and it's certainly something that they're focused on, and we will communicate once any decision gets made.

Great. Thank you for letting me ask questions.

Thanks, Ahmed. Thanks, Ahmed.

And our next question comes from Chris Baker from Credit Suisse. Please go ahead with your question.

Hey, good morning, guys. Derek covered a lot of this, but maybe a few different angles on the big topics. First question, just on the impressive growth in oil and gas production this quarter. I'm just curious if you could share any insight into what drove that result, and perhaps if you could share what the growth would have been on an organic basis, just backing out any accrual noise. Just in terms of the organic growth profile this year, it'd be great.

Sure. Hey, Chris. Yeah, I think, you know, one of the big drivers, I think, as I kind of mentioned when I talked to Derek, is in Q2 and Q3, the level of completions that happened across our property were about as high as they've ever been. Anytime we've been over three net completions, that has marked really strong performance. In fact, the only time I can think of when we had three net completions was in the first quarter of 2020, right before the pandemic hit. So that was kind of the end of a culmination of a real high activity level through 2019 and early 2020. And so to have two quarters, Q2 and Q3 of 21, where we also have that level of completion activity, I think that was really the big driver of the robust growth that we saw in 2021. And I would still say, you know, like you see with us and even some of our peers, you know, in times of high growth, you definitely get some increasing accrual activity as it comes to like the royalty production. But I would still say if you compare our full year production number to the 2020 production number, that's a pretty fair comparison of the actual organic growth that you saw across those assets. You know, the vast majority, you know, sometimes on average you probably have a two-month lag, three-month lag for gas and NGLs. And so sometimes you certainly have checks that come in from beyond that period. But I think if you look at the whole year for 21 compared to the whole year for 2020, that really should give you a good idea of the growth profile.

Okay, great. And then just on the acquisition front, it does seem like the retained cash going towards acquisitions is sort of the strategy today. Any sort of color on factors you think might have prevented you from deploying capital there? Just curious if you could make any comments around the spread that you're seeing in the market.

Yeah, I mean, there's definitely a lot of competition in the Permian right now. You know, people are really paying up for near-term development. I would say in 21, we looked at a lot of deals. You know, we said in the past our bar is really high, but we actually evaluated over $2 billion worth of deals in 21. You know, we didn't transact for a number of reasons, but I would say, you know, I think I think that should give everyone comfort that we are being disciplined and that we do transact. We won't be overpaying for anything. You're right about the cash balance. Right now, we haven't authorized any shares. We're very hesitant to use the leverage for M&A. Keeping that dry powder for future growth is really the only form of capital that we have right now to grow the business.

Okay, great. And then just my last question on governance. You guys had mentioned the 90-day mark on the McGinnis end. Any color you can share in terms of the timeline to get sort of a firmer view on de-staggering or an outcome in terms of that piece of the annual meeting?

Yeah, I mean, that's being handled the same way as Dan McGinnis' resignation. you know, by the NOM and GOV committee. And right now, they have not provided the board an update. But as soon as I have an update, you guys will have one shortly thereafter.

Okay, great. So fair to think that we'll get some sort of announcement later this year?

Yeah, that's fair.

Okay, great. Thanks, guys.

Thanks, Chris. Thanks, Chris. And, ladies and gentlemen, with that, we'll end today's question and answer session as well as today's conference call. We do thank everyone for joining today's presentation. You may now disconnect your lines.