Civitas Resources, Inc. (CIVI) Earnings Call Transcript & Summary

Good morning. My name is Julianne, and I will be your conference operator today. At this time, I would like to welcome everyone to Civitas Resources Second Quarter 2022 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to John Wren. Please go ahead.

Thank you, operator. Good morning, and welcome to Civitas' Second Quarter 2022 Earnings Conference Call. I'm joined today by Chris Doyle, President and CEO; Marianella Foschi, CFO; Matt Owens, COO; and Brian Cain, our Chief Sustainability Officer. Yesterday, we issued our earnings press release, filed our 10-Q and posted a new investor presentation, which is available on the Investor Relations section of our website. Please be aware that on today's call, we may make forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from projections. Please read our full disclosures regarding forward-looking statements in our 10-K and other SEC filings. On today's call, we may also refer to certain non-GAAP financial metrics. Reconciliations to certain non-GAAP metrics can be found in our earnings release and SEC filings as well. I'll now turn the call over to Chris Doyle.

Thanks, John, and good morning, everyone. I'm excited to talk about our results in the second quarter, but I want to start by highlighting what I see as the fundamental pillars of how we run our business. First, operate assets to maximize free cash flow; second, maintain a fortress balance sheet; third, commit to returning meaningful capital to shareholders; and fourth, lead the way in terms of environmental, social and governance. We believe this is the winning formula to create a durable or sustainable and certainly more investable business through any cycle. We have been and will continue to be strong believers in the value of consolidation, but only as those opportunities enhance, extend or optimize our business around those 4 pillars. Scale for scale's sake is not what we're about. We want to be better, not just bigger. Staying disciplined and to what matters most and falling back on those pillars as guiding principles is what will position Civitas for long-term success. That discipline means we don't have a significant transaction to highlight for you today. but it also means we have a very clear picture of how the underlying assets are performing. So let's talk about the quarter. Operationally, we delivered 175,000 BOE per day, that includes 80,000 barrels of oil per day and total CapEx of roughly $240 million. The team is executing well. The assets' performing ahead of expectations. We beat our internal oil targets. We beat our internal total production targets and came in under CapEx, and that's in the face of continuing inflationary pressure. I'd also like to note some of the success our oil marketing group achieved during the quarter. They were very active, optimizing netbacks on our oil production, which, thanks to 18 months of consolidation, is not only of significantly more scale, we produced 110,000 barrels of oil per day gross, but is also geographically diverse. And that allowed the team to go out and find some very interesting in-basin sales opportunities, some at a premium to WTI. Whether we continue to capture those opportunities is yet to be determined. The focus from this team is expanding margins. From drilling and completions, to production and marketing, the economies of scale that come from the active and accretive DJ consolidation is very apparent, and they establish Civitas as a cost leader within our peer group. For a company focused on generating free cash flow ahead of production growth, ahead of activity, cost leadership is an absolute imperative. On the financial side, and I would direct you to our release for reconciliation, we generated GAAP net income of $468.8 million, adjusted EBITDAX of $739.2 million and free cash flow of $436.6 million during the second quarter of 2022. The fortress balance sheet just got stronger. We redeemed $100 million in senior notes with cash on hand. And as of the end of the quarter, the company was unlevered on a net debt basis with $400 million of total debt outstanding against roughly $440 million in cash. We also affirmed as a company our commitment to return meaningful capital to shareholders with the announcement of our $1.7625 per share total quarterly dividend. This is comprised of our base dividend of $0.4625 per share, plus our variable dividend, which was increased to $1.30 per share this quarter. This represents about a 30% quarter-over-quarter increase and one of the highest payout ratios in the industry, and at our current share price, implies roughly a 12% yield. As the business continues to create significant free cash flow, we will evaluate the best use of cash, whether that's reinvesting in our business through the drill bit, launching share buybacks, extending the runway with additional acquisitions or increasing dividends back to our shareholders. The relative merits of each of these options shift, they shift continually, especially in the market as volatile as what we've seen over the past quarter. But this management team, our Board and our largest shareholders are fully aligned and we're committed to getting it right. On the permitting and regulatory front, our 2022 plan is largely permitting at this point. Looking ahead into 2023, roughly 20% of our programs under fully approved OGDP is for permits, another 30% of the permits are submitted with the majority of those deemed complete and simply awaiting hearing dates. And we'll continue to submit the remainder as we approach year-end and into the first quarter. In total, we have 575 wells working through what we call our permit pipeline. I'd also like to highlight the Box Elder CAP. As expected, this was deemed complete during the quarter, and we have a hearing set for early November. Quick note on our updated 2022 guidance. We've increased our production guidance to account for outperformance year-to-date and the small acquisition that we closed in early July. That adds about 1,000 BOE per day to 2022. On CapEx, we've increased the midpoint of our '22 guidance slightly, due mainly to cost inflation, but are importantly staying within the high end of the original guidance. Our operating cost guidance has been updated. Our oil differential guidance was updated, a decrease from $6 to between $4 and $5 per barrel. We also are now guiding $75 million to $125 million of 2022 cash income taxes, and that assumes oil average is $100 per barrel for the remainder of the year. As Colorado's largest pure-play E&P and first carbon-neutral E&P company on a Scope 1, Scope 2 basis, Civitas is well positioned for future success within Colorado and the industry more broadly. We're a young company. We've come together over the past 18 months, and there is certainly more work to be done. But the pride that the team feels after integrating 5 companies is well earned, and that challenge can't be overstated. I am confident in saying we are in the early innings of optimizing this business, and I look forward to sharing our continued progress and execution in the quarters to come. Thank you again for joining the call this morning, and I'll pass it back over to the operator for Q&A.

[Operator Instructions] Our first question comes from Neal Dingmann from Truist Securities.

Fantastic quarter. My first question is really on capital allocation. I'm just wondering, given the -- what appears to be substantial free cash flow going forward, Chris, I'm just wondering, could you discuss how share buybacks will play into the mix along with -- you certainly mentioned the dividends. I understand that as well in the mix, but also potentially even more -- hopefully, more accretive deals like this latest non-op purchase?

Yes, Neal, thank you for the question and the comment. So I would say that we're in a great position. We have a tremendous amount of optionality and flexibility. We're going to look opportunistically for opportunities, as you said, to do accretive deals, like the one that we did. But we will also consider whether that's a buyback, a special dividend or other acquisitions. All of those are in play. And as we've guided, most of the year, there's still a few in-basin opportunities within the DJ that we'll continue to run to ground. We've been running to ground but disciplined in our approach, and we'll be opportunistic. I think that we take most of those over the course of the next quarter or so. And as you said, we're generating significant free cash, and the Board is really focused and the team is focused on what the best use of that cash is going to be.

Great. And then second, just for Chris, for you, or Matt, maybe on permitting. So basically, I'm just wondering, how long a runway do you all anticipate is prudent in order to continue to have the efficient D&C pace that you all are sort of laying out?

Yes, I'll start, and then I'll kick it to Matt. I like to have 12 to 18 months of permits in front of us, always in the queue, and that allows us to optimize our capital allocation. I would say we're early days with both the COGCC and the industry as more broadly. If you think back, Neal, to Appalachia early days, it takes some time for operators to get their feet under them, it takes some time for the regulators to get their feet under them as well. I think we're getting there. But ultimately, I'd like to have 1 year to 18 months of permits in hand. Matt?

Yes. I think that's a great number. And that's permits in hand. So that's why when you look at that new Slide 5 that we have, we're showing a lot more than that, almost 600 permits that we have in the queue because we want to have that 18-month runway that is approved. We've got a lot of projects that we're working on internally. Chris mentioned in his prepared remarks that we did get our first CAP deemed complete earlier in the quarter, and we hope to have our second one submitted by the end of this year.

Our next question comes from Leo Mariani from MKM Partners.

I was hoping you could talk a little bit more about some of these kind of pending M&A deals? I know that you guys have kind of had a few of these privates in your sites for quite a while now. They've kind of been sitting there in the slide deck. I guess, there's still kind of ongoing negotiations here. Are they kind of heavy? Or is it just kind of getting difficult to transact here at the right price? Just trying to get a sense of how you're thinking about M&A right now?

Sure. I would say, we're in continuous dialogue with multiple folks within the basin. Obviously, it's a rapidly consolidating basin, thanks to the efforts of this company and others. It's not a difficult discussion to have, quite honestly, as long as we are disciplined, and we have been, coming back to how do we make this company better, not just bigger. And so what you saw in the second quarter is we were disciplined. We didn't get anything over the finish line other than the small transaction that we highlighted in the comments. But that's the right approach. We are to a point now 18 months in where we are a scaled position, one of the larger operators, one of the most active operators in the basin, and we can be selective, and we'll continue to be selective. We're not going to pull down acquisitions that simply make us bigger, unless they do 4 things for us, unless they allow us to create more cash flow, get that back to shareholders, protect our balance sheet and lead the way in ESG, and it's as simple as that.

Okay. And I guess, just is there any kind of high-level sort of time frame? Or do you feel like at some point, we've had these things in our sites, been in ongoing active dialogue where that just becomes exhausted where it's just clear maybe there's not going to be a deal at some point for one of these targets? And at that point, would you pivot to just a higher return of capital? You obviously have no net debt at this point, strong base dividend, the variable was up a lot this quarter, but still a lot of excess free cash flow above that. You did mention buybacks in your prepared comments. Just trying to get a sense, if some of these deals don't come to fruition, should we be expecting maybe a buyback to come into play here?

Sure. Yes. Thanks again, Leo. I would say time frame, there was -- we're always going to be in the market within the DJ, certainly looking at opportunities. We'll know, I would say, in the next quarter, certainly by the year-end, we'll be sitting on significant free cash that we will deploy and what we'll determine working with the Board and the management team is the best use of those funds. But I think, from a time perspective, Leo, I'm thinking the next quarter, possibly to the end of the year.

Okay. And then, I just wanted to ask on the production here. Obviously, very strong outperformance in the quarter. I know historically, the company has kind of talked about trying to keep volumes fairly steady. There was some benefit from the Bison deal, but volumes were up a lot more than that. Can you just provide a little bit of color around that? Did you get just a lot more wells on, maybe they came on early in the quarter? Did you see better well performance? What kind of drove the performance there? And do you expect second quarter to kind of be the peak on production? Do we kind of start falling the rest of the year? When you look at the guidance, it kind of implies that.

Yes. Great question. I would say, if you look at first half, we're essentially flat to the second half. The second quarter is higher than -- came in higher than what we expected. A lot of that's due to early but outperformance in the Watkins area, longer plateaus and good execution by the team. We think production moderates, as reflected in our guidance, but comfortable with our update. Matt, anything to add?

Yes. The only thing I'd add is, remember, we had a bunch of capital that we spent in the fourth quarter last year, accelerating a bunch of DUCs. A lot of those wells were in our oilier areas like Watkins, like Chris mentioned, and out in the legacy Bonanza Creek position. Those wells are the type that go on those oil plateaus on production for a couple of quarters, and we just frankly saw outperformance due to our completion design and -- on those plateaus, and it really manifested in the second quarter oil numbers.

Our next question comes from Nicholas Pope from Seaport Research.

I was hoping you guys could talk a little bit about the kind of shift mentioned in crude marketing. Kind of, I guess, longer-term plans there, a big jump in transport cost, but obviously, you saw it in the realizations. I guess what is the bigger picture? What's the long-term plan with how you guys are planning to kind of move all this oil and how those costs kind of play into those realized pricing?

Yes. Great question. So our better realized prices mostly come from having opportunities to sell our crude in basin. We are the largest producer of low gravity crude in the DJ now after this consolidation effort we've gone through. So pretty much, we control the supply of sub 42 oil. We're able to sell that at a premium in basin when the markets are there. Because of the restructuring of several of the previous companies that have created Civitas, we were able to remove legacy contracts and have the ability to sell that crude in basin. So as we continue developing, especially in our southern area, we will have more volumes that we're able to sell in basin, potentially at these better prices like we saw in the last 2 quarters. We also have a large volume commitment with NGL that rolls off in 2023 that was associated with the legacy Bonanza Creek position, which would free up another 25,000 barrels a day of low gravity crude that we would then be able to access these in-basin markets with. So as long as those in-basin markets stay strong, we should be able to continue taking advantage of these prices.

Our next question comes from Noel Parks from Tuohy Brothers.

I just had a couple of questions. I was wondering, with all the free cash flow you've generated, have you been doing any work in terms of looking at additional benches, secondary targets on your plays now that most of the consolidation of the different companies is under your belt?

Yes, great question, Noel. I would say that's exactly where you start, right? I mean you start with the performance of your existing asset, how do you optimize base declines, how do you optimize completions. But then you go up and down wellbores and look for other opportunities. I would say we're early days of thinking about that. But exploration within the DJ, I think, is an area that could -- we could allocate some capital to if we see a real opportunity, and it would be an easy tuck-in to our ops. Matt?

Yes. The only other thing I'd add is we're not really focused on new formations at this point in time, but there are alternate benches, like you mentioned, in some of our areas that haven't been adequately tested. As we test those, I don't think it will add a new formation in total for us to develop, but it will allow us to kind of develop a little bit tighter chevron pattern if we are able to squeeze a few extra wells in because we see productivity in those new benches. So that's kind of what we're looking at right now.

Great. And just thinking about the continued -- well, just the long process of integrating the 5 companies. And I just wonder if there is anything that happened recently or on the horizon as far as different types of service contracts rolling off, you're reconciling agreements that some of the component companies had to what the now combined company is having. I'm thinking either on the sort of the cost side or in terms of operationally or even affecting G&A?

Yes. I think when you look at G&A quarter-over-quarter, a significant decrease as we continue to peel off costs and rationalize systems and put integrated process and systems in place. Again, I would say we're very early in that process. The team has done a very good job. We are shifting some things around. We're bringing in some new folks, and we'll continue to drive further integration of the business. But don't lose sight of 5 companies coming together and the complexity with which the team has really executed extremely well is really impressive from my viewpoint 3 months in. Nella, I don't know if you have anything to add on the G&A and integration?

Yes. I would say, in general, no. And this may -- we've been very impressed at the speed at which we've been able to extract midstream synergies. It's an area that we didn't really underwrite or significantly quantified in the various acquisition due diligence. On the G&A side, like Chris mentioned, we were down 18% quarter-over-quarter. We're currently about $20 million for the second quarter and down a lot more than that on a per unit basis. We're not done yet. I think that just the roll-off of the companies and the excess services, we continue to shave off G&A as quickly as we can. And given where we are in the year, we believe the guidance that we gave was a little bit more appropriate, but we're definitely making meaningful strides on both those items.

Our next question comes from Michael Scialla from Stifel.

I apologize for joining the call late. If any of these questions have been asked previously, I apologize for that. But I was wondering on Slide 14, looking at your activity level for the year. It looks like in terms of wells drilled, completed and brought online, a little bit lower than what you were guiding to previously. I'm just wondering, is that -- any impact from the higher working interest that you have in some of these wells? Or just how does that reconcile with -- because you kept the -- no change on the production forecast.

Yes. Thanks, Michael. I would say a couple of things. One, the asset's outperforming on a production basis and allowing us to generate significant free cash flow, which is our #1 focus, more so than activity. We did update those numbers. We're on the lower end of the previous guidance. Some of that's related to the working interest that we picked up, that obviously pulled in about $10 million of capital into our program and is allowing us to beat our production guidance with lower activity. And we floated between 2 and 4 rigs this year. We're at 3 right now. And we say we would average around 3 for the year. We're still there. But really happy with how the asset is performing. And if we can deliver or outdeliver on our promises with less activity, that's a win for the team and win for our shareholders. Matt, anything, any other color you'd add there?

No. Besides the acquisition, the only other thing is we've had some success with our internal leasing program and just setting up organically our working interest in a few pads. So I think that's helped, played into it as well, being able to hit our production numbers with slightly less activity.

Sounds good. And then I wanted to ask on if the Inflation Reduction Act is -- if that becomes law, what impact that might have on Civitas, in particular, with your methane emissions, if there is a methane emission fee attached to the bill or any other aspects of the bill that would be positive or negative for the company?

Yes. I would say, and this goes to the fourth pillar that we talked about in our prepared remarks, is we will, as a company, lead the way in environmental, social and governance. That means, for us, becoming the first carbon-neutral company in Colorado. We think that's the right thing to do for our shareholders to ensure the longevity of this business. But we will be very aggressive in our reductions in overall emissions, including methane, simply because we are allocating capital out the door to be carbon neutral. And so we'll -- we can talk about potential impacts, but I'll tell you, we were going to lead the way in terms of ESG. And Brian, I don't know if you want to add anything?

Yes. No, we have -- so this is Brian. We have aggressive emissions reduction program in place over the next 3 years. We're going to be spending about $6 million a year to retrofit pneumatic devices, which, at about year 3, should result in a 30% to 40% reduction in emissions. And that, in addition to some of the other sources that we found in looking through the portfolio of 5 companies, we are targeting a 50% reduction by 2027. And so as Chris said, we have an extremely aggressive program. We are not net zero by 2050 or in 30 years or something like that. We are carbon neutral today, and we are making investments today to significantly reduce emissions in the short term, because to your point, we see that regulations and particularly regulations around air quality, they tend to get tougher and not easier. And so we are taking the proper steps to be ahead of that.

Our next question comes from Bill Dezellem from Tieton Capital.

Chris, in your opening remarks, you had mentioned that you're in the early innings of integrating the 5 companies. Would you please give us some examples of really what you're referring to there, given that it appears as though you have integrated the 5 companies?

Sure. And I would say, we're early innings of optimizing the business. The companies are fully integrated, as evidenced by a great quarter -- great string of quarters, quite honestly. But the business, I would -- if we were looking around this table and walking the halls, we know there is more that can be done to optimize our production base, to optimize our performance in all aspects. I would highlight a couple of things that are continuing to get attention. I think while not necessarily reflected in future guidance, I guess, could be some potential upside. To me, this is, if you think back 18 months ago and the individual constituents of this company, we are now a $5-plus billion company. What that means is the addition of clear process, clear accountabilities, clear systems integration, I think, can yield a lot of value that we're not in place previously. I would say we're early innings there. We are now 170,000 barrel a day company. That is a massive base production, much bigger than any of the constituent parts. And so really focusing in on base production, not just drilling and completing wells, but base production, I think we are early innings and we've reorganized a bit to put more focus in all that. And I think more broadly, we have everything plugged in together. To your point, we're fully integrated. But optimizing process, optimizing systems, getting the right folks in the right spots and everyone aligned to one central mission, we're early days. And we're going to get there. And I think that's what I wake up every morning really excited about is that how the asset is performing, how the team is performing in the wake of 5 companies coming together, knowing that there is much more to come, I get really excited about.

And I recognize this sort of effort is never complete, but when would you expect the bulk of this optimization process for the businesses that you have acquired to be far enough down the path that there's a noticeable difference to the outside world?

Sure. I would say, there should be a noticeable difference visible to the outside world based on the second quarter results. But I would also say, have this discussion a year from now, we're not going to be done. We may be closer to middle of the innings, but we will, as a company, continuously improve every aspect of our business. We will drive out as much cost as we can to maximize free cash flow and give that back to shareholders and protect our balance sheet. And so I would say, and the company is doing a phenomenal job of this, is we will not accept where we are today. We will continuously drive improvement throughout our company, throughout our business.

Our next question comes from Michael Scialla from Stifel.

I just had a follow-up on -- just wondered if you could give any guidance, or if you did previously, again, I apologize, but on where current taxes may be for the remainder of the year?

Sure. I'll start off and then kick it to Nella. In previous quarters, we had guided, at $75 flat, we would not expect to pay cash income taxes. What we've put out there, assuming $100 for the rest of the year, is between $75 million and $125 million. And we think it's a good idea to put that out there, given where commodity prices have been and look to be for the remainder of the year, but let me kick it to Nella.

Yes. Thanks, Michael, for your question. I would say, consistent with our prior messaging, if you look at where commodity prices have been kind of around the first quarter in that $85 to $90 range, our NOL for 2022 fully offset our taxable income. If you look at oil averaging about $108 for the second quarter and using our assumption of $100 a barrel, the resulting cash impact is essentially all 25% effective rate of that incremental revenue. So that's why we guided to about a midpoint of $100 million based on that incremental oil price.

We have no further questions in queue. I'd like to turn the call back over to Chris Doyle for closing remarks.

Sure. I'd like to thank everybody for being on the call today and your continued interest in Civitas. Have a great day and be safe. Thank you.

This concludes today's conference call. Thank you for your participation. You may now disconnect.