Good morning. Thank you for standing by. And welcome to the SM Energy Second Quarter 2021 Financial and Operating Results Q&A call. [Operator Instructions] Please be advised, today’s conference is being recorded. I’d now like to turn the conference over to Vice President of Investor Relations, Jennifer Samuels. Please go ahead..

Good morning and thank you for joining us. We are very pleased to report second quarter across the Board seats in conjunction with an improving outlook for free cash flow generation and absolute debt reduction in 2022. To answer your questions today, we have our President and CEO, Herb Vogel; and CFO, Wade Pursell.

Before we get started, our discussion today may include forward-looking statements and discussion of non-GAAP measures.

I direct you to slide two of the accompanying slide deck, page five of the accompanying earnings release and the risk factors section of our most recently filed 10-K and 10-Q, which describe risks associated with forward-looking statements that could cause actual results to differ and refer to slide 26 through 28 of the accompanying slide deck in pages 12 through 15 of the accompanying earnings release for definitions and reconciliations of non-GAAP measures to the most directly comparable GAAP measures and discussion of forward-looking non-GAAP measures.

Of note, our second quarter 10-Q was filed this morning. With that, I will turn it back to the operator to take our first question.

Molly?.

[Operator Instructions] Our first question is going to come from the line of Leo Mariani with KeyBanc..

Yeah. Good morning, guys. I was hoping to talk about CapEx. You guys obviously are expecting kind of to be at the higher end of the range for the year. It looks like CapEx is staying pretty robust here in 3Q, and I guess, to get to the high end, it kind of implies a pretty big drop in the fourth quarter.

Are we seeing a fourth quarter activity cut and can you just talk about the dynamics that are getting you to the high end of the range?.

This is Wade. I’ll make a few comments and Herb can add some color, if he’d like. But you’ve said that pretty well. We gave a range for the full year and we’re still seeing that, but getting towards the high end with some moderate inflation assumption in there.

But in terms of the cadence, we did accelerate the program and that’s enabled us to achieve our objectives the quarter-to-quarter kind of is the way it is and it will tail off in the fourth quarter from a CapEx standpoint for sure..

Okay. And I just wanted to ask about production. I think you guys put a comment in the transcript, where you are talking about kind of low single-digit growth in 2022. Not really sure if that’s just kind of a high level comment.

For now you guys will find that going forward? But if I just kind of run the math, you guys are talking about second half 2021 production of around 142,000 BOE per day at the midpoint, if I was to hold that 142 even flat for next year, I guess, that would get me closer to 7% year-over-year growth.

So I’m just trying to understand the comment around the low single-digit growth next year?.

Yeah. Leo, this is Herb. It’s a real simple number when we say that. So it’s really just we take the annual average for 2021 and then we say what’s the annual average for 2022 and depending on the actual cadence of the capital spend and when the well come on in 2022 we will determine that quarterly phasing. And we have not budgeted for 2022 yet.

We just do the outlook at this stage and then as we get into September through November then we really lock it in more. So I wouldn’t read a whole lot into that. It’s just a low single-digit growth when we look at the annual average for 2021 -- annual average for 2022..

Yeah. I’ll just remind you that that’s absolutely an opposite. I mean we put this plan together to generate the most free cash flow that we can and that’s exactly what’s going to happen. It generates significant amount free cash flow next year and beyond and delevers the balance sheet.

And the production number that comes out is what it is and we just and sort of said not generally today, right now that looks like a low single-digit growth rate, but we will refine that as we get closer to the end of the year..

Okay. That’s helpful.

But there’s no plan for any like big activity decline or anything like that, is there?.

No. I mean we are -- we don’t have at all worked at this stage, so, no, I mean, there’s no big change..

I would say, it’s as we -- what we call the optimal activity level projected out into the future and that’s still the case..

Yeah..

Okay. Thank you..

You bet..

[Operator Instructions] Our next question will come from the line of Michael Scialla with Stifel..

Hey. Good morning, everybody.

Maybe just a follow-up on Leo’s first question, the implied drop in activity for fourth quarter, is that anticipated be in both to your operating areas or is it concentrated in South Texas or can you say any more color on what the activity might look like for fourth quarter?.

Mike, we’re just basically just executing on the program through the year and meeting in terms of the expectations overall on the number of completions and the number of drill wells and the CapEx spend.

So, it will drop from 3Q to 4Q, but there’s nothing really remarkable or intentional about anything other than those three capital objectives we have in our plan longer term..

Okay. And I guess, as you look forward and then realize, you just said you haven’t finalized the 2022 budget, but you’re obviously getting some very positive results out of the Chalk.

I’m just wondering as you think about allocating capital between South Texas and the Permian next year, thoughts on the Chalk getting or South Texas getting a bigger percentage of the capital for 2022 versus what you saw this year?.

Mike, I’ve been asked that several times and we obviously have not set our 2022 allocation between the two assets. And what we really find is that, it doesn’t make that much difference from a free cash flow delivery perspective, longer term whether it’s 60/40, 70/30, 80/20, how we allocate it.

But commodity prices will make a little bit of difference and so we’ll just look at the time and decide on the allocation at that time. But I will tell you, we’re real pleased with the way the Austin Chalk’s been performing.

And I’ll quote one of our asset managers that said, some of this well, there’s a little energy that could and that the yields are hanging in there longer in some cases than we expected and that leads to the outperformance on oil. So we’re happy with the program.

We’re continuing to delineate and test development and we’ll continue to do that at the right pace and that right pace will be determined as we learn more and we’ll continue to design the programs in the out years..

Okay. And just wanted to follow up on Wade’s comments in the prepared remarks where he said you probably hedged less as the leverage comes down. Can you give any color there on what you’re thinking the appropriate level of hedging might be for next year? It looks like you did add some hedges for next year but wondered….

Yeah..

…could you give little more detail on that?.

Yeah. It’s good -- very relevant question. Yeah. What -- and it’s still consistent with what we’ve been saying regarding our strategy, which is always tied to leverage and as we look out and see leverage falling pretty dramatically.

I think I said right now the forecast that’s kind of stripped and current cost estimations is getting below 1.5 times by the end of next year. So, looking at those metrics, were much more inclined to target a hedge percentage if not more than 50%.

So, that’s kind of the number we’re looking at as we approach next year, because we’re forecasting a leverage number still well out year and a half from now.

So, we’ll be wanting to walk in some of the cash flow to protect that, but not near the levels that we would have when the leverage was a higher number, which is what you see this year and last year. So hope that helps..

It does. Thanks, guys..

You bet..

Our next question will come from the line of Nicholas Pope with Seaport..

Good morning..

Good morning..

Good morning..

Just a couple questions, I guess, as you -- you’ve done a lot with the balance sheet here 2021, looking at free cash flow from here on out was kind of where commodity prices are set up for the next two years. I guess how are you thinking about what your priorities are? There’s not a lot of near-term debt that can be paid down anymore.

So you look at -- as you look at kind of the opportunity set with your additional balance sheet work or I guess maybe how do you think about the dividend that’s in place and how that’s related to the free cash flow profile going….

Yeah..

…forward? Yeah..

No. Great question. Yeah. Great question. No. I -- as I just said on the last answer, we do project getting below 1.5 times by the end of next year based on what we see right now current market conditions. And are -- we put forward this long-term plan that focuses on free cash flow, focuses on debt reduction and that is absolutely still the case.

So as we move along next year getting to that point that I mentioned, there certainly are still pre-payable auctions, no question about it.

Not -- they’re not near-term anymore, which is great, because we moved out the near-term maturities but if you look at the debt structure, there’s call features within them, and for example, the 25, as we move into next year callable at a pretty favorable area of 100 to 101-ish.

But then you have the more expensive secondly now it’s which I think I’ve mentioned before by us doing the -- we bought the refi transaction [ph] I’ll call it late in the second quarter.

That really enables us to use free cash flow to really target some of the more expensive debt in the structure, which obviously the second lien notes qualify for that and they, while they start, we can call middle of next year. So, we’ll be targeting those things and deliver -- and continuing to deliver.

Your question about at what point do we consider like dividends or raising dividends things like that. That’ll definitely be on the table once we start getting to those low leverage levels.

And so, as I’ve said in prior calls, when the question is asked, let’s get to that point and then let’s look around and see what the market conditions are that are creating that.

In other words, if you had a really, really high low price that would -- I think that would be a factor and whether it’s kind of a mid-cycle type level and a comfortable level. But if it feels more like sustainable as I think you said then something along the lines of a dividend program would definitely be on the table at that point..

Got it. That’s very helpful. And how do you think, I mean, I know there’s been a lot of questions trying to get you guys to going in on where CapEx might be next year.

But I mean what do you think the triggers might be as you look at that cash profile for when maybe adding a sixth rig? Like what -- I guess what would you need to see from a high level for that to be incorporated into what the 2022 program I would like? Thank you..

Yeah. Nick, this is Herb. So we’re really just sticking with the plan, gen -- we wanted to generate that free cash flow and getting our absolute debt down. So we’re not really laying out there to add activity, we’re really steady activity, we can be very capital efficient and that really helps on the free cash flow generation side of things..

Got it. Thank you. And maybe just a little bit of clarity on, in South Texas of the 11 wells, I guess, you would have been drilled in 2021.

Are any of those -- what the split with Austin Chalk versus kind of the more traditional Eagle Ford focus?.

Well, let me talk about completion, because actually we probably drilled more than that. On the completion side, we completed three Eagle Ford wells down in that JV and three Austin Chalk wells down in that JV. And so -- then we talked about the three additional Eastern Eagle Ford -- Eastern Austin Chalk wells and we got a couple more online.

You saw that we’ve got total is 17, I think, total number of wells, nine were last year. And then we got several more of that are just started producing, well, start producing later in the year..

Got it. That’s helpful. Thanks. That’s all I had. I appreciate the time, guys. Thank you..

Thanks..

Our next question will come from the line of Karl Blunden with Goldman Sachs..

Good morning. Thanks for taking the time. There are a couple different items touched down in terms of capital allocation, but I didn’t hear much discussion of M&A, whether it’s acquisitions or divestments.

Is there any update on that front that you could share with us?.

Yeah. Karl, this is Herb. Yeah. Really there’s no real big update on M&A. We’ve been pretty consistent in our messaging there, really no change in our views at all. We do think scale does matter and it’s more than just lower G&A.

And when we talk about our criteria and it’s really going to have comparable quality assets and that’s -- we’ve got really high quality assets as everyone’s aware. It’s got to be accretive to free cash flow and then it ought to be neutral that beneficial to leverage at the levels we’re talking about now..

Okay..

And when we look at the scale, it would really help to have some industrial logic behind it and improve capital efficiency and then that could lead to lower cost of capital. And then, there is some benefits on the ESG side from scale also. But, yeah, no action at this time..

Got you. And then, you’ve done some nice work in reducing revolver borrowings and it’s down to relatively low level. When you about the next time you have discussions with the banks in terms of extending and setting up a new or updated facility.

Can you remind us when that happens and what your goals might be in those discussions?.

Sure. That’s a good question. Our revolver it’s -- it doesn’t mature until second half of 2023, so it’s still a little early.

I would anticipate what -- I think there are several peers that are doing new revolvers this fall, we’ll be watching those closely just to kind of see what the market looks like and maybe start thinking strategically, maybe as early as the spring of next year as far as looking at possibilities for extending that.

But we still have a little time to watch. And in the meantime generate free cash and basically get out of the revolver, frankly, so and not be using it which is typically our strategy..

Got it. Helpful. Thanks for the time. Appreciate it..

You bet..

Our next question comes from the line of Gail Nicholson with Stephens..

Good morning. You guys -- good morning. You guys just finished your first two simultaneous frac operations in the Midland.

Can you talk about the cost savings you saw there and how applicable that is across the remainder of your Midland inventory? And do you have any plans to test it in South Texas?.

Hey. Thanks, Gail. Yeah. It was great accomplishment on the simul-frac, went really smoothly. We’ve run at a two different pads. We -- that’s a two different service providers on those.

And so bottomline is you can see the way the efficiency gains with this, because you have about 60% more horsepower on site than you would with just regular zipper-fracking. But you’re pumping at twice the rate. The number saving you can do in a day. So you can see the intrinsic efficiency that we anticipate.

And so, when you schedule it out, well, there are certain pads where they’re very amenable to simul-fracking, so if you got the large number of wells on the pad, it’s easier to do. If you just have a single well, it’s obviously not going to work and then you just stick to a single frac operation to get two wells and zipper-frac them.

So, when we look at 2022, we’ll be lying out on those places that you can use simul-fracs and those where you do zipper-frac versus single well operation. We’ve lined that out. And the benefit is if we have a spread or a provider that can do both simul-frac and zipper-fracking operations, clear efficiencies in the scheduling side of things.

So, yeah, we do anticipate on like-for-like basis, we could achieve some savings. Hard to put a percentage on it, because we have a combination, not every pad is amenable to simul-fracking, but we sure like have worked for us in these two cases..

Great. And then you also did a four-mile lateral this quarter in the Midland.

Can you just talk about how that was, has that changed, it had technical difficulty to drilling and how applicable is that? Does it stay for long laterals are in the 2022 plan potentially?.

Yeah. Thanks for pointing that out. Yeah. It feels really good for our team to have done the record long lateral in the State of Texas, which -- there’s a lot of wells in Texas, right? So, felt really good and where it was real applicable is it obviously gives us a lot of capital efficiency.

It works in some areas to access acreage that’s quite far out and that you may not get to for a while. So it’s beneficial for us. It worked like a charm. We drilled that in 20 days.

We -- I think it’s 105 frac stages in that well, which is a lot and then we drilled it out without any difficulties and we bought it online on June 25th and now it’s producing great. So keep a look out for the performance of that well. It’s still the same sized pipe, the 5.5-inch pipe down the well. So you can’t get that many more barrels out faster.

This leads to a plateau level and a little bit lower decline rates and if you have a shorter well. But in terms of the economics, the efficiencies are great. So we’ll see how it is going to play. But we also -- you’ve seen in the slide that we tend to be the longest lateral well drilled in the Midland Basin..

Understood. Great. Thanks guys on excellent quarter..

Thanks, Gail..

And seeing no further questions in queue, I’ll turn the call back over to CEO, Herbert Vogel. We do actually have a question that just came into the queue. That would come from Scott Hanold with RBC Capital Markets..

Hey. Thanks. Sorry, I forgot to dial star one there. But you’ve had a lot of success in the Austin Chalk and obviously more recently continued to see very good results.

And can you talk a little bit about those 400 locations you’ve identified? Does the success you’ve seen so far give you more confidence in those 400 wells and do you think there could be potential to expand that given what you’ve seen so far?.

Scott, yeah, thanks for announcing that. So we have quite a bit of confidence in Austin Chalk and I have talked about this before where we had 600 penetrations of the Eagle Ford that went through the Austin Chalk, so we could map it extremely well. We got core then with the delineation program, we spread it over a large area.

Now we expanding that area and we’re also testing development in a number of locations. And there’s been a tremendous amount of geoscience work just what the mechanism of the high permeability is and where the land is, that we’ve improved upon quite a bit.

So the recent well results kind of just come in line with what we were expecting and then we got I think the first one we put online was in July of 2018. So we got some performance history that makes it feel good. So the 400 well inventory estimate is a round number and assumes 11,000 foot lateral length.

If we choose to go shorter laterals than the number might go up, if we go longer than that number would go down. And then we talked about being very oily up to northwest and then gassier to the south.

So we’ll do our normal thing in terms of the conversion into proved reserves over time under SEC guidelines stated in the five-year plan and doing that about. So bottomline, it just depends on the economics at the time and we’ll just watch that number as time goes on and how we see things working.

But the confidence level continues to improve as we get more well results..

Okay. Got it. So what I’m hearing here is, you guys are seeing, expected some good results, those 400 locations have certainly underpinned by what you’ve seen. But I guess from our perspective it should give -- continue to give us more confidence to risk that inventory over time some upside.

Okay, if I could just one more and I apologize for hitting on 2022, but certainly there is some questions around the commentary on the path of potential production into next year. But I guess that the basic question, when you look at going forward and it’s not as much 2022, but it’s even beyond that.

I mean is your base view and I know it’s about maximizing free cash flow, but as part of that, I would assume it’s going to also include some level of at least maintaining production. And so it looks like 2020 to 2022 sort of soft guide talks about and it feels like it’s maintaining production throughout the year.

Is that the right way to kind of think about it? I know you’re maximizing free cash flow, but part of that has to be strategically having some sort of a maintenance level in production?.

Yeah. Scott, I mean, we truly do line out our client base on the free cash flow generation targets and getting certain leverage target that’s where we start from and then the production truly is an output.

And just so happens that not winds up being on and year-over-year single-digit production growth and that can vary quarter-to-quarter on where that sits, just like it did in 2021 and that’s really how we do to fund that.

There isn’t -- I don’t anticipate production decrease at all if we’re meeting our free cash flow objectives and it’s just a matter of how much it grows and that year-over-year..

Yeah. It’s the key is, it’s a long-term plan. It’s putting together a long-term plan that generates a lot of free cash flow, not just one year, obviously, because one year you can blow down and that would not achieve long-term objectives at all. This is long-term.

So it is flattish to single-digit production growth is what we can see out, because it’s sustainable long-term..

Yeah. Yeah. And I guess that’s spot on that point and I guess the only nuance is with year-over-year comparison obviously the shut-ins, oh, I am sorry, not the shut-ins, but obviously, the weather issue early this year had an impact on production. So the year-over-year, arguably if you’re keeping flat from exit rate, should be up.

Is that a fair way to think about it?.

We don’t really look at the exit rate. That’s just too short a time period to worry about. And I think that weather that’s a classic example, right? We have done shut-ins with our power that’s cut off, right? Not go into our bills but cost [ph], because there’s a lack of power.

And so -- and lower production but then we made up for it in the second quarter and third quarter and the rest of the year, so 2021 will look quite lumpy. But we reached our overall objectives for or we intend to reach our objectives over the entire year and that’s just the way you have to look at it.

You can’t pin down an exit rate for the last months of the year, because it depends on the timing of completions. And they can fund that on this side of the end of the year if you lined up on the other side of the end of the year just a matter of execution.

And then when you get the wells actually hooked up and producing and how quickly the flow back happens. So it would -- you really got to look at a longer time period..

I think one point worth reminding everybody is that the long-term plan we put forward is less than 75% reinvestment rate, which delivers continued long-digit growth in production. And if people are getting cut off by quarter maybe it’s not a straight line under five years, but it delivered annual….

Year- to-year..

…year-to-year growth in production at that investment rate which quite frankly was higher commodity prices may be less..

Yeah..

All right. Appreciate it. Thank you much..

Thank you..

Thanks..

I’d like to turn the call over to CEO, Herb Vogel, for closing comments..

Okay. Well, thanks all for joining us and your insights and questions. We’ll plan to see you in another call in mid-August..

Thank you for participating on today’s conference call. You may now disconnect..