Good day, and welcome to the Magnolia Oil and Gas Second Quarter 2021 Earnings Release and Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Brian Corales, Investor Relations. Please go ahead.

Thank you, Ilene, and good morning, everyone. Welcome to Magnolia Oil and Gas' second quarter 2021 earnings conference call. Participating on the call today are Steve Chazen, Magnolia's Chairman, President and Chief Executive Officer; and Chris Stavros, Executive Vice President and Chief Financial Officer.

Thank you. Good morning, and thank you for joining us today. My comments this morning will focus on our first partial semiannual dividend that we cleared yesterday and some thoughts around our differentiated dividend framework. I will also discuss how we plan to allocate our capital and free cash flow for the remainder of the year. Chris will then review our second quarter results, provide some additional guidance before we take your questions. Magnolia's business model and disciplined approach to our capital investment has not changed since our inception almost exactly three years ago. Despite the volatility around product prices, we continue to consistently execute on our plan as demonstrated with the strength of our second quarter operating and financial performance, which included record net income and earnings per share. Our plan has not changed; we believe that business is fundamentally improved, resulting in the strong productivity and efficiency in our Giddings asset. Another of our key corporate goals was to generate EBIT equal to 50% or more of our realized boe price. This is defined as accounting profits after all costs, including DD&A or before interest and taxes. Our average realized price in the quarter was $42.42 per boe and an EBIT of $21.85. Strong margins are a direct result of our team's focus on cost control, safety, well productivity, and this is especially pleasing to me because it's always been a corporate goal to maintain a strong correlation with product price. The quality of our assets in the business unburdened by large debt should allow for continued moderate production growth with high operating margins, generating significant free cash flow at much lower prices. We now believe this could be achieved by spending within 55% of our EBITDAX on drilling and completing wells compared to spending within 60% previously.

Thanks, Steve. And good morning, everyone. As Steve mentioned, I plan to review some items from our second quarter results and provide some guidance for the third quarter and the remainder of the year before turning it over for questions. Starting with Slide 4 in the quarterly presentation, Magnolia delivered very strong second quarter 2021 financial and operating results. The company generated total reported net income of $116 million or $0.48 per diluted share. During the quarter, we had $19.2 million of pre-tax special charges, most of which was associated with the termination of our operating services and other agreements with EnerVest. After tax affecting these items, our total adjusted net income for the quarter was $135 million or $0.56 per diluted share. Both reported and adjusted net income were quarterly records for Magnolia and were well ahead of consensus estimates. Net cash provided by operating activities was $188 million during the second quarter and our fully diluted shares averaged $242 million during the period. Our adjusted EBITDAX was $195 million in the second quarter, with total capital of $54 million for drilling and completing wells. Total second quarter production grew 4% sequentially to 64.9 Mboe/d with both our Karnes and Giddings assets contributing to the increase, and total oil production grew 11% sequentially to nearly 32,000 barrels per day. The sequential improvement in our quarterly financial results benefited about equally from both the increase in product prices and our production growth. While oil prices have risen further into the current quarter, prices for natural gas and NGLs have been particularly strong.

We will now begin the question-and-answer session. Our first question today comes from Umang Choudhary with Goldman Sachs.

My first question is on cash returns and how you plan to deploy your free cash flow. You talked about increasing your dividend next year based on $55 long-term oil prices and capping it at 50% of earnings. I was wondering if you can help us frame how we should think about the excess free cash flow after you pay the dividend? How are you comparing the opportunity to buy back shares versus investing towards further growth given the returns which are being generated on organic operations are also very attractive at current commodity prices?

The business model really doesn't change. To constrain us, we use the 55% of drilling to prevent us from trying to ramp it up or speed the drilling. It provides for a reasonable mid single-digit growth rate in the business, and that's really our target. As I said in my remarks, I hope the focus now, because we believe there'll be large amounts of our stock available for sale over the next couple of years, is on share repurchases. When you model the share repurchases at a reasonable price into the model, it has a dramatic effect on our earnings and cash flow per share. Drilling more wells is really not in the cards, except based on that 55%. So if you think about the dividend this way, we've given the information of how much we could afford to pay at $40 oil. That's what this interim dividend does. That's information for you, and we could very safely pay that 2x, so that's $0.16 a year. We're going to reprice the whole dividend package next February; that's going to be a larger dividend than $0.08, for sure. We're going to reprice it based on our results this year, taking this year's results and adjusting it to a lower price because we believe that's a long-term value, long-term price. The dividend per share is much less than we could theoretically afford to pay. However, the share reduction will build value in the stock. To be clear, we want the stock to go up and not just from dividends; after we get through this period where we have this opportunity to buy shares, then we'll re-evaluate the dividend plan. But right now, it's very rare to have an opportunity to buy a significant number of shares and bring the capital structure to a point where your return on capital employed enhances all of your share metrics. We haven't raised the risk in the company because the debt stays the same. It's a strategy to make the stock go up. A dividend of 2%, 3%, or whatever it is, fluctuates every day, every hour. So the dividend is a placeholder for the future. As we get through this period, we'll be able to pay a regular safe dividend, but a regular growing dividend. If we profitably grow production at 5% or 6% a year and buy back 4% of the stock each year, then you could see a kind of 10% area dividend growth. We think for many investors, that's an attractive outcome, especially for me. So that's the story.

Got you. That's really helpful. And I guess my next question is probably more on the operations side. Maybe you can talk a little bit more about your Giddings program. Any updates around appraisal activity? Anything you're just seeing recently from well performance? That will be helpful.

We have over 30 wells in the core area at this point, and they're highly predictable. The newer wells look like the older ones, except maybe a little oilier. There's nothing really new, and some of them have been on long enough to sort of measure everything, but we're highly confident, we're achieving great predictability and great outcomes. Of course, in this environment, every aspect is positive, and the decline rate is low. The reason we can reduce spending is that when we started, we were a Karnes producer; the decline rate was high. Here, the decline rate is much less, so we're much less capital intensive. That's what's driving this whole thing. Nothing is happening at Giddings that wasn't the same as last quarter and the quarter before; we just have more and more wells, and we've got a lot more to drill. It's a very positive story at this point.

Well, we tried to draw the comparison, Umang, between now and 2029. It's sort of indicative of what's happened over the last couple of years; it's much better and very clear.

It's much better than I thought it would be when we bought the Giddings asset. I would not have imagined this outcome. I think if I looked at my plan from the beginning, we're sort of in year six of that plan, and this is three years in.

Those are helpful comments and we are seeing the same thing in the core area at our end when we do well results.

Our next question comes from Leo Mariani with KeyBanc.

I wanted to stick with the operations here. I think you guys have clearly identified in the past that you've got a 70,000 core acreage position within a much larger footprint at Giddings. You talked about kind of 30 wells in the core. I guess, do you feel that those 30 wells have sufficiently appraised that entire 70,000 acre sweet spot? I know you're going to do some further appraisal work this year with that second rig. So what's your thoughts on the potential of expanding that 70,000 acres late this year and into next year? Would that be a contiguous expansion, or are you looking more at other sweet spots in the greater 430,000 acres?

The answer to your question is that we continue to step out and add. We have sort of a model, if you want to think of it that way. We step out and add every time we get a well; we can gather more data. We try different kinds of spacing; that sort of thing. I hate sports analogies. But if we want to use baseball, which I think has nine innings, we're sort of in the second inning of our plan. We have other areas we're looking at. We don't like to talk about them because they're still in leasing and those opportunities. We want to retain those rather than tip someone off as to what we're doing. The core area continues to grow and continues to have significant opportunities for more, and the spacing is still a work in progress. When we talk about extensions, this involves testing other areas to build the model in some other area. We don't really know the answer to that at this point; that's why we drill the wells. You can always imagine an answer. Unfortunately, you have to drill to figure it out. What you find is that the well may be good, or better, or different, but it gives you data, so you might have to drill two or three more wells to confirm it. We went to a gassier area a couple of quarters ago, and we think those will produce 600 barrels a day of black oil. At some point, we might start developing that. But we try to keep our capital under control. We want to maintain a mid-single-digit growth rate; we're not trying to spend all our money drilling wells. We also want to pay dividends and buy back shares; all these things are important. For a small company, the stock needs to appreciate. It's not an MLP; it’s not a royalty trust. The money made in a small company is primarily through the stock price appreciating. It's a different model and perspective because we’re small. However, we might near $1 billion in sales.

Very helpful for sure in terms of the way you guys are thinking about it. I wanted to get to a question on the two rig program. You theoretically talked about kind of a 5% to 6% production growth longer-term, Steve. But just looking at the data, you guys have grown more than that, just running the one rig for the past several quarters. I know there was some benefit of DUCs in there, but do you have any concerns that kind of running two rigs continuously could put the growth a little bit into overdrive? Or are you kind of happy to grow a bit faster if the well results are outstanding over the next year or two?

We'll take what we can get. But that's correct; we do want to spend, maybe not $50 million, but we want to spend some money. The problem with running one rig is the error bar because if the rig is delayed for two weeks for something, it makes extra noise. The other factor is that in the region, some numbers are a little different than we had hoped. Non-op activity, not in Giddings, but in Karnes has been less than we thought. This gives us more control over the outcome of the second rig. I suppose if I wanted to manage production better, I could set it in the well, but that doesn’t seem like a good idea. The next year, if things go well, we could possibly exceed our projected numbers.

That makes a lot of sense. And I guess just lastly, I wanted to clarify the mechanics of the growth and the base dividend versus the variable dividend. You certainly talked about kind of reassessing everything in February, but I wanted to make sure I understood. It sounds like there will be this semi-annual base dividend that's sustainable at a much lower oil price. But perhaps maybe you could come full circle and talk about how the variable dividend payout would work?

Not going to be a variable dividend.

That's been taken kind of off the table.

Yes. I listen to all these other calls, and I was confused. I decided that we would run this like an industrial company. You have a very secure dividend, and we will give you defined numbers of how we computed it. We know that there's room to grow that dividend, but not in a variable way—more based on results. I'm trying to convey information to you about our business. I can't rely on the stock market to do that. We're trying to convey how strong the business is at fairly low oil prices, and we can afford to do this; that's the point of the dividend. I enjoy dividends too, and my wife especially does, but that's really the point of this now. Now this will evolve over time. A variable dividend is something that dividend investors care about three things: it must be safe, it's a balance sheet issue, it should be paid out of earnings—not out of financial gimmicks—and it should grow. We're trying to deliver on this plan: safe, out of earnings, and with growth. That's the fundamental plan over time; it's not complicated; it's similar to what many companies do in other industries. The opportunity for us is during this period to make a significant impact on our return on capital employed. Unlike larger companies that refrain from buybacks due to apparent risks, we don’t have that concern. I think this is just different because of the way we were set up; always better to be lucky than good, I think.

Our next question comes from Zach Parham with JP Morgan.

Maybe just a follow-up on Leo's question. Gallagher spends $80 million to $90 million a quarter on CapEx in the back half of the year, running a two rig program. I know it's early, but as you look out, do you see Magnolia continuing to run that two rig program through '22? And I guess, just in general, how are you thinking about activity levels with the current 2022 strip near $65 a barrel?

We expect to run the two rig program next year. If you do the 55%, there's plenty of money to do that. We probably won't hit 55% if you run the numbers through. I'm very cautious about operating activities. I want to be safe, efficient, focused, and economical. I'm always reticent about expanding activities too quickly. It’s likely; if the strip is right—and I guess if that's unlikely—we'll be well under 55% next year. This will provide opportunities for other things, but you should plan on that two-rig program. I think the growth will depend on timing and non-op activity. We want a little more control than we have now so we can forecast better, but I don't see any reason to expand the business next year. I’m satisfied with where we're going now and the growth we’re achieving. I appreciate the low finding cost; this is run as an economical business. It's designed to generate decent returns—a business that mid-cap investors would like to own, and that’s our goal.

Got it, that's helpful. And then maybe just one quick one on the quarter. Can you talk a little bit about what drove your gas price realization this quarter? You were at $3.28, which was well ahead of NYMEX?

No. It's just, when we calculated it, it looked obviously much better than it was in the second quarter.

At the beginning of the quarter, NGL prices were particularly attractive for us. We don’t actually know if there was anything special about that; we just benefited from it, as someone said—it's a check we cashed.

Our next question comes from Charles Meade with Johnson Rice.

Going back to your earlier comments, shutting in wells so that you don't exceed your growth target, that would really be a novel way to run an EMP company. I have heard that one before. But Steve, you mentioned in your prepared comments that you see a lot of stock for sale, and that you could ramp up your buyback program past that 1%. So it's kind of a two-part question there. Are there specific blocks and specific owners you're talking about, or do you mean just the stock that's for sale every day with daily liquidity? And the second question is, if you're successful with your share buyback program— as you've highlighted, making the stock price go up—at some point, that would naturally come to an end. How do you imagine that might play out?

We'll start with the first question. We have a private equity owner who owns about 35% of the company; he used to own 50%. You see a lot of movement with some larger companies that have private equity investors sell stock into the market to look for liquidity. In this situation, over time—and I have no idea what they will do—those blocks will be for sale. Last quarter, we bought 5 million shares from them in a block, and the prior quarter, the same thing. They have a life and instead of dumping it into the market when they sell shares, we can buy some of those shares so that everyone benefits from this sale. For example, if he sells 7 million shares into the market, we might buy another 5 million shares; this benefits everyone, not just the people buying the stock but our existing shareholders because the share count goes down. Unlike most people, when the stock is offloaded, they just dump it; we’ll absorb some of that. I can’t predict when or if that will happen. Yet, given the life of the fund and the recent past, you would expect that some shares would show up over time. We could also go to them and negotiate to buy stock, but we prefer to do it as part of an offering so we don’t pay too much. At some point, this buying activity could come to an end; that's right.

We still have roughly $200 million in cash.

We don't need $200 million in cash. We maintain this in case of an urgent need. Looking ahead two or three years, you’ll see more of a shift towards a dividend model. It’s very difficult to assemble large quantities of shares in the market, even buying back 1% a quarter is not that easy. In the next couple of years, we have a unique opportunity to improve our capital return metrics without increasing financial risk, which is usually a concern for larger companies. I believe all of this is distinct due to how we were set up; being fortunate is always better than being good, I think.

Right. You painted that picture well. And then one question about the Karnes DUCs, specifically the gassy Karnes wells. I regard that as more of your high-quality or high-rate oil area. So what am I missing that you have these?

A little off the main topic; these aren't gas wells, they’re just a little gassier than normal. All we’re trying to convey, perhaps inelegantly, is that you should expect to see the gas percentage be a little higher next quarter than it has been this quarter. We probably should have explained it better.

Message received, thanks, Steven.

It's all Brian's fault. We'll have to discuss it over lunch if it comes to that.

Our next question will come from Neal Dingmann with Truist.

My first question refers to your earlier comments about planning to shift towards a bit more gassier wells, given the gas prices. Was this shift always a part of your plan? I know some folks have mentioned— are there some that are out there claiming you guys are gassier; I don't believe that to be the case. Could you clarify this plan, Steve? Would you pivot back towards more oily later in the year or next year?

There really isn't much of a shift; this is more of a tweak. We’re primarily drilling oil wells. We have a gassier area in Giddings that we discussed a few quarters ago; we aren't changing there. At $4, I am indeed tempted; I've been a gas supporter for nearly 40 years, so I'm tempted, but not by much. So we're an oil producer, producing gas and NGLs; that is our focus. Don't overemphasize the shift; we’re making some minor adjustments in our production strategy due to DUCs and new wells, but we’re not planning to run gas rigs right now. I don’t trust oil drillers and even less gas drillers to control the markets.

No, no. It's not a shift.

Not a shift; this is a tweak, more timing-based because we were focused on placing the wells on in winter.

Well said. And then my second question concerns Karnes. Ballpark, how many locations do you have left there? Are there opportunities for some small bolt-ons that would continue to enhance the situation? I know a year ago when Giddings wasn’t coming in strong, you were boosting some locations there. What's your outlook on that?

I think we keep a three-to-five-year inventory and we generally maintain it there. We look for small bolt-ons. There’s a lot of activity from private equity. We’re not pressed on Karnes, to be honest; we show that in the financial statements; it's a small amount of money. Those acquisitions are mostly interest in varying wells we possess mostly in Giddings. I'm very focused on capital efficiency and not spending unnecessarily— if we have a well that doesn’t decline as much, we face less of a stress to keep the production growing, so I’m not keen to emphasize a treadmill approach.

No. Understood. And then just to combine the two, your oil progression in the near future will remain the same as it has always been?

Yes, it will be similar. In Karnes, there's a lot of non-op potential opportunity; that's the only place where we don't have much control over that, and we can't predict it, which adds some variability to the numbers. But it doesn’t mean that our locations will disappear, obviously; we just don’t know what the thought processes of those operators are, if there is any.

This concludes our question-and-answer session as well as today's conference call. Thank you for attending today's presentation. You may now disconnect.