Earnings Call Transcript - MTDR Q4 2020

Operator, Operator

Good morning, ladies and gentlemen. Welcome to the Fourth Quarter and Full Year 2020 Matador Resources Company Earnings Conference Call. My name is Liz, and I'll be serving as the operator for today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session at the end of the company’s remarks. As a reminder, this conference is being recorded for replay purposes, and the replay will be available on the company's website through March 31st, 2021, as discussed in the company's earnings press release issued yesterday. I will now turn the call over to Mr. Mac Schmitz, Capital Markets Coordinator for Matador. Mr. Schmitz, you may proceed.

Mac Schmitz, Capital Markets Coordinator

Thank you, Liz. Good morning, everyone, and thank you for joining us for Matador's fourth quarter and full year 2020 earnings conference call. Some of the presenters today will reference certain non-GAAP financial measures regularly used by Matador Resources in measuring the company's financial performance. Reconciliations of such non-GAAP financial measures with the comparable financial measures calculated in accordance with GAAP are contained at the end of the company's earnings press release. As a reminder, certain statements included in this morning's presentation may be forward-looking and reflect the company's current expectations or forecasts of future events based on the information that is now available. Actual results and future events could differ materially from those anticipated in such statements. Additional information concerning factors that could cause actual results to differ materially is contained in the company's earnings release and its most recently quarterly report on Form 10-Q. Finally, in addition to our earnings release, I would like to remind everyone that you can find a slide presentation in connection with the fourth quarter and full year 2020 earnings release under the Investor Relations tab on our website. I would now like to turn the call over to Mr. Joe Foran, our Chairman and CEO. Joe?

Joe Foran, Chairman and CEO

Thank you, Mac, very much and thank you for joining us for Matador's fourth quarter and full earnings conference call. In addition to our earnings press release, I would like to remind everyone that you can find a slide presentation in connection with the fourth quarter and full year earnings release under the Investor Relations tab on our website. We appreciate you participating in today's call. And we appreciate your time and interest in Matador very much. Similar to last quarter, we've prepared a set of slides to provide background and color to what we're going to present today. I'm going to turn the call back over to the operator to take your questions in a moment, but there were three or four points that I wanted to particularly make. First, I wanted to commend our staff and Board for the way they've worked together and achieved these results. Everybody on each of the teams has done their part, and it's been a total effort with everyone helping out in all the different ways that they can. Much of our success is related to performances and well results that have been better than expected. This applies particularly to the wells that we've been drilling, the operational results, and commodity prices. I would add that the experiences of everybody working together this year to overcome the problems of COVID, and prices, and the like have led to improvements in our processes, in our results in the field, in innovations, and that the asset groups that we've had have done not only what we've expected, but found new ways to add value to Matador. San Mateo has also been an important part of this whole effort, reaching new highs this quarter in EBITDA and in their contributions to Matador, for example, having the pipes ready as we turned on wells, that helps both the environment and keeps trucks off the road. Most importantly, during the high storm, we were still sending product down the pipeline to be handled, which saved us a lot of money on trucking and other expenses. So, we appreciate the extra effort there. And then, for me, one of the most exciting developments is that Matador has gotten to a position where it can comfortably issue a dividend policy and start paying back to our shareholders, many of whom have been with Matador since inception. This was made possible by the free cash flow that we've generated in the fourth quarter and the debt reduction that we accomplished with that money. We've achieved debt reduction, a dividend policy reinstated, and the pay cuts that people took during the COVID and price crisis yet kept our promising outlook and the development of these eight plus locations, which have been key to our success in the past couple of years, the improvements in capital efficiency and an outlook that we think has us on the right track for further debt reductions, strong dividend policy and, of course, strong operating results with these eight plus locations. With that, let me open the floor for questions.

Operator, Operator

Thank you. The first question is from Neal Dingmann with Truist Securities. Your line is now open.

Neal Dingmann, Analyst

Good morning all. Good morning Joe and team. Joe, could you or David talk about now with the fourth rig at and maybe just give us a bit of color on how you think about sort of maintenance capital starting in that March period going forward? And maybe how that pertains to how you're viewing free cash flow for the year?

David Lancaster, COO

Yes. Good morning, Neal. This is David. And thank you for starting with that question. I won the pool. So, Neal, I hope that in all seriousness, we did a good job of laying out our decision to pick up the rig in March. As you know, we began the year running three rigs and had every intention of staying with the three rigs there throughout 2021. About a month ago, after the inauguration of President Biden, the Department of the Interior came out with an order that limited the approval of the local offices to grant permits or sundries or other approvals necessary for the development of federal oil and gas leases. It's a pause, a 60-day pause. The good news was it didn't limit any of the activities on existing federal leases, and we've continued our operations there without any hiccups. I think we remain optimistic that the BLM will return to more normal activity after this pause is over. But the fact is we just can't be sure. Most of our investors know our properties at the Stateline in the Stebbins area and of the Rodney Robinson; these are important properties to Matador. They have many of the A-plus locations that Joe just referred to, and we felt like it was important for us to ensure that we preserve the value in those properties for the company and its shareholders. As a result, we considered and began talking about picking up the fourth rig. It's not a decision that we took lightly. We thought about it carefully. We wanted to be sure that in picking up the fourth rig, we could continue to deliver free cash flow in 2021, and we believe we can. We wanted to be sure that we could pay the dividend that Joe just mentioned, and we can. We want to be sure we'd still be able to pay down debt during the course of the year, and we could. We've already paid down some just this January and we'll continue to pay down debt as we go through the year. We've consistently said that we also wouldn't have done it if we didn't feel like we could pay for it and fund it without having to borrow additional money. The properties are important to us; they carry a lot of value. They also carry the ability, not only for Matador, but they're also valuable to San Mateo. They enable us to earn incentives from Five Point. We think this year that we may earn upwards of $35 million in incentives, which is just additional cash flow that comes from our partner in San Mateo. The wells have very strong returns. So, I think for all those reasons and having considered it, we felt like it was the right thing for Matador to do. As a result, we have looked to contract another rig coming in March. It's going to be on a short-term contract. If things change, we have a lot of optionality with how we'll go forward with our program as we always do at Matador. For now, I think we feel like we've made the right decision. Go ahead, Mac.

Mac Schmitz, Capital Markets Coordinator

Joe, regarding the rigs, we have one contracted for three months. The rig returning to us is one we used last year, and Patterson has been an excellent partner. Our relationship with them remains strong. This rig will be on a short-term contract for about three months. In June, we will have the opportunity to decide whether to keep that rig, and we will have another option in August. This means we could reduce our number of rigs from four to three, or even down to two by the end of August, depending on our choices at that time and the conditions we face.

Neal Dingmann, Analyst

David, I may just ask one follow-up. It sounds like you are confident in still the free cash flow with the program. I'm just wondering, what are you assuming from San Mateo? I mean you already had $21 million in free cash flow last quarter. It seems to me that, as you all continue to fully ramp there, and you have more third party coming on, there's obviously - I'm just wondering kind of in your expectations, how much are you assuming from sort of the free cash flow side from San Mateo? Thank you, guys.

David Lancaster, COO

Yes, as we've discussed for some time, we expect Matador's share of cash flow from San Mateo to be around $35 million this year. When you combine that with the incentives, it totals approximately $70 million in cash attributable to San Mateo as a business. San Mateo is likely to generate about $70 million in free cash flow overall. Our share will be around $35 million, and we anticipate receiving the remaining $35 million in incentives from Five Point, of which $15 million has already been earned and should be paid in the next week or two, typically arriving in early March. This is a reliable expectation. The incentives come directly from Five Point, not from San Mateo, so they do not affect San Mateo's cash flow or revenues. This represents an additional source of cash for the company.

Neal Dingmann, Analyst

Very good. Thank you much for the details.

David Lancaster, COO

Yes, sure.

Mac Schmitz, Capital Markets Coordinator

Thanks, Neal.

Operator, Operator

Next question comes from Michael Scialla with Stifel. Your line is now open.

Michael Scialla, Analyst

Good morning, everybody. Maybe just a follow-on to the conversation on the fourth rig. What would you need to see out of the administration in order to let that fourth rig go in June when the contract comes up?

David Lancaster, COO

I think Mike, that you would want to see a certainty of a return to normalcy. We'd like to see them go back to issuing permits, issuing extensions to existing permits, granting sundries. I think if we begin to see these kinds of things coming through on a regular basis and on a timely basis, similar to what we were seeing prior to the pause being initiated, that there might be reason to consider changing course a little bit. But, I think we'd have to feel like we're seeing those things happen and that things are continuing to move along at a pace that’s fairly commensurate to what we saw before the pause.

Michael Scialla, Analyst

Got it. Thanks. And you noted in your budget, it includes 10% inflation starting in the second quarter. I just want to see if you've seen any indications of service cost inflation yet? And if so, where? And in that budget have you built any additional capital efficiency improvements into it?

Matt Hairford, CFO

Yes, Mike. This is Matt. And thanks for the question. Right now we're not seeing a whole lot of cost inflation. We have built it into the budget. One of the good things for us is particularly on the completion side, 40% of the wells that we're going to drill this year, we're going to complete in this first quarter in this lower pricing environment. The way we typically think about our vendors is, we're looking for vendors that help us create value. So, we anticipated that some of the vendors couldn't continue to work at the processing that they have for the last couple of quarters to ensure that they're able to do their business effectively, so that we can become more capital efficient. We do anticipate some service cost inflation, but I also think the efficiencies will probably make up a lot of that difference.

Michael Scialla, Analyst

Great. Thanks, Matt.

Matt Hairford, CFO

Thank you, Mike.

David Lancaster, COO

Thanks, Mike.

Operator, Operator

Next question comes from Richard Tullis with Capital One Securities. Your line is now open.

Richard Tullis, Analyst

Hey. Thanks. Good morning, everyone.

Joe Foran, Chairman and CEO

Hi, Richard.

David Lancaster, COO

Hi, Richard.

Richard Tullis, Analyst

How is everybody? May to start with you Joe or David, how many of the 50 gross operated wells planned for 2021 will be located on federal acreage? And does adding the fourth rig change any of the planned wells for the other three rigs for 2021?

David Lancaster, COO

I believe that out of the 50 wells that we're drilling in this plan, two of the wells are on federal acreage. We are drilling two wells in our Wolf asset area. One that's drilled and one that will be finished just in the next few days. Those are the only two that don't have some federal component. You have wells like the Rodney Robinson and the Stateline, which are 100% federal. We have others like those in the Stebbins area that tend to have a federal component to them in that they pass through federal acreage or maybe they start on federal acreage. Most of the wells that we contemplate are going to be on federal acreage. How did that change things? Prior to a couple of months ago, putting together our plan, we probably would have drilled a few more wells in Rustler Breaks or perhaps in the Antelope Ridge area that were not directly associated with federal properties, and we probably would have drilled a few more wells down in our Wolf asset. So, we certainly have modified things a little bit to focus more heavily on the federal properties.

Richard Tullis, Analyst

That's helpful, David. Thank you. And just a follow-up. As Joe mentioned, you've initiated the dividend policy. How do you see the dividend potentially growing over the next two years say in an oil price environment of $55?

Joe Foran, Chairman and CEO

Richard, I'll take this first and then Dave can expand. But it's just too early to tell. We've initiated this dividend policy. We feel, of course, we're confident it's sustainable, but we don't know how it will work or the effect on our shareholder group. So, we'll take this cautiously and see how well it works? See what the cash flow is? See what the needs of the business are and go from there and how fast it can grow? Certainly, at the $55 level, we see growth in it, but we want to again move cautiously because we're on a path we haven't been before. Matador always had a dividend; it was much smaller when private. Getting used to this, we want to ensure there are no problems with the payment and make sure everybody gets paid. Then we can look and plan to increase it over time but want to begin conservatively and not have missteps. We're very excited about it. Our legacy shareholders and other shareholders have called in to say how much they like it and appreciate it. We see this as a win-win arrangement. Our management group and staff have large ownership and they're eagerly looking forward to the checks too, and we'll see how it works. We'll have more at the next conference and each one after that to let you know how it's going.

Richard Tullis, Analyst

Thanks, Joe.

Operator, Operator

Our next question comes from Gail Nicholson with Stephens. Your line is now open.

Gail Nicholson, Analyst

Good morning and thank you for taking my questions. Every quarter the team gets more efficient. Looking at the guide for the fourth quarter, it looks to be considerably higher than what the market was anticipating, predominantly driven by better efficiencies versus that fourth quarter helping the 2022 volume outlook. Can you just talk about how those sign-offs and other efficiencies that you guys are implementing really speeds up that process and gets wells on quicker?

David Lancaster, COO

So Gail, what we've decided to do, and we like to do, we think is absolutely the right way to conduct our business. You'll notice the lumpy nature of the production. We've gone to these multi-well pads where we're drilling two, three, four, sometimes five wells per pad. This leads to a lot of efficiencies in drilling; you've fewer rig moves. Our team has put these rigs together where we can drill these wells more efficiently one whole section at a time, getting them drilled a lot faster. Additionally, with fracture crews, we initially started to frack a well, we would do wireline work and then fracking and wireline working. We've moved to what we call the zipper design, where we've got two wells that we're fracking while doing wireline work on the other. Now, we're moving closer to final frack wells, completing four wells at a time, and we’re doing it with maximum efficiency. With few adjustments, we can complete more lateral footage per day which ends up saving us a couple of hundred thousand dollars per well on a four-well pad. Moving to the production side, our team has done a great job ensuring that we've got water, oil, and gas pipe on location so that we're flowing directly from the wellhead through separators into production facilities. We're selling gas, disposing of water, and selling oil directly off the pad – all these measures lead to quicker well access and increased capital efficiency.

Gail Nicholson, Analyst

Great. And then just looking at the number of wells that are in progress at year-end, which is a healthy number. Do you think this makes the 2022 volume outlook less lumpy on a quarterly basis? Or should we anticipate that lumpiness continues?

David Lancaster, COO

Yes, Gail. I think even in 2022, we will still see the lumpiness. I think that's just a natural outgrowth of how we've chosen to develop these properties. When we're drilling these 12, 13-well sort of batches at a time and putting all these wells into production simultaneously, it just causes us to continue to have the ups and downs in production. The good news is it may be up and down quarter-to-quarter but six months to six months or year-over-year, it tends to be consistently going up. So, that's the positive aspect, but I would expect this to continue for some time.

Operator, Operator

Our next question comes from Zach Parham with JPMorgan. Your line is now open.

Zach Parham, Analyst

Hey guys. Thanks for taking my question. Could you talk about the permitting process in New Mexico and what you've seen recently? I know you don’t talk about getting to around 300 permits by year-end on federal acreage, but it didn't seem like the permitting process really moved forward, like, even in November and December of last year. So just any clarity on what happened?

David Lancaster, COO

Yes, sure, Zack. Good morning. Happy to answer that question. I think that we did have three new permits that were approved in the fourth quarter, but that was more an outcome of what we did. We had a number of sundries on existing wells or wells that were due to come up particularly in the Stateline area in Stebbins. We wanted to get through the system, which impacted things. The important thing was our drilling team has done a great job of being able to drill with just three casing strings instead of four. A number of the sundries we requested during this time had to do with reducing the number of casing strings, and we were routinely receiving those approvals. A reduction in casing strings saves us several hundred thousand dollars a well, allowing us to drive down the costs further. We asked them to move these sundries up in the queue, so we could continue operating efficiently, which probably delayed getting more of the permits through the system in the fourth quarter.

Zach Parham, Analyst

Got it. Thanks for that. That's good clarity. And then, just one follow-up on the dividend: how do you think about that going forward? How do you compare growing the dividend with debt reduction? Do you have a target debt level or leverage level you'd like to get to?

Joe Foran, Chairman and CEO

No. It's a balance between the two; debt reduction has the first priority to work with our banks on that. We've been helped by the better-than-expected performance of our wells, which has increased our borrowing base. We want to lower that, and we were pleased that our leverage ratio over the year got down to less than 3 points, finishing the year at 2.9. Customarily, we'd like to be around two points. It won’t happen overnight, but we expect to reduce steadily through the year. There will be lumpiness, our production will be a little unpredictable. The dividend will have priority. Once you start diving in, you don't want to cut it. We'll be cautious but hope to grow it parallel with production, revenues, and profitability. We have two sayings around here; we want profit growth at a measured pace, and we want a similar measured path for debt reduction and dividend growth. The second thing is we’ll reserve the right to get smarter, and if circumstances change, we will change our approach as well.

Zach Parham, Analyst

Yes. Thanks so much for the clarity. That's all from me.

Mac Schmitz, Capital Markets Coordinator

Thanks, Zach.

Joe Foran, Chairman and CEO

Thanks, Zach.

Operator, Operator

The next question comes from Scott Hanold with RBC. Your line is now open.

Scott Hanold, Analyst

Hey, good morning.

Joe Foran, Chairman and CEO

Hey, Scott.

Scott Hanold, Analyst

I was curious about adding the fourth rig, obviously with the progress of the San Mateo system. When you think about San Mateo and the higher level of activity and growth, is there some capacity expansion needed or do you think San Mateo is set up where it needs to be here over the next say one to two years?

Matt Hairford, CFO

Yes, Scott, this is Matt. I think we're in pretty good shape. We've added the processing capacity to handle 460 million cubic feet at the Black River processing plant. When we put all that together, we were contemplating a six-rig program. So we've got plenty of capacity. The challenge for us now is adding third-party volumes. Mac, Corey, and others on the San Mateo team are actively doing that. We have a saltwater disposal permit that we were waiting on but we'll go ahead and drill that. It’s built into the $20 to $30 million CapEx. For us, San Mateo is transitioning from building to operating and adding third-party volumes. If we happen to land a major contract that requires additional capital, it would need to guarantee us a good return before we would proceed.

David Lancaster, COO

Scott, I just want to take a moment to give a shout out to our San Mateo production team. They did a marvelous job keeping those facilities operational during the recent cold weather. There were only 5% of the plants operating in New Mexico and San Mateo was one of them. Their work has been incredibly important, especially over the last 10 days.

Joe Foran, Chairman and CEO

Scott, I want to jump on your question to highlight our field staff. These individuals work 14-day shifts; they're on and off 14 days, working through the night and morning to keep production going. Their impressive teamwork and effort really helped us in this quarter, and provide a promising outlook for the first quarter. On maintenance, if the federal government restricts building pipelines, it makes the pipelines already in the ground even more valuable. It’s an interesting development to keep an eye on.

Matt Hairford, CFO

To also follow-on to what Joe said: the San Mateo team will tell you it takes gas for us to run the plant. The production team will say we need an operational plant, and the marketing team has to find homes for all that gas and oil. It's a complex operation, especially during challenging times, but our drilling team set a record for laterals drilled even in freezing conditions. Our team managed to maintain operations and sourced crews to keep our two frac crews running despite many sand mines being shut down.

Scott Hanold, Analyst

And maybe just to play off a comment that Matt and David had regarding the uptime of the system during the rough weather. I mean, that’s likely going to enhance your ability to market and attract more third-party volumes. Has there been an increase in non-operating activity you're expecting this year, or is that not quite in the right area?

Matt Hairford, CFO

Yes, Scott, some of it may be non-operated. It depends on acreage dedication, whether it's dedicated to us or someone else. The San Mateo team is definitely monitoring rig counts and looking at where these rigs are located; if there's an opportunity, we're going to their offices and outreach.

Scott Hanold, Analyst

Okay, absolutely. And just at a high level with adding that fourth rig, what are your thoughts on the risks of needing that rig? I know there’s flexibility, but can you talk about how you sense that may evolve here?

Joe Foran, Chairman and CEO

That's a crystal ball that's a little cloudy. Honestly, we don't know what the administration will do. We'll find out in the next 30 to 60 days whether permits and sundries will be granted on a routine basis. When you see that happening then you'll know. A lot of this is opportunity-driven; it’s clear we’re in very good areas, having drilled 98% of our wells at two miles or longer. We don’t intend to lose any of those locations as that would be a loss of value. We prioritize profitable growth at a measured pace. If situations worsen, we could put the fourth rig on hold in June. This fourth rig granted us flexibility, allowing us to act better than wait 90 days or even six months for options. We aim for a broad perspective on all angles. As we engage throughout the year, we encourage you to ask us, and we'll keep you updated on developments.

Scott Hanold, Analyst

All right. Good. Thanks. And maybe if I could key off that with one other question. You all had some nice pacesetter well costs coming into the fourth quarter at $6.25 per foot, and I know you're targeting a little over $700 in 2021. Is the $6.25 just a trough level, or is the difference down to inferred inflation?

Matt Hairford, CFO

Yes, Scott, this is Matt. It’s a good question. The wells we drilled in Q3 at that very low cost came from longer laterals that allowed us to be very efficient. We intend to continue this trend. However, we built in a 10% budget for inflation and are drilling wells in different areas. Some costs might be higher in different areas than they were down at Boros. So it’s a combination of both factors. But I think the $730 number is a reasonable target, given our previous performance. From a capital efficiency outlook, in the past few years, the lateral footage we’re drilling has almost doubled, so we’re getting much more done in the same timeframe.

Joe Foran, Chairman and CEO

I also want to highlight MaxCom Marine. Initially, we were unsure how it would impact us, but it has been invaluable. It goes 24/7 and supports our directional drilling, which significantly improved our in-zone time. We’ve increased from staying in zone 70% of the time to over 95%. This has provided incredible value and reduced drilling costs, saving us tens of millions of dollars by preventing re-drills and other issues. A strong commendation is owed to these young guys and their efforts in collaboration with the drilling team.

David Lancaster, COO

Scott, I just want to add a bit of color. We currently have 19 wells being completed in Q1, with around 40% of our net wells for 2021 in progress. These Rodney, Rustler Breaks, and Ranger wells are set for production late March and April. They were drilled and completed at 2020 pricing, which will contribute to a favorable average for the year. Although inflation is anticipated later, this first batch of wells will help balance our average, keeping us confident in our $730 target. The $625 figure was specifically for the Rustler Breaks wells, which are among the shallowest.

Scott Hanold, Analyst

All right. I appreciate the clarity. Thank you.

David Lancaster, COO

Yes, sir.

Operator, Operator

Thank you. Ladies and gentlemen, this ends the Q&A portion of this morning's conference call. I'd like to turn the call over to management for any closing remarks.

Joe Foran, Chairman and CEO

Thank you very much. We appreciate the questions. We again want to invite you to call us whenever you have other questions or suggestions. We'd like to engage with you and extend the invitation, whenever we finish working our way through COVID to come see us in person. Your views, relationship, and friendship mean a lot to us. We're very excited about this journey ahead, and we believe we're continuing to come of age. We appreciate all your support and interest over the years. On behalf of all the staff that's here, thank you all for hanging with the company in the historic cold. The team has worked hard to get things done and that made it a total team effort. Thanks.

Operator, Operator

Ladies and gentlemen, thank you for your participation today. This concludes the program.