Good morning. Thank you for standing by. And welcome to the SM Energy Second Quarter 2021 Financial and Operating Results Q&A call. 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 results across the board 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 slides 26 through 28 of the accompanying slide deck and 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?

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 to be at the higher end of the range for the year. It looks like CapEx is staying pretty robust here in Q3, 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 assumptions 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 wells come online in 2022, we will determine that quarterly phasing. 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 and the 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 a significant amount of free cash flow next year and beyond and deleverages the balance sheet. The production number that comes out is what it is, and we just 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 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 what we call the optimal activity level projected out into the future, and that’s still the case.

Yeah.

Okay. Thank you.

You bet.

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 the fourth quarter, is that anticipated to be in both of 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 the fourth quarter?

Mike, we’re just basically 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 Q3 to Q4, 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 obviously we have not set our 2022 allocation between the two assets. 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…

It's a very relevant question. Our strategy remains focused on leverage. Currently, we are seeing leverage decrease significantly, and I mentioned that our forecast, which reflects current cost estimations, is expected to fall below 1.5 times by the end of next year. Given these metrics, we're more inclined to aim for a hedge percentage at or above 50%. This is the figure we are considering as we approach next year, as we anticipate a leverage number well into the next year and a half. We want to secure some of the cash flow to protect that, but not at the levels we would have when leverage was higher, which was the case last year and the year before. I hope that clarifies things.

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.

I have a couple of questions regarding your balance sheet activities in 2021 and your outlook on free cash flow for the next two years, especially in light of current commodity price trends. What are your priorities moving forward? Given that there isn’t much near-term debt left to pay down, how do you view the opportunities linked to your balance sheet adjustments? Additionally, how does the existing dividend relate to your future free cash flow profile?

Yes, that's a good question. As I mentioned earlier, we project to be below 1.5 times by the end of next year based on current market conditions. We have established a long-term plan focused on free cash flow and debt reduction, which remains our primary goal. As we progress through next year towards that target, we still have pre-payable auctions, although they are not imminent anymore since we have pushed out the near-term maturities. Looking at our debt structure, there are call features available, such as the 2025 notes, which become callable next year at a favorable range of 100 to 101. Additionally, the higher-cost second lien notes are eligible for redemption since we executed a refinancing in the second quarter. This allows us to use free cash flow strategically to address more expensive debt, with the second lien notes being a prime candidate starting in the middle of next year. We plan to pursue those strategies and continue delivering results. Regarding dividends, we will definitely consider that once we achieve low leverage levels. As I've stated in previous calls, we need to reach that point first before assessing market conditions. If there are favorable pricing conditions, that could influence our decisions. If the market feels sustainable, then a dividend program would certainly be on the table at that time.

Got it. That’s very helpful. How do you think about where capital expenditures might be next year? What do you think the triggers might be as you evaluate the cash profile for the potential addition of a sixth rig? What would you need to see from a high level for that to be included in the 2022 program? Thank you.

Yeah. Nick, this is Herb. So we’re really just sticking with the plan, 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.

Thank you for the clarification. In South Texas, of the 11 wells drilled in 2021, what is the breakdown between Austin Chalk and 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 then we talked about the three additional Eastern Eagle Ford and Eastern Austin Chalk wells, and we got a couple more online. You saw that we’ve got a total of 17, I think the total number of wells, nine were last year. And then we got several more that are just starting to produce, well, starting to produce 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 on 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?

Yes, Karl, this is Herb. There’s really no significant update on M&A. We've been consistent in our messaging, with no changes to our views. We believe scale is important, and it involves more than just reducing general and administrative expenses. When we discuss our criteria, it’s essential that we have comparable quality assets, and as everyone knows, we possess high-quality assets. It must be accretive to free cash flow and should be neutral or beneficial to leverage at the current levels we are discussing.

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 are some benefits on the ESG side from scale also. But yeah, no action at this time.

Sure, that's a good question. Our revolver doesn't mature until the second half of 2023, so it's still a little early. I would expect that several of our peers are initiating new revolvers this fall, and we will be monitoring those closely to understand the market dynamics. We may start considering strategic options as early as spring of next year regarding the potential for extending our revolver. However, we still have some time to observe. In the meantime, we aim to generate free cash and ideally reduce our reliance on the revolver, which is our typical 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 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 a great accomplishment on the simul-frac, went really smoothly. We’ve run it at two different pads. We had two different service providers on those. And so bottom line 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 of savings 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 a 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 laying out 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 liked how it 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, did it have technical difficulty in drilling and how applicable is that? Does it stay for long laterals or in the 2022 plan potentially?

Thank you for highlighting that. It's truly rewarding for our team to have completed the longest lateral well in Texas, a state with numerous wells. This achievement significantly enhances our capital efficiency and enables us to access distant acreage that might have been challenging to reach otherwise. The process went exceptionally well; we drilled that well in just 20 days, completing 105 frac stages, which is quite substantial. We encountered no issues and brought it online on June 25th, and it’s now performing excellently. I encourage you to monitor its performance. We maintained the same 5.5-inch pipe in the well, which means we can't increase barrel output too much. However, this configuration results in a stable plateau level and lower decline rates compared to shorter wells. The economic efficiencies are impressive, so we'll observe its ongoing performance. Additionally, as noted in the slide, we are proud to have drilled the longest lateral well in the Midland Basin.

Understood. Great. Thanks guys on an excellent quarter.

Thanks, Gail.

And seeing no further questions in queue, I’ll turn the call back over to CEO, Herbert Vogel.

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?

We have a strong level of confidence in the Austin Chalk. I previously mentioned that we had 600 penetrations of the Eagle Ford that passed through the Austin Chalk, allowing us to map it very accurately. Through our delineation program, we've gathered core samples over a broad area. We are now broadening that area and testing development in several locations. A significant amount of geoscience work has been conducted to understand the high permeability mechanisms and to identify the land where we’ve made substantial improvements. Our recent well results align well with our expectations, and we began bringing wells online in July 2018, providing us with solid performance history. The estimate of 400 well locations is a general figure based on an 11,000-foot lateral length. If we opt for shorter laterals, that number might increase, and if we go longer, it could decrease. We anticipate being highly oily to the northwest and more gas-prone to the south. We will follow our standard practice of converting our resources into proved reserves over time in accordance with SEC guidelines as outlined in our five-year plan. Ultimately, the outcome depends on the economics at the time, and we will monitor those numbers as conditions evolve. However, our confidence continues to grow as we receive more well results.

Okay, I understand. What I'm hearing is that you're expecting good results, and those 400 locations are certainly supportive of that. From our perspective, this should give us more confidence to gradually take on that inventory with some potential upside. If I could ask one more question, I apologize for focusing on 2022, but there are certainly some questions regarding the future production plans for next year. The main question is, looking ahead—not just at 2022, but beyond it—while your primary focus is on maximizing free cash flow, does that also involve maintaining some level of production? The guidance from 2020 to 2022 suggests maintaining production throughout the year. Is that the correct way to view this? I understand you're maximizing free cash flow, but strategically, shouldn't there be a certain level of production to maintain?

We clearly outline our client base on the targets for free cash flow generation and leverage. That's our starting point. Production is essentially an output, and it typically results in year-over-year single-digit growth, which can fluctuate from quarter to quarter, similar to what we experienced in 2021. That's our approach for funding. I do not foresee any decrease in production as long as we are meeting our free cash flow objectives; it really just depends on the extent of growth we achieve year-over-year.

Yeah. 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 in 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. 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 focus on the exit rate since it's too short a timeframe to be concerned about. The weather is a classic example. We've had shutdowns due to power outages that impacted our operating costs. This resulted in lower production initially, but we compensated for that in the second and third quarters, making the overall year for 2021 appear uneven. However, we expect to meet our goals for the entire year, which is how we should approach it. It's not feasible to determine an exit rate for the last months of the year because it relies on the timing of completions. These can be orchestrated before the year ends, but execution is key. The process of connecting the wells and the speed of the flowback are crucial factors. Therefore, it's essential to consider a longer time horizon.

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. 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 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.

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

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