Thank you for standing by. My name is Angela, and I will be your conference operator today. At this time, I would like to welcome everyone to the SM Energy Second Quarter 2022 Financial and Operating Results Q&A Call. I would now like to introduce Jennifer Samuels, VP of Investor Relations. You may now begin your conference.

Thank you, Angela. Good morning, and thank you all for joining us for our second quarter 2022 Q&A call. 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 2 of the accompanying slide deck, Page 6 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. We may also refer to non-GAAP measures. Please see the slide deck appendix and 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. Also, look for our second quarter 10-Q, which was filed this morning. With that, I will turn it back to Angela to open it up for questions.

We will now take our first question from Zach Parham with JPMorgan. Please go ahead.

Yes, thanks for taking my question. I guess first, just on the CapEx raise. Could you give us a little more detail on the decision to add a bit of activity to the 2022 program? And maybe just also detail how much of the increase in the budget is from that incremental activity versus the increased inflation expectations?

Good morning, Zach, thanks for calling in. Regarding how much is from continuing operations, we have some excellent crews working for us. When examining those operators and service providers, we have some of their top crews based on their performance benchmarks. We had about four months of activity open towards the end of the year, and we decided to close that down on the frac spread side. On the drilling side, we have seen improved penetration rates, which is something we initially assumed would not get better, but we continued to see improvements. That was another advantage for us. We also mentioned in our prepared remarks that we added more drills and have three turn-in lines scheduled later in the year. We invested capital for that. Essentially, we added around 10% to 15% due to inflation, and the rest was attributed to the continuing activity. That's how you can interpret it.

Something that will roll into '23.

Yes. And I should mention for 2023 is where we actually get the benefit of a lot of that completion. So there's some additional completion activity that does not result in an incremental turn in lines this year. That does result in more in 2023. So that helps you out on that one?

Yes, that's great color. My follow-up, really, just one thing we noticed in the guidance update. It looks like you're now completing five additional wells in South Texas, now up to 43 and two less wells in the Permian. Anything specific that drove that mix shift? Or is it more timing related? Really just looking for a little more color on that change?

Yes. You noted it correctly, Zach. We had a larger gap in South Texas, and we have now closed that gap, which primarily affects the frac spread side. Regarding the Permian, it's more about the timing at the end of the year with the turn-in lines, as we have two that will come online after the start of the year. As you might have observed from the second quarter, we shifted some that turned in just after the beginning of the third quarter. It's just that it's difficult to pinpoint exactly which side of the end of the month it will fall on, that's all it comes down to.

Next, we have Gabe Daoud with Cowen. Your line is now open.

Thanks. Good morning, everyone. I appreciate all the prepared remarks so far. Following up on Zach's question, could you remind us about the 20 wells in Midland that were expected to be completed early in 2023, specifically in January or February? Is that still on track? Additionally, I'm interested in how securing more equipment for 2023 impacts your outlook on volumes.

So Gabe, that one is difficult to answer is just what we said actually previous quarter was that we had quite a few turn in lines in the beginning of 2023, and that was the result of four pads in the Permian with about 20 wells that we said, okay, they're actually going to start up on the other side of the year-end. So that's the crux of what's going on there. And what we're doing now really isn't changing that, those four pads any at all. And that's really driving the turn in lines this year versus next year in the Permian. It's just the size of the pads and the fact that you need to drill them, frac them and drill out the plugs, all before bringing on all 20 wells. And you can see how that's a massive amount of activity.

No, understood. That's helpful. And then maybe on the cash return angle, I appreciate the prepared remarks from last night. But curious if you can maybe give us a little more color? And then also, do you anticipate you would do a little bit of a formulaic approach similar to peers where you would kind of allocate a percentage of free cash flow to shareholders? Just curious how the framework could look.

Yes. I'll just start that and then hand it over to Wade. Just I think it's just great how fast we've gotten this position to be able to return capital to shareholders. We're way ahead of what our original plans were. And it's just the underlying assets that we have, they keep on performing better than expected. Our base performance is doing great. The wells are doing great, the enhanced completion designs in the Permian have really paid off. And then the Austin Chalk has just continued to help us out on the upside. So with that, I'll just hand it over to Wade because that's really what's underpinning that free cash flow generation.

Yes. No, I appreciate the question. And I'm not sure I can add a lot. It'd be able to premature to be getting into any specifics at this point, but we are really close. And that's very exciting being below 1x already and having a real line of sight to getting below that net debt target of $1 billion is obviously exciting. And what we shared with you in the prepared remarks, hopefully helps you think about how we're thinking about it right now. Your specific question about percent of free cash flow, it's too early for me to say anything about that. But we're going to do something that we're confident is very sustainable. And I'll just repeat that I mentioned, you could expect something in the fixed dividend area, an increase there and something that's very reliable that you can count on even at lower commodity prices. And we mentioned that our thinking right now would be something in terms of stock buyback. And we always have a view, an internal view on NAV. And by my comments saying that we thought that we feel like that's very appropriate at these prices, should obviously tell you that our current view of NAV is a higher number. And going forward, we would continue to analyze that. But that's probably all I should say at this point.

Your next question comes from Michael Scialla with Stifel. Please go ahead.

Good morning, guys. I wanted to follow up on the change in plans with the additional rig and crew or filling those gaps. I guess, I wondered how far you've contracted those? And I guess for all of your contracts, how far are you contracted? Are you into '23 and maybe any kind of insight you can provide on what you would expect when you re-up those contracts for next year?

Yes, Mike, thank you for being on the call. There's quite a bit to address regarding your question, particularly about our entire supply chain. To begin with, for us to have the drilling wells operational, we need the tubulars along with all the casing prepared. We are currently focused on securing firm allocations for 2023. Most of our prices are already set, although there are still some aspects for 2023 that need finalization. Overall, we aim to manage our supply chain effectively through the end of the year. Regarding rigs, we are not increasing the number of rigs; instead, we are utilizing our existing schedule and addressing any previous gaps. As a result, the number of rigs remains unchanged, but we're completing more wells because our drilling speed exceeded expectations. On the pumping service front, while we have contracts in place, they differ from the rig contracts. However, we have reliable commitments from our frac service providers for this year and into next year, ensuring we can close any gaps without issues and continue smoothly into next year.

Okay. I guess do you have any sense of what you might expect for inflation for next year based on what you've seen so far this year?

No. We knew you would be curious, and after Russia invaded Ukraine, understanding the supply chain became quite challenging. Fortunately, we had commitments in place for most of our needs throughout much of this year. We quickly secured everything necessary for this year and began planning for next year earlier than usual. This includes steel, and we have also secured our sand supply for 2023 in South Texas, which we had initiated previously. We are thoroughly reviewing every aspect of our supply chain to ensure we have what we need at the best possible prices. While we have a good idea of inflation impacts for some activities, there are still uncertainties for others. This will be addressed as part of our regular processes in the fourth quarter and as we finalize our budget for 2023.

Okay. Understood. And I wanted to ask, in your prepared remarks, Herb, you had mentioned 13 years of drilling inventory in the Midland Basin. And then you've got some exciting results from some new zones. Looking at Slide 16, you've got a lot of zones listed there. I'm just wondering what is built into that 13 years of inventory in terms of some of these new zones? And if they're not all built in, what the potential upside could be there in terms of the overall inventory if these new zones work out?

Sure. Mike, I'll begin by saying that we have a presence in all of those eight zones, but our main focus is on expanding the potential in each of them. We typically conduct an annual review in November, during which we'll detail how much we've added in each area. Therefore, we won't provide any updates on inventory until the end of the year and will revisit this in February. This approach allows for a more thorough and comprehensive analysis using the same criteria we've successfully applied in past years. Last year, we effectively replaced all the inventory we drilled and completed in 2021, and we aim to achieve the same for 2022. We'll assess the outcomes at the end of the year.

We have a question from Zach Parham with JPMorgan. Please go ahead.

Just one follow-up on the A&D market. Chesapeake announced they were going to be exiting their Eagle Ford position. And while that's still early on, and we don't know exactly what that sale process is going to look like. They do have some acreage that directly offsets your northern area in South Texas. Could that be something you're potentially interested in? And maybe just general thoughts on the A&D market in general?

Yes, Zach, I appreciate your question. Regarding the Austin Chalk, we see significant potential in that acreage. It's essential to consider the specific land terms and midstream commitments to accurately assess its value, but I'm not sure how it currently stands. We consistently evaluate these factors, ensuring they align with our shareholders' interests. This announcement is quite recent, so its implications are still uncertain. Generally, undertaking acquisitions and divestitures is challenging with commodity prices where they are. There is a considerable gap between what sellers expect and what buyers are willing to pay. Sellers often want buyers to accept a higher price, while buyers are looking for something that offers mid-cycle or lower pricing to ensure they can deliver returns. Therefore, it's not an ideal time for acquisitions and divestitures from our viewpoint. We will monitor how commodity prices evolve, but there are indeed valuable acreages adjacent to us in South Texas.

There are no further questions at this time. I would now like to turn the call over to Mr. Herb Vogel, President and CEO, for closing remarks.

Yes. I'll just be really brief here. Thanks for joining the call. If you're wondering why invest in SM Energy now, I just want to repeat, we're producing really top-tier low breakeven assets in two excellent basins, and it's really a great time to be in SM stock. Thanks again. Have a great day.

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