Good morning. My name is Emma, and I will be your conference operator today. At this time, I would like to welcome everyone to the SM Energy Third Quarter 2022 Financial and Operating Results Q&A. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. Jennifer Samuels, Vice President of Investor Relations, you may begin.

Good morning and thank you for joining us. To answer your questions today, we have our President and CEO, Herb Vogel, and CFO, Wade Pursell. As usual, before we get started, our discussion today may include forward-looking statements and discussions of non-GAAP measures. I direct you to Slide 2 of the accompanying slide deck, Page 5 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 discussions of forward-looking non-GAAP measures. Also, look for our third quarter 10-Q filed this morning. And with that, I will turn it over to Herb for brief opening commentary.

Thank you, Jennifer. Good morning. Thank you for your interest in SM Energy and for joining us this morning. We have reached a really exciting time for our business, and I would like to reiterate that we are very pleased to initiate our return of capital program ahead of expectations. Our initiation of share repurchases in September was earlier than expected and our first increased fixed dividend gets paid next week. We designed our sustainable dividend program assuming $60 oil and $3 gas, which gives us upside flexibility in a stronger commodity price environment, including acceleration of buybacks. With that, let me now turn it to Emma to open the line for questions.

Thank you. First question today comes from the line of Zachary Parham with JPMorgan. Your line is now open.

Hey, guys. This is Zach Parham from JPMorgan. First, just wanted to ask on the oil cut, which moved a little lower in the 4Q guidance. Can you just talk about the drivers of that oil cut moving lower and how do you expect the oil cut to true as we move into 2023?

Yes, Zach, that is a question we hear quite a bit. It is really just driven by how many completions come on in Midland versus how many completions come on in South Texas. We kind of look at it longer-term and the quarterly variations in that really don’t make a difference. We just know it is ultimately going to be driven by the capital allocation between South Texas and Permian. But the returns are very important and those returns are very comparable between the two areas.

Got it. And then just shifting over to cash return, particularly on the buyback. You did about $20 million in buybacks in September. Can you talk about the pace of that buyback going forward? Is that going to be systematic or purely opportunistic and utilized when you are not blacked out?

Yes, great question. This is Wade. I would say it will be somewhat systematic and methodical, but also very opportunistic. We will certainly take harder looks on down days, I would say that. But it will be done over time and we will do some each quarter, and that is just the way we will play it. We always have a view of the NAV and we certainly believe we are trading below that right now. That makes it easy.

Just one quick follow-up. Are you planning on putting in a 10b5-1 plan so that you can buy back stock consistently when you are in blackout periods?

We have not done that. I would say right now, that is not the plan. But that could change; currently not.

Okay. Thanks for taking my question.

You bet.

Your next question comes from the line of Timothy Rezvan with KeyBanc. Your line is now open.

Hi. Good morning, everybody. In your press release, you mentioned three high-performing wells that proved up the Western Flank of Swedish Pac. Just curious if you could provide some more details on zones or what essentially you proved up and why you felt the need to call that out in the release?

Tim, great question. Yes. Those three wells were a one-mile step-out to the West from our closest producers, and they were in three different zones, and we were quite pleased with the outcome of the wells. So that is why we called those out.

Okay. Do you have any information on the zones you tested and how much acreage maybe that derisks pretty well?

So the one is middle Spraberry, one is lower Spraberry, and the others are Wolfcamp A. It just moves to the proved category, an area that would have been in probable or possible previously. So it is more or less what we have been doing, which is at the same time, we are concentrating on development in the core parts. We are also extending our boundaries, and that is a great example of doing that.

Okay. Thank you for the color. If my follow-up, I wanted to touch on a big topic in the Midland Basin on well degradation. A lot of operators are talking about it. You all seem to have been less impacted looking at your results over time. So I’m just curious how you think you have sort of sidestepped this issue and how you are thinking about that going forward?

Yes. Tim, that is an excellent question. If you look in our deck, that is really the whole latter part of the deck is how much time we spend on modeling the fracs and the wells to get the well spacing tuned to each DSU, driven by how much oil is in place in each zone, the vertical and horizontal interference. That is where I think we really stand out with our ability with the proprietary tools we have developed, and we have that one slide where we show the cloud of all the potential completion designs and where we are compared to kind of the competitors in the Midland Basin. That is why we view ourselves as really having predictable wells. For us, it is very easy to predict them. Their performance is spot on always with what we expect on a per lateral foot basis and on a per well basis, if we have got the lateral length fully delivered. That is really what drives it.

Okay. And then if I could just follow-up on that. Your spacing assumptions over the last couple of years versus how you are thinking about the next two years, are those consistent or have you made any upspacing changes?

We have basically lined out by DSU, and after all these years of tuning, there is less and less tuning going on each year. I think we are pretty much right on. We have done really well with the Dean wells. Those are really outperforming. We have made some changes when we saw zones that performed particularly well. We have done some minor modifications, but in entirety, it is pretty much the same.

Thank you. I appreciate the comments.

You bet.

Your next question comes from the line of Gabriel Daoud with Cowen and Company. Your line is now open.

Hey guys. Gabe here. Thanks for all the prepared remarks last night. I was curious if we can maybe just get an update on some of the supply chain issues that were referenced in the pre-release about a month ago or a couple of weeks ago, and then also the offset frac issue. I guess how long you think these issues could linger, and just given all the wells that were anticipated to come on and maybe push to the right of it, should we expect a pretty nice start to the year in 2023?

Yes. Gabe, great question. We put that early release out to cover the production differences from our expectations. That was really about 60% from delays in turning wells inline and about 40% from offset activity. The supply chain difficulties really are where we have got a finely tuned instrument out there, especially when we are final fracking or even when we are zipper fracking. If the provider has to wait for parts, that slows us down. If there are slowdowns in trucking, whether that is counterparts or other materials required on the site, that can slow us down. For the service sector, finding and keeping experienced folks labor on the job is another challenge. So those sorts of things with the activity at the highest level has been in several years now. That is what is really driving that. Overall, the number of completions in the Midland Basin, we completed 14, but some came on later in the quarter than expected. Two of those are already online now, but two more are yet to come. Our base production looks great, but it is just a matter of what the outlet timing is. That is really the story on that one. On the offset activity, it is kind of funny actually that we have been accused of being conservative in our forecasts. It is kind of funny that three quarters in a row, we are accused of being conservative while that offset activity was lower than we expected, and then this quarter the offset activity was higher than what we had baked into our estimates. So that will happen at times, and not much we can do about it.

Okay, got it. Thank you. That is great color and very helpful. Maybe now just on the buyback. I’m just curious what do you have to see to get comfortable with either accelerating it or even raising it. You noted it is on a pretty conservative price deck and calendar 2023 showing about $84. How long is that to be sustained, or is it something on the debt side? Obviously, you are pretty close to or about to exceed your target. So maybe just help us to think about upside to that program and what you guys need to see?

Sure. Great question. As you mentioned, we are kind of right at our target on the leverage side well below one times and right around the billion dollars of net debt. All I can say right now is that we will move forward. We will deliver on our commitment to return the levels to the shareholders that we have talked about. As you mentioned, we built that in pretty conservatively to make sure that would happen, so we use $60 and $3. As we move forward into finalizing our plans for 2023 and looking at other opportunities we might have, seeing how stable the commodity prices along with that will just be part of the decision-making as we go. Can’t give you any like metrics to watch for right now, but the more comfortable we get with the stability of the commodity and the free cash flow we are generating, there is obviously an opportunity and a possibility that we will increase the levels on the return to the shareholder side, but it is too early to indicate any of that yet.

Okay. Understood, thanks Wade. Thanks guys.

You bet.

Your next question comes from the line of Oliver Huang with TPH. Your line is now open.

Just wanted to follow back up on the Q4 guide. Compared to prior expectations of having encountered the offset frac and supply chain issues in Q3. Does that 60/40 mix you referenced for Q3 also hold for Q4 or does it lean a bit heavier one way or the other?

Yes. Oliver, for Q4, all we would say is there have been delays in when we can turn some wells in line. Offset activity is something that is really hard to forecast. For our Q4, we just delayed turning lines somewhat. For the asset activity, we basically just use our asset activity model where we know our own offset activity, and then we know what offset operators will do. Sometimes they will change their schedules, and sometimes we will have a delay. There is nothing specific that I would say into percentages of one versus the other; kind of all grouped together.

Okay, thanks. That makes sense. And for a second question, I know you all historically bake in some risk in per offset frac downtime, but just kind of getting the strong commodity prices, more players and activity in the basin. Just kind of wondering if you all are expecting a more elevated impact relative to historical norms when thinking about 2023 based on conversations that other operators have kind of communicated with you in the planning phase for next year at this point in time?

Not really. It is something that every month we will get an update on things, so it is really hard to forecast exactly what the rig count will be in Howard County. That is one proxy. Just look at the rig count in Howard County; when it is way up, there is going to be more activity in the area. South Texas is different because we have quite a bit of - it is only our own wells really. It is very complex to where we have got offset activity directly off us.

Perfect. Thanks for the time.

Your next question comes from the line of Gregg Brody with Bank of America. Your line is now open.

Just to follow-up, in terms of the debt side, clearly below your leverage target, and you have paid down your revolver. So you still got another $600 million or so to reduce in terms of debt from the bond side to try to get to your $1 billion target. Just talk to us about how you are planning on approaching that. Should we think about you just calling on the first maturities as they come due or are you thinking about it in a different way?

You know how we operate typically by maturity. So you can assume that when we are ready to reduce the absolute debt numbers to get down to that $1 billion. As you mentioned, we have a lot of cash right now; that is why we can say close to $1 billion. It would probably be the '25s would be the first target, although we watch the trading levels of the others as well. That is just generally speaking how we would do that. We tap the brakes a little bit on that just given the uncertainty with inflation and interest rates. It feels like a good time in this time of uncertainty and rising rates to have cash. That is kind of the way we are running things right now. As we move forward and build more cash than that, we will make those decisions as we move forward. But that is kind of a general thinking.

And then you had some comments in your pre-call that I just wanted to clarify to make sure I understand them. I think when you were talking about inflation, you mentioned that for 2022, you average in 25% to 30%. I think you said you expected the exit rate to be above that number, implying 2023 inflation is higher than 25% to 30%. Did I understand that correctly? Just how does that translate potentially for your capital budget when we think about what you may have locked in from this year already and maybe how you are approaching contracting? Are you thinking about having longer duration contracts to try to address some of the inflation?

Yes. I will respond to your comment on my prepared remarks. But let Herb add any color he wants. You did hear it correctly; 25% to 30% and that we are seeing an exit rate out of 2022 higher. We listed the things that are still going up, too early to give any specifics on 2023 in those areas though.

Yes. Gregg, the only thing I will add on that is that we have not done the 2023 budget. We are watching things closely. We have done as much as we can to lock in the supply chain for next year. But there is no doubt there is inflation going on and we don’t know when it will pop out.

Are you considering smaller duration contracts now with some of your providers? Was it also addressed in the supply chain issues that you have had occur this quarter?

Yes, it is a mix of the contracts themselves, getting the steel, making sure we have got the steel and we can drill the wells. That is a critical starting point. On the frac service providers, making sure we are set there. We are in great shape because we do lock that in a bit longer-term. We really work that hard is the way I would sum it up.

Great. Thanks for the time, guys. I appreciate it.

You bet.

Your next question comes from the line of Daniel John with Daniel’s Energy Partners. Your line is now open.

Hey, guys. Thank you for including me. Herb, I got a quick question on just the supply chain. If the industry activity stabilizes from here, do you think the industry sees these headaches ease in 2023? What happens in your view if we see another 5% to 10% activity across the board? What is the duration of the headaches, if you will?

Yes. John, thanks for the question. You probably know better than anyone what it looks like. There are areas that are quite tight, and if there were the hypothetical of increasing activity, those tight areas will obviously have more inflation. There is quite a bit of discipline on the E&P side and the service side. But I think the thing is that if you are going to forecast, forecast often. I don’t think we are ready to forecast just yet. We are going to put a budget together with our expectations in the November through January timeframe. We will go with that, and then we will see where things come. We are focused on our relationships with those key suppliers and service providers and materials. That is just what I would say on that.

Fair enough. I have got a dumb guy question for you now. Where are we on the evolution of well completion designs? Any big picture thoughts on that? How often are you testing new designs?

So John, I’m going to point you to one slide in our deck. I don’t know if you have looked at it, but it really just showed how we have moved our completion design to add value. In some cases, it does take additional capital, but the performance that incremental return for that additional capital is phenomenal. We are going to continue to do that. You are going to continue to see us get better and you are going to see our competitors moving towards our designs over time. I think we are right at the cutting edge on that and it is a place we want to be.

Awesome. I really appreciate you guys letting me ask some questions. Thank you.

You bet, John.

This concludes today’s Q&A. I will now turn the call to Dr. Herb Vogel, Vice President and CEO.

Thank you, Emma. And thank you all for your interest in SM Energy. Thank you.

That concludes today’s call. Thank you for attending. You may now disconnect.