Callon Petroleum (CPE) Q1 2021 Earnings Call Transcript

Callon Petroleum (CPE)
Q1 2021 Earnings Call
May 06, 2021, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Callon Petroleum Company first-quarter 2021 earnings conference call. [Operator instructions] Please note this event is being recorded. I would now like to turn the conference over to Mark Brewer, director of investor relations. Please go ahead.

Mark Brewer -- Director of Investor Relations

Thank you, Sean. Good morning, and thank you for taking the time to join us on our first-quarter '21 conference call and webcast. With me this morning are Joe Gatto, our president and chief executive officer; Dr. Jeff Balmer, our chief operating officer; and Jim Ulm, our chief financial officer.

During our prepared remarks, we'll be referencing the earnings results presentation we posted yesterday afternoon to our website, so I encourage everyone to download the presentation if you haven't already. You can find the slides on our Events and Presentations page located within the Investors section of our website at www.callon.com. Before we begin, I'd like to remind everyone to review our cautionary statements, disclaimers, and important disclosures included on Slide 2 of today's presentation. We will make some forward-looking statements during today's call that refer to estimates and plans.

Actual results could differ materially due to the factors noted on these slides and in our periodic SEC filings. We'll also refer to some non-GAAP financial measures today, which we believe help to facilitate comparisons across periods and with our peers. For any non-GAAP measures we reference, we provide a reconciliation to the nearest corresponding GAAP measure. You may find these reconciliations in the Appendix to the presentation slides and in our earnings press release, both of which are available on our website.

Following prepared remarks, we will open the call for Q&A. With that, I'd like to turn the call over to Joe Gatto.

Joe Gatto -- President and Chief Executive Officer

Thank you, Mark. We're glad everyone could join us today as we review the results of another solid quarter for Callon. Commodity prices have rebounded, activity levels are measured, and our sector has found its footing with a shift to more moderated reinvestment rates and a commitment to improving corporate returns on capital. Against this improving industry backdrop, it is critical to maintain discipline and not waver from the goal of firmly establishing sustainable business models as investors assess those companies that can differentiate themselves in terms of asset quality and execution through longer-term cycles.

Our focus at Callon remains unchanged, continuing to strengthen our financial position to overlay on a top-tier asset base and organization, ultimately reducing our cost of capital and increasing the value of our cash flow streams. We delivered free cash flow for a fourth consecutive quarter and estimate generating roughly $200 million for full-year 2021 at recent strip prices. This robust free cash flow visibility, supplemented by an ongoing methodical monetization program as evidenced by our recent Delaware Basin divestitures, will further decrease our absolute debt levels, which are down almost $400 million since the middle of last year. We also anticipate an acceleration of the rate of improvement in our credit metrics as EBITDA increases alongside our cash margin strength and 2021 production profile.

We are steadfastly committed to reinvestment rates to capitalize on the efficiency of our full field development program and optimize our free cash flow generation while preserving our longer-term asset value proposition. In lockstep with our operational and financial priorities, we have incorporated sustainability targets and process changes across the company that we believe will have lasting impacts and translate into improved shareholder value over time. Turning to Slide 4, we've hit the highlights of a solid first quarter that checked several important boxes and delivered against both internal and street consensus expectations. In the face of winter weather impacts, we produced 81,000 BOE per day with a higher-than-anticipated oil cut.

Field operations continue to control our lease operating and workover expenses. And combined with the impact of improved pre-hedge pricing, we posted an operating margin that was up nearly 60% from the fourth quarter of 2020. Operational capital came in below $100 million in our adjusted EBITDA top consensus estimates by roughly $10 million, driving free cash flow generation of approximately $25 million. Earlier this week, we received a unanimous reaffirmation of our credit facility borrowing base and associated commitment levels, solidifying our liquidity position as our bank balances steadily decrease.

Including the proceeds from the announced sales agreements of our noncore Delaware acreage, our total monetization proceeds since the second quarter of last year have now exceeded $200 million. Add to that the consensus estimates of more than $160 million in free cash flow generation for the remaining three quarters of the year, and we will have significantly advanced our debt reduction efforts by year end. In March, we issued a press release announcing changes to our executive compensation program and outlining our new greenhouse gas emissions reductions targets. Comprehensive changes to our executive compensation program included accountability for achieving both quantitative and qualitative ESG goals in the near and medium term.

Over the last several quarters, we have provided updates regarding our initiatives to address our environmental footprint. And on the left-hand side of Page 5, you can see a sample of the key projects that will impact 2021. As I stressed on our last call, meaningful progress can't be accomplished only through a list of projects. It requires a change in mindset across the entire organization, which I have seen occur at Callon.

This powerful dynamic has now positioned us to set the ambitious goals illustrated on the bar charts, including a 40 to 50% decrease in GHG intensity by 2025 and the elimination of all routine flaring in the same time frame. Slide 6 summarizes the broader changes to our executive and corporate incentive compensation programs that we believe are firmly aligned with the investor priorities to emphasize financial outcomes and corporate sustainability. The redesign addresses both short-term and long-term components to incentivize value creation. The annual program outlined on the top of the page, is 80% based on specific quantitative metrics with the remaining 20% based on the board's assessment of progress toward our longer-term ESG and strategic goals.

Importantly, the calculated payout for the annual program will be capped at a maximum of 100% of target value in the event total shareholder return for the year is negative. The long-term incentive plan has also undergone meaningful change with traditional relative stock price performance units being replaced by cash performance units that will be based on free cash flow generation over a three- year period. In addition, the calculated LTI payouts based on free cash flow performance will be capped if threshold levels of corporate returns on capital employed are not achieved over the period. On the topic of free cash flow generation, any conversation starts with the building blocks of corporate cash margins.

On Slide 7, you can see the expansion of first-quarter all-in cash margins, which is the difference between the light blue diamond in the stack bar to over $20 per BOE on a hedged basis. This is an impressive hedge margin considering the event-driven increase in per-unit expenses caused by lost production from Winter Storm Uri. Over the course of 2021, the progression of our hedge book will expose realized pricing to increasing upside participation, resulting in an all-in corporate cash margin approaching $25 per BOE for full-year 2021, assuming current consensus benchmark pricing of $58.67 per barrel of oil. In the chart on the right, our field level realized pricing for the quarter was up significantly in both operating regions and increased our corporate operating margin to $33.46, representing a 58% increase over the fourth quarter of 2020.

Overall, we continue to benefit from the diversification of our portfolio with both the Permian and Eagle Ford contributing meaningfully to our profitability. At this point, I'm going to turn the call over to Jeff.

Jeff Balmer -- Chief Operating Officer

Thanks, Joe, and good morning, everybody. So we'll be on Slide 8 right now. Let's start with something that our team has been working on for a number of quarters, and that's having a real impact on both well productivity and our development costs. In the charts here, you can see an ongoing trend of reduced water loading in our Midland Basin development program.

Over time, we've been able to shift to reduced water levels in our completion designs, which has resulted in lower overall well cost, an acceleration in reaching peak oil, and an improved oil cut overall. All of these contribute to greater well profitability as we lower the cost and bring forward revenue from a timing perspective. In addition, our water usage per well is meaningfully reduced, which further mitigates the environmental impacts of our operations. And speaking of environmental impacts on Slide 9, I'm very proud to say that we recently completed our first multi-zone, multi-well completion using an electric frac fleet.

The team did a fantastic job of pulling this together and leveraging our access to infrastructure so that the fleet could be powered by produced fuel gas volumes. In total, the completed three wells averaged more than 10,000 feet per lateral in a vertical multi-zone development that contains the Lower Spraberry Wolfcamp A and Wolfcamp B in Northwest Howard County. Completion efficiency was on par with our expectations for standard completion fleets after we work through some initial setups on the project. While we are currently using dual fuel fleets for our other completion activities, this successful test provides Callon with another avenue to expand its operational efficiency, lower costs, and continue reshaping how we impact the environment.

As we previously mentioned, much of our early year completion activity was focused on the Eagle Ford. And our Richmond West Pad was the only project placed on production in the Delaware during the quarter. And you can see on Slide 10 that while it was impacted by our freezing weather, it has returned to production after nearly 10 days off-line with a strong resumption of its previous trajectory. In the Eagle Ford, on the right-hand side, our Gardendale pads were the first pad turned to production during the quarter.

And you can also see in the chart that the average production for that pad is tracking right alongside our expectations, again, even when accounting for the winter weather impacts that disrupted production around day 30. These are long laterals, over 12,000 foot per well, which tend to exhibit very nice flat production curves and hold the rates quite well. And in fact, the older vintage wells, which directly offset these Gardendales are some of the longest-time producers in our portfolio, and these existing -- these new wells are producing right on par with our expectations. Our choke management program and changes to our flowback techniques have also continued to produce these very reliable results that exhibit improved long-term well performance.

On Slide 11, our drilling and completion teams continue to advance our development efficiency, and the charts on this slide exemplify those successes. In the lower-left chart, our completions in the Eagle Ford have shown an improvement of nearly 300 lateral feet per day or a gain of more than 15% in completion efficiency, again, in a very mature asset. And, of course, not to be outdone, our drilling team has posted impressive improvements in all four of our asset areas with the activity in the Reeves County area of Delaware showing significant strides. Recently, the team set a new Callon record for lateral drilling efficiency, covering just under 11,400 feet in only 75 hours in this area.

The continued improvement in the Midland Basin, where drilling costs are approaching the leading-edge figures for our Eagle Ford asset area, really speaks to the continuous effort to reduce both time and cost without sacrificing quality of execution. This is also a more mature asset area, where we have a more extensive drilling history than the Delaware, yet we continue to see incremental savings and efficiency. I'm very proud of what the overall operations team has accomplished, and I look forward to seeing what we can achieve in the upcoming quarters. That's all for operations.

So I'm going to turn things over to Jim.

Jim Ulm -- Chief Financial Officer

Thank you, Jeff, and good morning, everyone. On Slide 12, we provided a recap of our current hedge positions. With the forward curve having risen lately, we have been strategic about slowly layering in positions for 2022, and we have continued to be methodical in our approach to protecting cash flow. You can see in the chart at the bottom right of the slide that as we move through the second half of 2021, our price realizations gained further significant upside, which will support our continued growth and free cash flow as we move into the first half of 2022.

I'll reiterate that we've shifted the majority of our positions into collars with our early 2022 positions, providing upside into the $60 a barrel price both at NYMEX WTI and MEH to reflect the balance in our physical sales points. The value of this price point diversity was reflected earlier in our cash margin analysis and is part of what allows us to weather changes in regional pricing for our various commodities. On Slide 13, I'm very pleased with the progress we've made in addressing leverage over the past several quarters. The entire organization has worked to maximize free cash flow, allowing us to pay down our credit facility and be successful in executing monetization opportunities with the cumulative proceeds in excess of $200 million.

On our current trajectory, we still see Callon generating between five and 800 million in cumulative free cash flow by the end of 2023 at prices between 50 and $60 per barrel of oil. As Joe mentioned earlier, we recently signed agreements for two separate packages in the Delaware, one of which was a gas-weighted property and a second that was undeveloped acreage. Between the two transactions, we are expecting gross cash proceeds of roughly $40 million. Despite current production of approximately 3,400 BOE per day and an oil cut around 25%, the impact to our free cash flow generation is minimal, and we expect to benefit from incremental reductions in operating expenses.

Callon has demonstrated the ability to effectively harvest value from noncore assets consistently over the past several years, and I expect that these credit-accretive transactions will continue. The other pieces that remain critical to advancing our leverage reduction goals is our cost control and commodity realizations. Joe mentioned the significant jump in our operating margin this quarter, and we expect to see continued strength as we see more of our production shifting to Brent-linked pricing over the coming quarters. Slide 14 provides a brief overview of our financial position and priorities.

Our senior secured credit facility and associated borrowing base, we unanimously reaffirmed by our banks at 1.6 billion earlier this week. With current borrowings currently standing at 950 million and an approximate 25 million of cash on hand, our free cash flow in the second half of the year should meaningfully advance our reduction efforts. Our bonds have seen significant appreciation since the lows of last year, and we are now beyond any window where debt for debt exchanges make economic sense. We will continue to be opportunistic with regards to refinancings and managing our near-term maturities.

Importantly, we continue to track toward our goal of less than two and a half times net debt to adjusted EBITDA by the end of 2022, and we see a clear path to pursuing a significantly lower leverage ratio long term. Overall, I am truly pleased with what we have been able to accomplish in a rather short period of time, and I look forward to seeing the team continue progressing these initiatives over the coming quarters. At this point, I would like to turn the call back to Joe.

Joe Gatto -- President and Chief Executive Officer

Thanks, Jim. Before we get to questions here in a second, most of you on call know, it's Jim's last earnings call with us to take some well-deserved time away to spend with his family. Jim, in behalf of the entire team, thank you. You're such an integral part of our organization, really upping our game on both professional and personal cases.

Thank you. We are certainly a better company because of you and your contributions to Callon.

Jim Ulm -- Chief Financial Officer

Thank you.

Joe Gatto -- President and Chief Executive Officer

Operator, that concludes prepared remarks. I'd like to open the line for Q&A.

Questions & Answers:

Operator

Thank you. [Operator instructions] The first question today will come from Neal Dingmann with Truist Securities. Please go ahead.

Neal Dingmann -- Truist Securities -- Analyst

Good morning, all. Nice details. Joe, my question for you or Jeff, you guys continue to run really nice, what I'd call diverse -- regionally diversified program. Can you talk -- and I think around the same question, but I just noticed you continue to do so well with that.

Could you talk, one, is -- maybe when you talk about -- a lot of people ask about cadence. I'm asking a little bit more about sort of regionally if you guys are going to continue with this kind of plan. And when you look at Delaware versus Midland, what kind of expectations are you -- are they really similar these days? Thank you.

Joe Gatto -- President and Chief Executive Officer

Yes. Generally speaking, the cadence is going to stay pretty much what it is. So this wonderful luxury of having the opportunity to work in multiple basins really paid off in 2020 when we were able to shift from some of the longer cycle time projects, more expensive on a per-well basis than the Delaware and shift over to the Eagle Ford and the Midland Basin. And you see a pretty equivalent spread of capital in 2021 with that.

So we would anticipate that being the strength going forward. One of the nice things with the Delaware, of course, is that it's a less mature asset. And so since we have the ability to put in different types of programs or learnings or geomechanical algorithms where we try to look at not just what the rock contains, but how it breaks and opens, it contributes. While we're learning that with a couple of well pads, we can then rotate over and have some expenditures and some progress in the more mature areas like Midland and then the Eagle Ford.

And then we can come back into the Delaware and make improvements over what we did in a relatively short time without having to have that consistent capital program where potentially you're overcapitalizing being a little less efficient than you would be. So that's kind of a general statement about why we've been able to continue to make progress in all the operational areas.

Neal Dingmann -- Truist Securities -- Analyst

No. Well said. I like the details. And then just one last one, Joe.

Again, CAPEX continues to come in a trend a little bit lower. I guess my thought would be around flexibility of the plan is the -- as you continue to beat on debt, is that going to sort of -- I guess, my question, is that sort of the sticking point? And if prices go higher, you'll still kind of keep the CAPEX as is? I'm just wondering, again, I guess, my question is really production more of an output? Or how do you think about sort of that overall strategy these days?

Joe Gatto -- President and Chief Executive Officer

Yes. And I think you got it there in terms of sticking to the plan. As you recall in our last earnings release and presentation, we laid out a three-year plan, sort of gave you a sense of how things will roll out over the next three years given the visibility we see in the program, and we intend to stay with those types of reinvestment rates in that 65 to 75% range. As you said, there is production -- small production growth as an output of that, but it really is about being disciplined around the CAPEX reinvestment for '21.

We're locked in on this program. What we laid out over the next couple of years, there's some slight increases in capital. But for a large part, this is sticking to our guns on those reinvestment rates and really driving some outsized free cash flow over the next couple years.

Neal Dingmann -- Truist Securities -- Analyst

Great. That's what I was hoping to hear. Thanks, guys.

Joe Gatto -- President and Chief Executive Officer

Yes.

Operator

[Operator instructions] The next question today will come from Brian Downey with Citigroup. Please go ahead.

Brian Downey -- Citi -- Analyst

Good morning. Thanks for taking the questions, and Jim, going to Joe's comments, we wish you and your family the best as you retire from Callon. We certainly appreciate all the help. Maybe for you or Joe, on the A&D side, clearly nice progress following recent asset sales over the past couple quarters.

The water assets, I believe, are one of the key items on the menu of potential disposition options that you haven't transacted on yet. Is that still something you're potentially contemplating? Or what else is still embedded in this year's remaining divestiture target?

Joe Gatto -- President and Chief Executive Officer

Yes. I'll take that. And, yes, the water is still something that's progressing. It's an opportunity that we're really looking to find the right partner and find the right fit, and that's a discussion that's really benefited as we provided more clarity on the -- not only the short term but the medium and long-term prospects for the business, strength of our asset portfolio over time.

It really helps those discussions with potential partners. They see the durability of this business and underwriting anticipated water streams off the business. That's ongoing. As we've talked about in our monetization targets that we put out, there's a lot of ways to be right, put it that way.

Right? The water is a component there, but there are other similar opportunities in line with this noncore Delaware divestiture across our footprint that we have in various stages of progress. So like I said, we're going to be methodical about this. We've gotten a lot of questions over the last couple quarters, and we're letting the market come to us. And I think it's developing quite nicely, getting to a point where not only can you sell assets, but you can sell them and make a credit accretive on a metric basis.

So more to come. Yes. Water is in the mix, but there are others that are in the queue. And I think we're encouraged to see the activity more broadly in the market.

Brian Downey -- Citi -- Analyst

Great. And then, Jeff, the e-frac test you laid out on Slide 9, clearly, some environmental and efficiency benefits there. How should we think about quantifying how that all translates into D&C costs perhaps coupled with the fluid-loading changes you noted on the prior slide. How does that all compare versus what you've achieved in 1Q or what's embedded in the full-year guidance?

Jeff Balmer -- Chief Operating Officer

Sure. The e-frac test was fantastic. Really -- the group really enjoys technical challenges and problem solving. And so from a -- it was beyond just a test.

It was a system of obstacles and opportunities that provided a lot of enjoyment, if that makes any sense. And so from a cost perspective, it's pretty neutral. Generally speaking, I think the groups that are moving to dual fuel fleets, which, of course, Callon has already done that, and e-frac fleets, there'll probably be -- there's potentially a premium on those relative to the historic diesel fleets. And that's just more in my opinion than anything.

So all that's baked into our capital program right now. I think that you see tremendous benefits both from reducing the emissions, the sound, noise, the opportunity to use field gas in addition to CNG and potentially even maybe plug into the grid at some point for that power supply. So from an overall D&C cost, when you couple that into what we've shown on reductions relative to the power grid. And that slide, of course, was, in particular, to the Midland Basin.

That's allowed us to continue to grind away and keep costs relatively flat, even though, obviously, the market is looking a little bit on the North side from a labor and sand and the -- we're not in $40 oil anymore. But overall, we've been -- I've been very, very happy with the cost from a to z on our operations.

Brian Downey -- Citi -- Analyst

And on that power grid point, is that something where there's already existing infrastructure in place? Or as you evaluate that, would that require any upfront capital that you weigh against per well savings?

Jeff Balmer -- Chief Operating Officer

Yes. That's a great question, and it kind of depends on where you are. So some of our areas have better -- Callon has already committed to multiple substations in the past, which, of course, gives us a lot more flexibility than having to ring somebody's doorbell and coming over. So it really just depends.

Obviously, if you're in an area where you're going to be there for a while and you have infrastructure in place, that's the most optimal opportunity that you would have. But anywhere that you have a reasonable or substantial amount of activity, we'll be looking into that.

Brian Downey -- Citi -- Analyst

Appreciate it.

Operator

[Operator instructions] At this time, there are no further questions, and this will conclude our question-and-answer session. I would now like to turn the conference back over to Joe Gatto for any closing remarks.

Joe Gatto -- President and Chief Executive Officer

Thank you, and I'm going to wrap up earlier. A little bit of user error on my part. So I'm going to reiterate something I said to Jim because it's worth saying twice even if you heard it before. But this is Jim's last earnings call with us and before he takes some time with his family and hopefully finds a different gear and enjoy his time.

We'll certainly miss him, and I just wanted to thank them on behalf of our entire team here at Callon for being such an important part of our leadership team and to me, personally. I know he's upped our game, both on a professional and personal basis every day. He's been with us over the last three-plus years. And at the end of the day, we're truly a better company because of you and what you've done for us, Jim.

So really appreciate that. We're going to miss you, but I know we'll see you very frequently. We'll keep tabs on you. So I wanted to wrap up with that, and we'll look forward to updating everyone later this summer with our continued progress with the business.

Thank you.

Operator

[Operator signoff]

Duration: 30 minutes

Call participants:

Mark Brewer -- Director of Investor Relations

Joe Gatto -- President and Chief Executive Officer

Jeff Balmer -- Chief Operating Officer

Jim Ulm -- Chief Financial Officer

Neal Dingmann -- Truist Securities -- Analyst

Brian Downey -- Citi -- Analyst

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