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Cimarex Energy Co (NYSE:XEC)
Q2 2021 Earnings Call
Aug 5, 2021, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the Cimarex Second Quarter 2021 Earnings Conference Call. [Operator Instructions]

I would now like to turn the conference over to Megan Hays, Vice President of Investor Relations. Please go ahead.

Megan P. Hays -- Cimarex Energy Co.

Thank you, Jordan. Hello, everyone, and welcome to Cimarex's Second Quarter 2021 Conference Call. For those who want to reference today's press release or presentation, you will find it on our website. Joining us on today's call will be Cimarex Chairman, President and CEO, Tom Jorden; our Chief Financial Officer, Mark Burford; our Executive Vice President of Exploration, John Lambuth; and Vice President of Operations, Blake Sirgo. Participants on today's call may discuss non-GAAP financial measures.

You will find the most directly comparable GAAP financial metrics and appropriate reconciliations to those GAAP metrics in our press release, which is available on our website. Also, as a reminder, during today's conference call, we will provide forward-looking statements based on current expectations. I call your attention to the forward-looking statements, cautionary statements and other disclaimers that are provided in the earnings release and presentation. Following our prepared remarks, we will take your questions. [Operator Instructions] With that, I'll turn the call over to Tom.

Tom Jorden -- Chief Executive Officer

Thank you, Megan, and thank you to those of you who are joining us this morning. As we reported this morning, Cimarex had a strong second quarter driven by strong operational performance and favorable commodity pricing. Our oil volumes came in at 72,700 barrels of oil per day. This is a 6% increase over Q1 and in line with the high end of our guidance. We understand that industry-leading capital efficiency is a competitive advantage, and our program is delivering on the promised increase in capital efficiency, driven by three focus areas: Optimizing well spacing, improving drilling performance and refining our completion techniques.

First, let's discuss our recent projects that incorporate relaxed spacing. We highlight the productivity uplift we observed in the Dixieland and Big Sky developments that are highlighted on Slide six of the investor deck. We are also flowing back a number of new developments that are delivering encouraging results. Moving to our drilling performance. We recently drilled our Lieutenant Gibson one state 7H well in Culberson County in 7.4 days from spud to TD, averaging 2,597 feet per day. Hats off to our operational team for this outstanding performance.

We also finished drilling and completing the [Carol Elder] 5-well project in the Mid-Continent, where we significantly invested our prior averages for drilling and completion productivity. We expect this project, which will come online in Q3, to be an important proof of concept. Our third focus area, refining our completion techniques, is continuous as we incorporate the latest productivity and performance data into our operational decisions.

Importantly, the culmination of our focus on these three areas means our cost and productivity continue to trend in the right direction. Our Delaware Basin well costs are tracking within our annual guidance range of $800 to $850 per lateral foot. As always, our cost numbers account for all costs associated with bringing in the well onto production, including drilling, completion, facilities, gathering and saltwater disposal infrastructure and flowback.

As Mark will describe, we had solid financial performance during the quarter. We maintain a sharp eye on controlling costs. Our production expenses are trending within our guidance range despite an uptick in workover expenses during the quarter as we further caught up with deferred workovers and maintenance. Strong volumes, good cost control and strong pricing drove $195 million of free cash flow, or $167 million of free cash flow after the payment of our base dividend. We ended the quarter with $799 million cash on hand and no borrowings on our revolver.

With strong operational momentum, favorable commodity prices and outstanding organizational performance, Cimarex is in terrific shape as we look to build for the future. On that note, I'd now like to make a few comments about our recently announced combination with Cabot. In bringing together Cabot's position in the Marcellus Shale and Cimarex's acreage in the Permian and Anadarko basins, the combined business will have a strong and differentiated foundation, creating a premier energy company that is focused on delivering leading returns of capital to shareholders through the cycles. The benefits of this combined business are clear.

I'd like to reiterate a few of these on today's call. First and foremost, the combined business is expected to be able to return substantially more capital to shareholders as compared to Cimarex stand-alone. Combined at mid-cycle pricing, we expect to deliver $4.7 billion of cumulative free cash flow between 2022 and 2024. Generating strong free cash flow against macro complexities enables us to target returning more than 50% of quarterly free cash flow with the capacity and confidence to distribute more than 30% of cash flow from operations and higher commodity price levels.

We believe this approach to shareholder distributions is industry-leading and understand several of our peers have begun adopting similar strategies. This best-in-class capital return profile is driven in part by a high-quality portfolio with premier multi-basin exposure. As I've said before, Cimarex has benefited from exposure to oil, gas and natural gas liquids. This remains a core competitive advantage that moderates the impact of price swings of any single commodity. And our combination with Cabot and their strong PDP base enhances our resilience to commodity price swings.

Importantly, the combined company will benefit from a strengthened financial profile. Together, we expect a lower cost of capital due to increased scale, increased liquidity and a strong balance sheet with less than 1 times net debt to EBITDAX. From a cultural perspective, we are also aligned in our strong commitment to environmental stewardship, sustainability and strong corporate governance and look forward to bringing our talented teams together.

To that end, dedicated teams from Cimarex and Cabot have been working diligently. And with our preliminary S-4 filed, the expiration of the HSR waiting period and integration planning underway, we are making important progress toward completing the merger in the fourth quarter of 2021. We look forward to completing the transaction and delivering on the value-creating potential of the combination. I am incredibly proud of the entire Cimarex team, and I am confident in our path forward, as we continue to deliver strong financial and operational performance, while focusing on bringing our business together with Cabot.

And while I'm speaking about my pride in the Cimarex team, I hope that you have not missed that we have posted this morning our updated environmental safety and health data on our website, including a very detailed fact-filled report of our emissions and safety data. We have made tremendous progress over the past few years as our emissions footprint has become a top engineering priority at Cimarex. This has driven substantial and meaningful reductions, and it will continue to do so in the future as our organization from the field to my office is highly focused on this. We will bring this focus together with Cabot's shared commitment on these principles to our new company and continue to make solid environmental progress. With that, I'll hand the call over to Mark.

Mark Burford -- Vice President and Chief Financial Officer

Thank you, Tom. Good morning, everyone. I'll address the key items in our second quarter 2021 financial results and outlook. Our production volumes this quarter came in above the midpoint of our guidance due to strong well performance. Additionally, second quarter production increased 8% compared to first quarter 2021 volumes. As Tom highlighted, operation, we are executing extremely well and are on track to achieve our fourth quarter 2021 oil production guidance, which is to grow oil volumes by more than 30% as compared to fourth quarter of 2020.

As we previously discussed, the fourth quarter production increase is a result of the resumption of an efficient drilling and completion cadence of five rigs and two frac crews after dropping to one rig and no crews in mid 2020. Combination of strong price realizations and production volumes resulted in oil, gas and NGL revenues for this quarter of approximately $700 million, which is nearly triple the revenue as compared to the second quarter of 2020. Per unit cash costs comprised of LOE, workover expense, transportation, production taxes and G&A totaled $9.36 per BOE, a decrease of 10% as compared to the first quarter.

With a projected higher second half volumes, we expect per unit cost to trend down further toward the midpoint of our annual 2021 expense guidance. Total capital investment for the second quarter was $199 million, including $168 million of drilling and completion capital. Adjusted cash flow from operations in the first quarter totaled $394 million, generating $195 million of free cash flow or $167 million of free cash flow after the dividend.

As a result of the strong free cash flow in the quarter and noncash property sales, we exited the second quarter with a net debt of $1.2 billion a decrease of $526 million from year-end 2020. Overall, we're executing very well on this new program. We're committed to maintaining capital discipline, and with the higher commodity prices, that translates strictly into incremental free cash flow. With that, I'll turn the call over to Blake.

Blake Sirgo -- Vice President-Operations

Thanks, Mark. Our operations teams continue to deliver strong performance. We're on track with our capital program while delivering the efficiency improvements telegraphed at the end of 2020. We find significant efficiency gains and steady concentrated activity. Maintaining a cadence of five rigs and two frac crews in the Permian allows us to focus our operations in key development areas, resulting in more wells per pad, longer laterals and faster cycle times while optimizing our facilities.

All these efficiencies come together to help improve our cost structure and keep inflation in check. We see continued inflation across the supply chain, including horsepower, labor, steel and fuel. Left unchecked, these cost pressures could increase our capital cost. However, due to the performance of our ops teams, we have been able to offset nearly all cost pressures with efficiency gains. Nowhere is this more evident than in our drilling performance, where our team set another record this quarter with the Lieutenant-Gibson one state F #7H in Culberson County, Texas, which drilled to TD in 7.4 days.

During the second quarter and across our Permian program, our drilled feet per day came in at 1,513 feet per day, which is up 7% from the first quarter and 35% from a year ago. Thanks to these continued efficiency gains, we are reaffirming our full year cost guidance for total well cost of $800 to $850 per foot. Our organization continues to make advances toward our goals to reduce our emissions footprint.

We have five of our new tankless facilities in operation with 11 more planned through 2022. These facilities replaced traditional tanks with surge vessels, thereby eliminating [Indecipherable] patches and end-of-line devices, which are common sources of fugitive emissions. We're constantly learning as we collect performance data from these new facilities. This data informs a critical feedback loop that allows us to iterate and improve on future designs to help further drive down emissions. These efforts, coupled with the great work by our field staff, help ensure that each new barrel produced at Cimarex has a lower emissions footprint in the last. And with that, we are now happy to take any questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Arun Jayaram with JPMorgan. Please go ahead.

Arun Jayaram -- JPMorgan -- Analyst

Good morning. Tom, I wanted to maybe start with some of the key learnings from Big Sky and Dixieland and how this is informing your future development planning in the Delaware Basin.

Tom Jorden -- Chief Executive Officer

Well, I'm going to invite John to chime in here with me. But certainly, some of the key learnings are from our up-spacing just purely and simply allowing a little more space between wells. We think it absolutely has confirmed our thesis that we can have a significantly increased capital efficiency, that the trade-off in lost reserves is minor, the gain in lowering capital is major.

And we've seen our initial flowback. And we have almost six months on a couple of these projects. And I would say it's absolutely confirming our core thesis that we can extract comparable reserves by drilling fewer wells. And we've also looked -- now Dixieland and Big Sky are very different. Dixieland is a triple stack project, Big Sky has two landing zones and they're in different parts of the basin.

So differences are not always explained by spacing and completions. But we've learned a tremendous amount about up-space completions and the differing performance in the sand and shale environments. We've learned a tremendous amount about well-to-well interference, and we're further looking to optimize. So we are just really excited about increasing our capital efficiency as we've highlighted, going into '21 and '22. John, anything you'd like to add?

John Lambuth -- Executive Vice President of Exploration

No, Tom, I think you covered it extremely well there. We are -- we've learned a lot over the last three years. And we really feel like for every section that we're about to develop, we're pretty dialed in on the spacing aspect of it. Based on the rock properties, based on reservoir properties and based on existing parent wells, we really have, we think, a pretty good process to come up with the optimal spacing for every section as we go forward.

Arun Jayaram -- JPMorgan -- Analyst

Great. My follow-up, Tom, I've gotten this excellent question from quite a few buy siders. So I wanted to ask you about this is to ask about the people side of the Cabot merger. We all know that your technical team has been one of the core advantages of the company. And I know you touched about integration planning. But could you talk a little bit about the Cimarex employee reaction to the merger? And perhaps your confidence in retaining your core technical talent, as it appears you're going to combine the corporate headquarters in Denver to Houston?

Tom Jorden -- Chief Executive Officer

Arun, thank you for that question because I think those of you that know me would know that retaining our core operational capability, the hearts, minds and souls that are the absolute engine that drives Cimarex is forefront in our mind, which is one of the reasons why our combination with Cabot appealed to both Dan and me. We're very different companies, but we're very similar in many respects.

I think you're going to see the overwhelming majority of Cimarex's talent at the new company. Our staff is excited about it. I think our people are ready and willing to take on a new challenge, and we're ready to get after it. But I want to just finish by saying I did have an opportunity to go to Pittsburgh two or three weeks ago. And it was my first opportunity to talk to the people there, and we also did a field visit.

And I was just wholly impressed with the people, the quality of the operation, and I came back more fired up than I had ever been about the absolute caliber of these two companies. This is going to be -- we are committed to make this the top-performing company in our sector with the absolute best operational talent in our space.

Arun Jayaram -- JPMorgan -- Analyst

Great. Tom, no state income tax in the great state of Texas. So that's also a good thing to think about. Thanks, Tom.

Tom Jorden -- Chief Executive Officer

Thanks, Arun.

Operator

Our next question comes from Doug Leggate with Bank of America. Please go ahead.

John Abbott -- Bank of America -- Analyst

Yes. This is John Abbott on for Doug Leggate. Doug will maybe, be on here for the follow-up call question. Just for our first question here. Tom, you laid out some pretty good commentary here on the merger. Could you just sort of discuss what the hedging strategy will be for the company on a combined basis going forward?

Tom Jorden -- Chief Executive Officer

Well, John, that's a very topical issue with us. We've been discussing that. And I'll say first, we'll need to sit down as a new company and talk through that. But I'll just tell you how we think about it. We think about hedging as insurance. And it's kind of a question, what it is you want to insure. I think classically at Cimarex, we wanted to insure our capital program, which, historically, prior to the Shale 3.0 era, was a very high percentage of our cash flow.

And as we look ahead, I think that we'll look at a hedge program as built to insure our capital program, but also our -- certainly our ordinary dividend, which is increasing. So although obviously, we need to get the NewCo team together and have this debate. I don't think you're going to find any serious disagreement. And I would expect -- and this is -- we haven't had that debate yet, but I would expect that there will be a pretty strong voice that we might hedge a little less going forward than we have currently.

And our current hedging program is a programmatic 50% of our volumes. But we'll debate that long and hard. And I never want to get caught up in short-term optimism when we discuss long-term capital planning, and it's really easy to do.

John Abbott -- Bank of America -- Analyst

Appreciate it. And for our follow-up question, it's related to the S-4 that had been put out. Just looking at it, it looks like COG ran a full process with regards to the merger for shareholders. Could you discuss the process that you ran for shareholders?

Tom Jorden -- Chief Executive Officer

Yes. I don't -- I didn't get that from my reading of the S-4, John, but I'll just describe what we did. As I think fairly clearly laid out in the S-4, we had multiple conversations with multiple counterparties over the year or two leading up to our merger announcement. And I don't want to represent that those were casual conversations. We have a very sophisticated set of tools here with our financial planning and our asset evaluation teams, so we can look at a counterparty in great detail with public information.

We know their assets, the publicly released financials are usually pretty solid, and we can do a fairly detailed projection of drilling upside and asset potential based on our understanding of the lay of the land. And our understanding is, I would say, second to none with our technical team. So although in the S-4, we represented that we only entered into one other confidentiality agreement, we did very detailed pro forma analysis on many potential counterparties.

And when we looked at Cabot plus Cimarex, it was just a, wow, that we firmly believe that the combination of these two companies allowed our shareholders a go-forward opportunity in a cyclic commodity environment that no other combination offered. So we were excited then. We remain as excited today. In fact, with the recent increase in gas prices, I just feel more stronger than ever that this is a fantastic transaction for our owners.

John Abbott -- Bank of America -- Analyst

Thank you, Tom and thank you for taking our questions.

Operator

Our next question comes from Neal Dingmann with Truist Securities. Please go ahead.

Neal Dingmann -- Truist Securities -- Analyst

Good morning, all. My first question, Tom, you or John, just on regional focus. I'm just wondering in the Del, will you continue to stick largely to that -- where you've had a lot of success in Northern Reeves? And if you would, could you talk about -- I see you've talked a lot about spacing in that area. You talked to well space in that area, the success you've had. Can you talk about the spacing there versus your thoughts in either like Northern Culberson or Southern Eddy?

John Lambuth -- Executive Vice President of Exploration

Well, in regards to spacing, as we've learned, again, over these years, our -- you're very right. Our acreage is vast across the basin. And the properties of both the Wolfcamp geologically as well as the reservoir properties, the -- whether we're gas and reservoir oil, all change. So we've learned to take all that into account to then lead to optimal spacing.

Currently, right now, it looks around the nine wells per section Reeves, but that will vary a little bit, again, depending upon the [current] well locations as well as the geology. By the time we get to Culberson, we're a little bit less pressured, we're gassier. We're finding we don't need as many wells to achieve the same kind of recoverable reserves.

So right now, we're a little bit lower kind of the heart of Culberson is around seven wells per section, although you'll see that vary too across our acreage position. I think the main thing to come across is there is not any one template that you would stamp across our entire position. We've learned the kind of space for fit based on every section we look at. And that's true even up in Lea County, where we have a wonderful acreage position.

There, we studied our peers, and we're now honing in on right around nine wells per section as being very optimal for the Upper Wolfcamp. And again, we'll adjust with results. But we're feeling very good about our spacing decisions going forward.

Tom Jorden -- Chief Executive Officer

Yes, Neal, I just want to add, when John quotes these numbers, we're talking about the Upper Wolfcamp. We have other landing on above and below us.

Neal Dingmann -- Truist Securities -- Analyst

No. Great add, Tom. And then if I could, just on the second, by our math, I think that obviously, the combination you guys are going to have some really nice free cash flow going forward. Tom, you alluded to this a little bit earlier. I'd just like to hear a little more of your thoughts on is sort of free cash flow piles up, you've got a great balance sheet.

What is your thought about like a near-term shareholder returns, if you think your shares are trading at a discount to NAV? I'm just wondering just in broad terms how you think about that versus potentially some dips.

Tom Jorden -- Chief Executive Officer

Well, we're going to look at all the options in front of us. I mean, we telegraphed that in anything but the most [Indecipherable] commodity prices, we think we can hit 30% of cash flow from operations returned to our owners. We've talked about calling those notes that are due 2024 and retiring that debt. But we'll also be modeling share buybacks. We look at that from time to time.

And all of those options will be on the table depending on what the -- we wake up every morning and look at it fresh. I mean there's lots of moving parts that contribute to that. Of all of those, the one that we're rock-solid committed to is returning that cash to our owners.

Neal Dingmann -- Truist Securities -- Analyst

Very good. Like the answer. Thanks, Tom.

Operator

This concludes the question-and-answer session. I would like to turn the conference back over to Tom Jorden for closing remarks.

Tom Jorden -- Chief Executive Officer

Well, thank you. I want to thank everybody for joining us. We're delighted to report a solid quarter. We'll continue to execute. We'll continue to update you on our integration efforts moving toward a fourth quarter close with our combination with Cabot. And I also want to say I very much look forward to the new organization coming together, performing, delivering everything we promised and becoming one of, if not the leading independent E&P operator. So thank you very much.

Operator

[Operator Closing Remarks]

Duration: 28 minutes

Call participants:

Megan P. Hays -- Cimarex Energy Co.

Tom Jorden -- Chief Executive Officer

Mark Burford -- Vice President and Chief Financial Officer

Blake Sirgo -- Vice President-Operations

John Lambuth -- Executive Vice President of Exploration

Arun Jayaram -- JPMorgan -- Analyst

John Abbott -- Bank of America -- Analyst

Neal Dingmann -- Truist Securities -- Analyst

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