Good morning, and welcome to the Texas Pacific Land Corporation's First Quarter 2022 Earnings Conference Call. This conference is being recorded. I would now like to introduce your host for today's call, Shawn Amini, Vice President, Finance and Investor Relations. Please go ahead.

Good morning. Thank you for joining us today for Texas Pacific Land Corporation's First Quarter 2022 Earnings Conference Call. Yesterday afternoon, the company released its financial results and filed its Form 10-Q with the Securities and Exchange Commission, which is available on the Investors section of the company's website at www.texaspacific.com. As a reminder, remarks made on today's conference call may include forward-looking statements. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those discussed today. We do not undertake any obligation to update our forward-looking statements in light of new information or future events. For a more detailed discussion of the factors that may affect the company's results, please refer to our earnings release for this quarter and to our most recent SEC filings. During this call, we will also be discussing certain non-GAAP financial measures. More information and reconciliations about these non-GAAP financial measures are contained in our earnings release and SEC filings. Please also note, we may at times refer to our company by its stock ticker, TPL. This morning's conference call is hosted by TPL's Chief Executive Officer, Ty Glover; and Chief Financial Officer, Chris Steddum. Management will make some prepared comments, after which we will open the call for questions. Now I will turn the call over to Ty.

Thanks, Shawn. Good morning, everyone, and thank you for joining us today. Yesterday, we announced a special dividend of $20 per share, and this special dividend is incremental to the $100 million share repurchase plan that we announced in March. We're excited that our shareholders will benefit from this increased return of capital driven by strong Permian activity, commodity prices that are some of the best we've seen in a decade, and a balance sheet that is debt free. Looking forward to the rest of 2022, we're bullish that our underlying business fundamentals will remain constructive. We're seeing more rigs added on to our surface and looking at our water sales schedule we can see that producers are intent on maintaining and growing completions pacing throughout the year. In our surface leases, easements, and materials business, which we refer to as SLEM, we are seeing a noticeable uptick in request for new infrastructure and well pad, especially in the Northern Delaware. All of these signs are a good leading indicator for future development activity. As we look at our well inventory, we have yet more reasons to be encouraged. Permitting activity and drilling activity have moved higher. For the first quarter of 2022, our data indicates that we had 200 gross spuds on our royalty acreage, which is the highest level since the pandemic. Although some of the increased drilling can be attributed to the fact that operators have less inventory of DUCs to complete, we also continue to see strong overall completions as well. In particular, we're seeing a nice ramp in activity in Loving County. Overall, it was a solid quarter for the Water segment. We did have a couple of frac jobs get deferred where we had source water sales lined up, but the deferrals mostly related…

Thanks, Ty. Total revenue for the first quarter of 2022 was $147 million. On a sequential quarter basis, our revenues were about flat compared to fourth quarter of 2021. Although this most recent quarter benefited from higher oil prices, royalty production was down modestly on a sequential quarter basis. Recall, last quarter benefited from higher-than-normal prior period production. And as Ty mentioned, our well inventory data suggests strong activity on our royalty acreage. We feel good about the growth trajectory of our royalty production for the next year, and over the long term, those certain quarters will be influenced by various factors such as the specific tracks of land, each new well crosses, and also timing related to when we actually receive cash royalty receipts. Our crude oil price realizations continue to be strong. Generally, we receive $1 or $2 less than WTI Midland. Our gas realizations have improved over the last 6 months or so, and we see some of our larger operators with pricing of both Henry Hub and Waha spot prices. And overall, we've been receiving Henry Hub spot pricing or better. Our NGL price realizations tend to fluctuate between 40% to 50% of WTI, though our NGL realizations this quarter were a bit weaker than normal due to some cash royalty receipts we received for NGL production associated from earlier months with lower pricing. I also want to point out that there's a new operating expense line item for ad valorem taxes, which we accrued an approximate $2 million charge for some background, which we also detailed in our last 10-K filing. When the company was a trust, there was a legacy agreement where the mineral estate paid ad valorem taxes associated with our NPRIs, following our reorganization to a C-corp, there is a dispute with a mineral estate on whether they were still obligated to pay those taxes for the C-Corp. Out of prudence, we began accruing for these taxes in our GAAP financial statements. Adjusted EBITDA and net income for the quarter were $130 million and $98 million, respectively. We ended the quarter with approximately $507 million of cash though that is before the effect of the $20 per share special dividend we announced with earnings and before our previously announced $100 million share buyback program was active. The buyback program cleared its 30-day cooling-off period in early April, and is currently active. And with that, operator, we will now take questions.

[Operator Instructions]. Our first question comes from John Annis with Stifel.

For my first question, could you offer color on Q1 oil production and how you see overall production trends playing out for the year? And then on the water side of the business, could you expand on your prepared remarks and speak to the demand for source water more broadly?

This is Chris. Yes. I think like Ty kind of mentioned in his prepared remarks, when we look at permitting activity that we saw in 1Q '22, and we look at the new DUCs that were drilled during 1Q '22, those were some of the highest activity levels for both of those that we've seen really since pre-pandemic, probably 1Q 2020. And so that backdrop is definitely encouraging when we think about what is the near-term inventory that the operators are going to be going after for the rest of the year. And so that makes us feel pretty good about the position we're in. I think as we've mentioned, in 4Q '21, we had some prior period production that probably acted to increase that production a little bit above normal. And I think we're at the point now where some of that's caught up. And so hopefully, we'll have some normalized quarters here for the rest of the year. And I might let Ty talk to some of the water activity levels.

Yes. Thanks. Yes. I would say on the source water side of the business, we had a couple of things happen. First, we had, like I said earlier, a few fracs get deferred. And so those frac jobs got pushed on our schedule, mostly because operators were unable to procure frac sand. So I would say that those jobs were pushed back timing-wise. So we do expect the volumes to come to us at some point this year. Secondly, the seismic response areas are definitely creating some limitations on downhole injection of produced water in some regions. So as we see that downhole capacity reduced, some of that incremental produced water is being recycled and competes against some of our source water for completion activity. That being said, we can compete on the recycling side as well, especially with the rights we've secured to pull water off, most of the produced water gathering infrastructure that we have on our lands. And we're definitely seeing an uptick in activity in that part of the business as well. So we have seen some near-term disruption. But I think longer term, the water business will continue to perform very well.

Great. I appreciate the color. For my follow-up, can you share with us your thoughts on where the best opportunities lie as you balance your growth versus return of capital priorities? Even after the special dividend, and if we assume you complete the $100 million buyback, it still looks like you're going to be generating a substantial amount of free cash flow?

Yes. Look, I mean there's still some deals out there. We're running through some of those deals, but I would say, given the current environment with $100 crude and $7 gas, our willingness to transact is probably a little bit diminished at this moment, but also say, sellers are maybe a little aggressive on their ask in this kind of environment. But look, we put in place the $100 million buyback program, which is now active. Obviously, we have our regular dividend, which we raised this year, and we just did the special. And so I think we've got a lot of flexibility, and our intent is just to maintain that flexibility. And I think we've got a nice mix of buybacks and dividends going right now. So going forward, we'll continue to evaluate the market environment and the industry fundamentals. And like I said, just maintaining that flexibility to keep going.

Our next question comes from Hamed Khorsand with BWS Financial.

The first question I had was the drilling activity you're seeing, is there any way for you to know if this is because the producers are low on inventory or if this is price driven?

Hamed, when you say low on inventory, are you kind of referring to their inventory? And if they're just trying to backfill some of the DUCs?

Yes. Their inventory. Exactly.

Yes. I think so. I mean we definitely have seen a DUC drawdown that had been occurring. And so I think one of the questions, at least on our acreage is at some point, are they going to kind of continue that drawdown, or what's the point where they start to backfill it. And so 1Q definitely seem to be a quarter where they've started to kind of backfill and increase back up that kind of current inventory that's available. And so some of it's just timing, but I think it is probably safe to say we have seen a trend of DUCs getting drawn down over the last few quarters, and this would be one of the first quarters where they've kind of replenished that.

Okay. And my other question was, given the sand-sourcing issue, is that broad amongst your customers who pay you royalties? Or is this really just a one-off where the producer is just not adequately ready for the lack of sand availability?

Yes. Hamed, thanks. I would say it's a pretty broad issue across the basin that we're seeing. I think maybe some of your smaller operators are suffering with it a little more than maybe your larger operators that have a broader supply chain team. But I think it's something that everybody is struggling with a little bit at the moment. When you look at the last few years, and all the bankruptcies that happened in the sand market, there's definitely a short supply. There's also a short supply of their truckers to get that sand where it needs to go. And so it's an overall basin-wide problem, but I think everybody is moving in the right direction to solve that issue.

And would this hamper the value you represent from drilling costs since sand is going to take the overall cost up?

Yes. I mean there's definitely some issues there, but I think most operators have baked that into their guidance for the year.

Our last question comes from Chris Baker with Credit Suisse.

I guess just maybe on the volume side. So it looks like 1Q oil declined 13% versus 4Q, and you mentioned the accrual. But I'm just curious on a run rate basis, if you back out the accrual, did the asset generate growth quarter-over-quarter?

Chris, that I'm sure as you and lots of folks know, we're always a little bit in the past when it comes to royalty, revenues and production that we're seeing. And so I think what we probably have seen with the data that we have is -- obviously, oil production was growing through the broad part of 2021. Fourth quarter, it may have started to see a level out. And this quarter, I think it's a bit early to say. The checks that have come in are really only from the first kind of 1 month, 1.5 months. But I would say that, that decline that you see in the financials is probably not representative of the background real month date production. I don't believe that, that pullback was nearly as much as 13%. I don't have a good number, unfortunately, to give you, and it will probably take us a few more months for some of the additional checks to come in. I have a really good feel on what that trend was. But it would be our belief that it was certainly not a 13% decline.

Yes. No, that makes sense. And then, I guess, just on the $20 special, obviously, a positive surprise there. Could you just maybe share some of your thinking around how you got to $20 as sort of the right number? I'm just curious if you kind of think about this relative to the cash balance or maybe looking to return some percentage of cash. Obviously, peers have pretty explicit targets there. But just how do you kind of frame that up as we perhaps look out to 2023, and think about what another special next year could look like?

Yes. Sure, Chris. I think there's a lot of factors. I don't know that there's any one particular factor being in a business with high commodity price volatility, which can lead to volatility of revenues. I think our belief is having flexibility with your capital allocation plan is a good way to manage a business like this. And so I think when we thought about returning that excess capital when we started the year, oil was in a very different place. And I think when we started the year, we definitely felt like we had a nice robust cash balance that will allow us to remain opportunistic, and achieve some of the goals for the year. But then as the year progressed, we saw a pretty tremendous improvement in pricing across the board, really oil, gas and NGLs. And so as we kind of get a bit of a reset and looked at the type of cash flow generation that was going to create, it just seemed like the right time really for 2 reasons, like Ty said, for one, in this higher price environment, I think our desire to transact on acquisitions, especially cash acquisitions has diminished. And so that being the case and also having in a pretty nice buyback program, I think the logical path was to do a special. And so I don't know if I can give you an exact mathematical formula as to how to calculate what a future special might be, but I think that those are some of the ways we would look at it, and work with the Board to kind of determine what might be an appropriate return of capital when the business is really generating strong cash flows.

Okay. Great. Yes, that makes sense. And then you touched on M&A earlier, but there was obviously a little bit of royalty acquisitions this quarter. Any additional detail you can share on what you bought and why that kind of made sense just in terms of the acquisition sort of punchless, if you will? Whether that's cash flow accretion or enhancing NRIs and DSUs you already own? Or any color there in terms of the acquisitions this quarter would be great?

Yes. Thanks for the question, Chris. That was a really small deal. It was all Midland Basin, heavy DUCs, really good operators, really good area, mostly up in Martin, Howard, Glasscock Counties. So we just felt like the quality was too good to pass. And it was small enough that we were able to pick it up. And honestly, I wish it was a little bigger. But yes, quality was just too good to pass off.

Okay. Great. And if I could just squeeze one more in. Just on the Aris enhanced alliance there. Is the expectation that, that would help put upward pressure on water capture rates? Or I guess any -- and I apologize if I missed this earlier, but any additional sort of, I guess, color on how that's going to show up eventually in the financials?

Yes. Like I said earlier, we've had a relationship there for a long time. They've been really a good partner. So this transaction just expands that existing relationship, and kind of capitalizes on the synergies that we have as partners to provide better and more efficient services for our operators. So I think longer term, the deal helps both Aris and TPL compete for volumes and provide better solutions for operators. So obviously, that's going to provide incremental volumes and cash flows for us. It also helps us drive some efficiencies on the source water side of the business as well. And maybe most importantly, just ensures that our operators have both the source water and the produced water takeaway they need to keep running the drill bit.

Thank you. We have reached the end of our question-and-answer session. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.