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Good morning, ladies and gentlemen. Welcome to the Freehold Royalties Limited 2018 Year-End and Fourth Quarter conference Call. Please be advised that certain statements on this call constitute forward-looking information. All statements other than historical facts may be forward-looking, and we caution the listener. I will now pass the meeting -- pass the call over to Tom Mullane, Chief Executive Officer.
Yes, good morning, and thank you for joining us. On the call from Freehold are Darren Gunderson, our CFO; Dave Spyker, our VP, Engineering; Bob Lamond, our VP, Exploration; and myself. We will summarize our 2018 and fourth quarter results, along with our outlook for 2019, and then we'll be happy to answer questions. 2018 royalty production averaged 10,718 BOEs a day, down 2% versus 2017. The decrease year-over-year reflected a combination of lower third-party drilling on our royalty lands and lower prior period adjustments. Royalty production volumes for the fourth quarter averaged 10,312 BOEs a day, flat versus Q3 2017. We grew our oil and liquids' volumes by 4% quarter-over-quarter, reflecting increased -- increasing oil-focused drilling and acquisitions. For 2018, royalties as a percentage of production, 94%, and operating income, 100%, represented all-time highs for Freehold as we declared victory in becoming a pure play royalty company. Looking into next year, we have unveiled our 2019 production guidance and are forecasting royalty volumes to average between 9,900 BOEs day and 10,300 BOEs a day, a slight decrease over our fourth quarter average. Our production forecast includes production from 20 net wells forecast to be drilled on our lands in 2019. The Canadian macroeconomic environment continues to be challenged for producers due to a number of egress infrastructure constraints, and with that, we are taking a conservative outlook for the year. We've also revised our guidance to reflect royalty barrels only as we continue to remain active in disposition of our noncore working interest portfolio and feel the funds from operations from our working interest portfolio do not make up a meaningful portion of our corporate totals. On the activity front, a total of 719 gross, 21.3 net wells were drilled in our royalty lands in 2018. This is a 55% increase on a gross measure and 4% decrease on a net measurement versus activity levels in 2017. We were encouraged by a ramp-up in drilling during the fourth quarter with 220, 7.4 net wells drilled in our land ahead of expectations. We continue to see much of the focus centered on oil-weighted targets, with approximately 90% of locations targeting oil prospects. The Viking, both in Alberta and Saskatchewan continues to deliver with growth-oriented private companies driving most of this activity. We also see drilling activity targeting Northwest Alberta Cardium prospects, Southwest Saskatchewan Mississippian carbonates and Certain Alberta Mannville heavy oil and light oil plays Building our production base for future years, we completed $62 million in value-enhancing acquisitions in 2018. This compares to $89 million in acquisitions in 2017. Acquisitions included a combination of low-decline, cash-flow-generating asset acquisitions that enhance Freehold's dividend sustainability and in emerging plays in the East Shale Duvernay and the Clearwater that will provide Freehold with multi years of development and production growth. Looking forward, we believe there remains opportunity for acquisitions as we continue to evaluate 2 to 3 opportunities on an ongoing basis. Furthering production adds in 2019 and future years, our leasing team completed 102 new lease agreements in 2018, up slightly from 100 in 2017. Since the inception of our leasing team -- well, since inception, our leasing team -- since the inception of our leasing team, it has completed 220 new lease agreements. Leasing activity was focused in the East Shale, Duvernay, Cardium, Frobisher, Midale and Viking formations. I'll now pass the call to Darren to walk through some of the financials.
Thanks, Tom. Good morning, everyone. Financially, we achieved a number of objectives and continued to position Freehold as a lower-risk oil and gas investment. In 2018, Freehold generated $145 million in royalty and other revenue, down 4% versus 2017, reflecting lower working interest revenue. However, totaled royalty revenue was up 3% at $138 million, largely due to higher oil prices. Bonus consideration and lease rentals at $3.8 million for 2018 increased by $1.7 million or 80% over 2017 as a result of the continued efforts of our leasing team. Revenue from oil and liquids production was 86% of total royalty and other revenue in 2018. Our royalty portfolio generated an operating netback of $35.30 per BOE in 2018, a 6% improvement year-over-year, reflecting higher oil prices and further improvement in our cash costs. Funds from operations for 2018 totaled $121.3 million, down 2% from 2017 levels. Funds from operations were negatively impacted by a material decrease in commodity prices during the fourth quarter when Canadian heavy oil differentials reached unprecedented levels. Funds from operations for the fourth quarter totaled $18.5 million, down 42% versus the same period last year. Our basic payout totaled 61% in 2018 while our adjusted payout was 64%. This was at the lower end of our outlined payout strategy of 60% to 80% of funds from operations. However, in the fourth quarter, our basic payout increased to 101%, reflecting the weak commodity price environment. In total, Freehold generated $43 million in free cash flow in 2018, which we allocated towards value-enhancing acquisitions. As part of our 2018 year-end release, we announced that our Board of Directors has approved maintaining our monthly dividend at $0.0525 per share or $0.63 per share annualized. Current payout levels are in line with our previously stated dividend policy. Based on our current guidance and commodity price assumptions and assuming no significant changes in the current business environment, we expect to maintain the current dividend rate through 2019. We will continue to evaluate the commodity price environment and adjust the dividend level, if necessary. Freehold closed the year with net debt of $89 million, representing 0.7x net debt to funds from operations. Net debt increased versus the same period last year as a result of our 2018 acquisition activity. Based on our 2019 guidance, net debt to funds from operations is expected to be 0.7x as of the year-end 2019 as well. Our debt strategy is to maintain net debt to funds from operations below 1.5x, and we expect to remain comfortably within this range. Now back to Tom for his final remarks.
Thanks, Darren. In closing, despite some industry headwinds, we executed the core aspects of Freehold's strategy in 2018, maintaining Freehold's identity as a low-risk oil and gas investment in Canada. While volumes came in slightly below last year, we believe we have made significant inroads in the quality of our underlying portfolio through noncore dispositions of our working interest assets and the execution of our acquisition strategy funded by our free cash flow. Q4 2018 activity levels surprised the upside as our oil-focused royalty assets continue to generate activity at current commodity prices. We continue to maintained significant flexibility in our balance sheet while maintaining sustainability in our dividend. At current share price levels, we feel the return proposition is an attractive entry port -- entry point for investors. In terms of how we expect to allocate free cash flow in near term, our preference is to take advantage of acquisition opportunities as they come along. The ability to access capital, both equity and debt, remains a challenge for many Canadian E&P producers. We believe we can service a financing tool through the creation of royalties in Canada and in the United States. If we are unable to complete acquisitions with our free cash flow, owing to the quality that is in the market, we expect to pay down debt. Our Q4 2018 payout was above targeted range. However, we expect to fall within our thresholds in the current commodity price environment. Now we would entertain any questions. Thank you.
[Operator Instructions] And the first question is from Dennis Fong from Canaccord Genuity.
I've got just a couple here. So the first is, just given the weakness of oil price and the tightening of E&P projects, how are you looking to incent incremental activity on your lands versus, say, a crown or other lands therein?
Okay. Dennis, thank you for that question. You're looking at how we incent to operators to drill in our lands?
Yes.
When we look at our portfolio of opportunities on our land, some of them are very, very attractive in this current price environment and at the current royalty rates. We do -- as you know, we've had 20-plus net wells drilled on our land under these current environments. When we look at our other lands where we want to increase number of drilling on those lands, we do try to incent development drilling with commitments. We can perhaps make some adjustments to the royalty rates if producers commit to drilling some wells or offer bonuses.
Okay, perfect. My second question is just around royalty acquisitions. You said that you're always working on a couple of M&A at any given time. How would you think about balancing that versus the balance sheet versus kind of looking at increasing the return on -- to shareholders via either dividend increases or potentially even a share buyback, just given the current capital market nature of the world right now?
Yes, I guess, you're looking at our -- how we allocate our free cash flow and looking at acquisitions versus some other opportunities. I guess, when we look at acquisitions, and we -- and there are -- a number of them are better -- continue to be in the market because producers don't have access to equity right now. We test any acquisition against buying back shares. And so all acquisitions have to make us a better company and have to be accretive. When we look at the use of our -- use of debt, we do have that upper limit of 1.5x net debt to funds from operations, which we do not want to breach. We're looking at 0.7x by the end of the year here on net debt to funds from operations. We'll be within our band, which is below 1.5x. We'd like to be a little bit below that, maybe closer to 1x in the long term. But remember, when we do an acquisition and we have a lot of excess free cash flow, we pay down net debt very quickly.
Okay, perfect. And then my final question here is just on PPAs. So we've seen PPAs fly kind of lower through 2018, I presume just given, I guess, the magnitude of them decreases as we get further and further away from an actual acquisition. How should we be thinking about this on a go-forward basis?
I'm going to turn this over to Darren.
Thanks, Dennis, for your question. We have -- you're right in mentioning the acquisitions there. They have resulted in some -- especially our larger acquisitions, in some significant prior period adjustments. But there will be prior period adjustments going forward with some of the other acquisitions we do, however, maybe not quite at the same level. But there will be some.
The next question is from Shailender Randhawa from RBC.
Just my question is related to the guidance for 2019. Can you give us a sense of activity levels, maybe pre and post breakup within the well counts of the year? And then is there anything built in for some of these emerging plays, like the Clearwater and the Duvernay?
I guess, as you saw on our note, we're forecasting 20 net wells on our lands. That's a slight drop from 2018. Most of the drilling we forecast will be on oil targets. I'm going to turn it over to Bob just to give us a little bit of flavor of where those are.
Thank you for that. So again, 2019 continues to look strong into the year. We're kind of seeing and forecasting for the year as continuing, like we saw last year, but maybe strengthening drilling on our Viking lands, both in West Saskatchewan and Eastern Alberta. We're also very excited about our -- the licensing that's been going on, on our Clearwater play in the north as well as the -- some of the licensing happening on our Duvernay lands. And we're hoping that translates into more drilling ahead of even where we're expecting for those 2 plays. So between Southeast Saskatchewan, Southwest Saskatchewan, Viking and then those 2 players I just mentioned, I think for the oil-weighted side, we should see continued strength in -- towards that 20 net wells this year.
Right. But just to reiterate, so I understand 20 net wells, more Viking, licensing positive in some of the emerging plays. But is there specifically anything built into the guidance? Or you're taking a cautious approach from those new plays in terms of wells and potential volumes?
Yes, the question is how many of our 20 -- how many of the 20 net wells are in the emerging plays?
I didn't understand what you were saying there. Yes, I mean, that's -- it is baked into our guidance here. So we're...
It's a pretty small number.
It is a relatively small number to date for this year. I mean, as we're saying, these emerging plays, we hope to see them grow over the next year and years. But it's multi years of development drilling, of which this year should be a portion, but a relatively small portion.
[Operator Instructions] The next question is from Jeremy McCrea from Raymond James.
Just going back to some of the acquisitions here. Like, I know the last couple of years, equity hasn't really been available for a lot of these companies but it's still -- the acquisition number is still pretty small for what you guys have done versus prior years, back in 2014, 2015 and 2016. Is there a reason why acquisitions just tend to be smaller for the last couple of years? And is -- like, when you talk about wanting to do more acquisition, like, is there the potential to do something more sizable, more impactful?
Thanks for that question, Jeremy. Well, we look at a large number of acquisitions, and some very large, some quite small. We pay very much attention to how every acquisition can be accretive in the long term and the short term as well. And it just happens sometimes that you just don't win the larger ones and you don't create the larger ones. Just the last couple of years, it's just been kind of a steady guide of smaller deals. But we believe that there's going to be some bigger deals in our future.
Okay. Is there anything specific that you are looking for? Like, is it more in the emerging plays? Or is it more you're looking for, I think, something in kind of in older plays that as long as you get for good value? Like what -- like where's -- what's the goal for doing acquisitions?
Yes, I guess, the #1 thing is, so we want to improve the quality of our assets, and we believe we did that in 2018. We balanced cash flow generating -- 70% of the acquisitions last year where cash flow generating with a 10% decline or less, and 30% were in emerging plays. We think that's a good balance. We're looking at how we grow our production and returning to position ourselves in the resource plays that have growth in them.
There are no more questions registered at this time. I'll now turn the meeting back to Tom Mullane.
Well, thank you, everybody, for joining us for this conference call. We had a solid 2018 year, and finished off with some exciting drilling on our lands. We have lots of opportunity on our land, as illustrated in our Asset Book in our Investor Day that we had earlier in 2018. We'll refresh that in 2020. But we have a lot of exciting things that are happening on our lands, and we -- and there's lots of opportunities. We're excited about that, and thank you very much for joining us on this call.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.