Tom Mullane - CEO Darren Gunderson - CFO

Shailender Randhawa - RBC Capital Markets Jeremy McCrea - Raymond James Nick Lupick - AltaCorp

Good morning, and thank you for joining Freehold's Q2 2017 conference call. On the call from Freehold are myself and Darren Gunderson, our Chief Financial Officer.

We will summarize second quarter results, and then we'll be happy to answer questions. Freehold has provided another solid quarter of returns for our shareholders.

I'd like to highlight 3 things from our quarter: number one, we continue to provide an attractive yield; number two, we increased production guidance; and number three, we've lowered our debt even further. Expanding on these points.

Firstly, we are maintaining our monthly $0.05 per share dividend, representing a 4.3% yield. This is an attractive yield.

More importantly, we paid out only 58% of our free cash flow in Q2 as dividends. Secondly, we are increasing our production guidance.

Stronger-than-expected production volumes with producer activity as well as continued strength from our audit group, we had over 700 BOEs a day of prior period adjustments in the quarter, resulted in an increase in our, to our production guidance for the year by 500 BOE a day to a range of 11,800 to 12,300 BOE a day. In line with our strategy of enhancing our royalty focus, we completed the sale of 650 BOEs a day of working interest production in Southeast Saskatchewan.

After completing the disposition in early April, royalties represented 97% of our operating income in Q2 2017. Thirdly, the excess free cash flow enabled us to pay down $13 million in debt, and we exited the quarter with net debt of $50 million, implying a 0.4x net debt to trailing funds from operations.

We continue to position ourselves as a safe income vehicle with continued sustainability in our dividend. Q2 marked the ninth consecutive quarter of royalty volumes growth for Freehold and the fourth consecutive quarter of production growth per share.

We grew our royalty volumes by 16% year-over-year and 5% versus the first quarter of 2017. We continue to see strong drilling activity in core areas such as Southeast Saskatchewan Mississippian core area plays, Southeast Saskatchewan Mississippian play, Central Alberta and Saskatchewan Viking and Mannville and the Deep Basin Montney and Spirit River from well-capitalized producers.

Activity on a net well basis was up greater than 300% versus the same period last year. In total, we had 208 wells or 10.2 net wells drilled on our lands through the first half of 2017 and continue to forecast approximately 20 net wells for the year.

The estimated capital spend in our lands by others year-to-date has totaled $400 million, outpacing our forecast of $550 million to $600 million for the year. Also over the quarter, we had 12 new lease agreements, bringing our total for the year to 37, surpassing all of 2016.

Increased leasing should create and correlate to more drilling in our lands. Now I'll pass the call to Darren to walk through our financials.

Thanks, Tom. Good morning, everyone.

During the second quarter, Freehold generated funds from operations of $31.8 million or $0.27 per share. Better-than-expected production, offset slightly by weaker pricing in Q2, helped the actuals to outpace our forecast.

Q2 2017 revenue totaled $38.4 million. Revenue from oil and NGL production was 80% of our corporate total over the quarter while revenue from royalties was 90% for the same period, significantly higher than last year.

Royalties as a percentage of operating income totaled 97% for the quarter and 94% year-to-date. Freehold declared dividends of $17.7 million or $0.15 per share in Q2, implying a 56% basic payout ratio and 59% adjusted payout ratio.

In March 2017, we announced a 25% increase to our monthly dividend from $0.04 to $0.05 per share. Based on our 2017 funds from operations estimate, we forecast an adjusted payout of 61% at the new dividend level.

This remains at the low end of our target payout ratio of 60% to 80%. From our $32 million funds from operations for the quarter, we generated $13 million in free cash flow over and above our dividends.

We disposed of our Southeast Saskatchewan working interest assets early in the quarter for $29 million. This is in line with our existing strategy to further enhance our royalty focus and improve our netback.

An immediate takeaway from the sale is the improvement in our cash cost over the quarter, which totaled $5.63 per BOE, down from $7.34 in Q2 2016 and $7.66 in Q1 2017. The largest driver behind that decrease is a reduction in operating cost associated with these assets.

We are now guiding operating cost to average $2.40 per BOE through 2017. We have set a goal to decrease our cash cost below $5 per BOE by the end of 2018.

Aided by proceeds associated with our working interest disposition, we exited the quarter with net debt of $50 million, as Tom mentioned earlier, or net debt to funds from operations of approximately 0.4 time. At current commodity price levels, we are paying off approximately $10 million in debt per quarter, with the forecasted current price assumptions to be debt-free in 2018 without acquisitions.

However, there appears to be adequate deal opportunity to apply excess free cash flow to quality acquisitions, and we revisit our dividend with our Board of Directors every quarter. We feel we have positioned the company as a safe way to play upside in oil prices.

Now back to Tom for his final remarks.

Thanks, Darren. In closing, Q2 was another strong quarter of operations for Freehold.

We achieved record royalty production and continue to generate strong per-share organic growth. We closed the disposition of some of our working interest assets, aligning with our royalty focus.

We continue to maintain a very strong balance sheet, and our payout ratios are in good position. As a leading royalty oil and gas corporation, Freehold's objective is to deliver growth and low-risk attractive returns to shareholders over the long term, which we have continued to provide in this reporting period.

Thank you. And now we will be happy to answer any questions.

Just 2 questions for me. So one, can you share your thoughts on the acquisition environment as you look ahead over the balance of the year?

And then secondly, you mentioned the $400 million year-to-date spend versus your full year expectations of $550 million to $600 million. Any idea roughly what the split on that $400 million would be in terms of GOR spending versus spending on mineral title lands?

Okay. And so when we look at the, thank you, Shailender, first of all for the question.

As we look ahead for deal availability, there are a number of royalty products that are in the market that we will continue to look at. We think it's, the royalty market over the last couple of years had been fairly strong and it continues to be so.

And so we will continue to add to the 2 acquisitions that we did so far this year. We hope to add in the balance of the year.

As far as the $400 million of capital spend on our year, when we look at where this money has been spent, I don't have the split between Freehold or GOR, but I would assume that it's likely in the half-half range. But I just don't have those stats with me right now.

What we are noticing with the drilling is the wells are a little longer. Almost all of them are horizontals these days.

And so we are seeing capital spend on a per-well basis a little more than we did in the first quarter or in previous quarters because I think people are just drilling longer wells. One of the biggest activities we're seeing is in the Viking, where a lot of the operators are moving towards 800-meter wells rather than 400-meter wells.

Just a couple of questions here, too. Just given you guys had another production revision here with your guidance, I'm just curious if you can give any sense in terms of what you guys are assuming now for the rest of the year in terms of the number of wells that you expect to be drilled on your lands and also the productivity of those wells here, too.

Okay. I guess our guidance, as given in our Q2 here, the midpoint range is just over 12,000 barrels a day, 12,500 BOEs a day.

We did not change the outlook for drilling on our lands. We've year-to-date, of course, Q2 is always a slow part in the year.

Year-to-date, we've had 10 net wells. We are forecasting 19 for the year.

This would be one of the highest number of drilling ever on our lands with 19 net wells. We don't know what oil prices will be in Q4.

I think there's a lot of things that, especially oil storage numbers, et cetera, are very positive for oil prices, but we haven't changed our drilling forecast and number of wells drilled on our lands so far. We are...

Is that a productivity thing that's been causing the increasing production number?

The productivity has increased. We see somewhere between 60 and 65 BOEs a day for full year production contribution number per well.

That is up slightly. One of the things that is happening is our producers are optimizing wellbores, debottlenecking areas.

We are seeing our declines, we haven't done a rigorous review of this, this quarter, we do it every year, but our decline could be shallowing a little bit. We think our current decline is about 18% per year base decline.

That's coming down from over 19% earlier in the year. We disposed of our working interest assets, and so that shallows decline.

But we just think operators are shallowing the decline in some of our areas.

Okay. And just kind of second question.

I know when we've talked in the past, the available free cash flow goes to debt repayment and then potential acquisitions and then dividend, buyback. I'm trying to get a sense of when do you guys look at doing a buyback versus potentially increasing the dividend.

Like what would be the things that you guys would want to see to initiate a buyback versus a dividend increase?

Well, right now, our dividend at between 4% and 5% yield, we think, is a fairly strong dividend. We also, when we look at the deal flow right now, we think it's pretty healthy.

We don't see that abating much. If we're in the $45 to $50 oil price, we think there's still be good acquisitions to acquire to soak up our excess free cash flow.

So we don't foresee, in the short term anyways, a share buyback.

Tom, quick question for you on the remaining working interest production. I know you've said in the past that the goal is to become a pure-play royalty company.

I was wondering if you could give us any kind of an update on how the divestment process is going for the remainder of the working interest production that you guys still hold.

Thanks, Nick, for the question. We had a package out with Sayer earlier in the year here.

We did not find a suitable bid to transact on that in the short term here, well, I guess, to date. We'll continue to try to monetize these working interest assets.

We will come out with another package later this year. Our goal is to be below 10% production in 2018.

We would like to monetize our working interest assets, but it's very difficult market right now. We're not going to give them away.

So we will, we'll continue to work on deemphasizing working interest and lower that with time.

Well, thank you very much for everyone to, getting up early here and participating in our conference call. We think we had a very strong quarter, and we just want to say thanks for being investors in Freehold.