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SRC Energy Inc. (SRCI) Q4 2018 Earnings Conference Call Transcript

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SRC Energy Inc.  ( ?????? : SRCI)
Q4 2018 Earnings Conference Call
Feb. 21, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to SRC Energy Incorporated Fourth Quarter and Full Year 2018 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) Please note, this conference is being recorded.

I will now turn the conference over to your host, John Richardson, Investor Relations Manager. Thank you. You may begin.

John Richardson -- Investor Relations Manager

Good morning, everyone. This is John Richardson, SRC's Investor Relations Manager. Thanks for joining us to discuss SRC's fourth quarter results for the period ended December 31st, 2018. With me today is SRC's CEO, Lynn Peterson; also available to answer questions during the Q&A session will be our CFO, Jimmy Henderson; Chief Operations Officer, Mike Eberhard; and Chief Development Officer, Nick Spence.

Please be advised that our remarks today, including answers to your questions, include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks and uncertainties that could cause actual results to be materially different from those currently anticipated. Those include risks relating to commodity prices, competition, technology, environmental and regulatory compliance, midstream availability and others described in our filings with the Securities and Exchange Commission, which are incorporated by reference. We disclaim any obligation to update these forward-looking statements. In addition, we may provide certain non-GAAP financial information in this call. The relevant definitions and GAAP reconciliations may be found in our earnings release and 10-K, which can be found on our website at srcenergy.com in the Investor Relations section.

Following the prepared remarks, time permitting, we'll open the call to your questions. I would like to remind everyone that a replay of this audio webcast will be available via the company's Investor Relations page at www.srcenergy.com.

I'd now like to turn the call over to the CEO of SRC Energy, Mr. Lynn Peterson.

Lynn A. Peterson -- Chairman of the Board, President and Chief Executive Officer

Thanks, John. Good morning. We appreciate you joining us for our call today. We filed our Form 10-K last evening and you can refer to it for a detailed information. Despite numerous distractions on the political front, as well as gas processing challenges on the operational side, our team delivered very impressive results throughout 2018. First, I would like to update everyone on our view of possible changes in Colorado's regulatory framework, which is the number one question we hear from the investment community.

Over the past few months, SRC personnel, industry representatives and related trade organizations have been actively engaged with legislators and the executive branch. While it is too early to predict the outcome or the timing of any legislation, everyone has been engaged and the progress is being made on designing regulation that should strengthen relationships with the local communities. We look forward to the clarity that these efforts will provide for our investors, our industries and the communities we impact.

We continue to believe that the core of the DJ Basin, including SRC's acreage generated some of the best economics in the country. While the state continues to experience political uncertainties, it has not materially impacted our operations in Weld County where 100% of our operations are located. Our team has always taken great pride in working with the communities where we operate, and from what we hear and see politically, we generally expect to operate as we have over the past few years.

We believe this has to be the case as a result of progressive processes that Weld County has already adopted through many years of working with our industry. An excellent example of this is a Weld Oil and Gas Location Assessment or WOGLA, that was put in place a couple of years ago. The WOGLA allows the local governments review of facility siting for drilling activity and production facilities, which is largely what other counties are pushing for in the current legislative session. We tip our hat to the officials of Weld County for their ingenuity, recognition of the greater good and the ability to be on the forefront of energy leadership within our state.

Switching to the status of gas processing, we were curtailed throughout 2018 and that situation is expected to continue during 2019. Operationally, we did see improvements with the third quarter 2018 expansion of DCP's Mewbourn plant, but we remain under a system wide allocation. The expansion and continuing allocations have resulted in reduced line pressures, which allows DCP to operate safely and has helped to minimize winter operational issues.

Looking forward, the additional capacity related to the O'Connor plant expansion continues to be on schedule and is expected to begin processing gas in the second quarter of 2019. This plan is designed for 200 million per day processing capacity, with an additional 100 million per day of bypass capacity, which we expect to be utilized later in 2019. As DCP's management has stated publicly, they remain committed to the future of the DJ Basin with the first phase of the 1 Bcf per day Bighorn facility now expected to be commissioned in the second quarter of 2020.

Now shifting to 2018 results, SRC's total production volumes grew by 31% in the fourth quarter and 48% for the full year when compared to the same periods in 2017. During these same periods, oil volumes grew by 20% and 40% respectively. Total capital expenditures in 2018 were $766 million with drilling and completion capital expenditures accounting from $584 million. In 2018, we spent just over $180 million for leasehold and production as we consolidated our acreage position with acquisitions and trades including the GC2 closing. This compares to just adjusted EBITDA of $488 million.

Total oil and gas reserves, PDP volumes and PV-10 values have continued to grow commensurate with our development program. SRC's year-end estimate of proved reserves grew 35% by volume and the PV-10 value increased by 80%. The large change in NPV value was due to the volumetric increase, but also to a 31% increase in oil prices and a corresponding NGL pricing used in the year-end reserves. The proved developed category represents 42% of our reserves with proved undeveloped at 58% compared to 38% and 62% respectively, the prior year.

As we initially planned for 2019, our announced guidance is designed around three key requirements: first, maximizing operational and capital efficiencies in a $50 oil and $3 gas environment; second, maintaining the ability to increase production volumes in line with SRC's expected allocation on DCP's growing super system; and third, retaining the flexibility to respond accordingly if market conditions change. Applying these three key drivers to our budgeting process results in a neutral to a slight positive total corporate cash flow. It is important to note that each dollar increase in oil prices equates to about $8 million to our bottom line. Any cash flow generated above our expenditures during 2019 will be utilized to reduce our outstanding debt further strengthening our balance sheet.

The year-over-year production growth implied by this guidance is approximately 20%. We anticipate production during the first part of the year will remain mostly flat to Q4 2018. When the O'Connor plant expansion becomes operational in Q2, we should see an increased allocation along the same lines that we saw with Mewbourn plant opened in 2018. We have reduced total 2018 capital expenditures of $766 million by more than 40% to an estimated $425 million to $450 million in 2019. This reduction reflects a slightly altered drilling and completion cadence with an effort to align turning wells into production when additional gas processing is available. I will remind our listeners that during 2018, we continue to bring on new wells at the expense of shutting older and gassier wells in. This practice was an attempt to maximize oil production and to not create an excessive number drilled uncompleted wells.

Looking back on the past year, we delivered a higher percentage of oil production, but consequently shut in a higher number of wells, resulting a less efficient use of capital. During 2019, we anticipate turning new wells on to production at a slower pace and only when additional process becomes available. As a result, our guidance has taken into account that our overall commodity mix will likely become slightly gassier. We will continue to analyze our well spacing and completion techniques during this constrained operating environment to ensure we are planning our development and make the best use of our capital dollars. We anticipate that the expenditures for bolt-on acquisitions will be significantly lower in 2019 as much of that work was completed last year.

The resulting consolidated position allows us to control our capital allocations and operate with a high working interest. Importantly because of our cored up contiguous position, we are in the initial phase of applying for a comprehensive drilling plan CDP with the COGCC. Our team will engage the local community early in the process to build support through a transparent process. The CDP will ensure our operator status and allow for a methodical permitting process over a significant area. We will be working with our surrounding stakeholders and the relevant government entities to finalize this plan over the next few months, which is key. To this end, we are taking thoughtful, proactive steps to learn from, educate and engage Colorado's newly elected governing body. We are confident that they too will recognize the significant benefits our industry provides to all Coloradans.

In closing, I would like to express my appreciation for the dedication and the hard work that our employees have exhibited during such a challenging period. Through the commodity price swings, midstream issues and political challenges, our team has remained focused on executing our plan in a safe and efficient manner. As we know our industry continues to improve performance, striving ways to maintain a safe and secure environment for our fellow employees, contractors and the communities where we operate and thrive. Finally, this is an industry that we all benefit from, an industry that is necessarily to sustain the world in which we live.

With that, I'd like to turn it back to the operator, and open the lines for Q&A.

Questions and Answers:

Operator

Thank you. At this time, we will be conducting a question-and-answer session. (Operator Instructions) Our first question comes from Welles Fitzpatrick with SunTrust. Please state your question.

Welles Fitzpatrick -- SunTrust -- Analyst

Hey, good morning.

Lynn A. Peterson -- Chairman of the Board, President and Chief Executive Officer

Good morning, Welles.

Welles Fitzpatrick -- SunTrust -- Analyst

It looks like the Mountain View CDP, I mean if I'm reading the state site right, it covers about 35 sections in 405 North, 66 West. A, is that right? And B, is the CDP process just kind of how things are going to be done going forward for you guys?

Lynn A. Peterson -- Chairman of the Board, President and Chief Executive Officer

Well, your numbers are pretty, pretty accurate, yes. I think it is a way that we'll go forward with. I think it's going to also be only a few companies can do that if you have a contiguous acreage block, not everybody has that situation, but yes, I think it should make our system more efficient. Nick, do you want to add anything to that? You've been more involved.

Nick A. Spence -- Executive Vice President and Chief Development Officer

No, I think it's the way to go. The state likes it. It's a very transparent process, which is what we've been engaged in on our single DSU permitting processes, but a larger scale, and makes everybody a little more aware of what our plans are for the next several years.

Welles Fitzpatrick -- SunTrust -- Analyst

Yeah, no, makes sense. And then one more. You guys have been -- I mean, as you hit on in the prepared comments, you guys have been tweaking spacing a little bit. Can you just talk to how that fits into the CDP? Can you build in optionality on sort of how many wells you're going to put in per unit, or is it kind of set once that goes through?

Nick A. Spence -- Executive Vice President and Chief Development Officer

Yeah. In the -- there'll be some optionality into that in the initial CDP planning, we'll put in what we feel will be permitting for. But we still got a permit individual to Form 2s and Form 2As for every DSU as we move along. So at that point, there'll be some flexibility for us to make a few changes if necessary.

Welles Fitzpatrick -- SunTrust -- Analyst

Great. That's all I have. Thank you so much.

Nick A. Spence -- Executive Vice President and Chief Development Officer

Thanks, Welles.

Operator

Thank you. Our next question comes from Irene Haas with Imperial Capital. Please state your question.

Irene Haas -- Imperial Capital -- Analyst

Yeah, hi. My question is it felt like the whole industry has been experiencing a head fake since last October. So it also felt like the CapEx spending has been cut back across multiple bases. And my question for you is, would that have a positive impact on space available on DCP? Could you actually see maybe more of your guests being able to move through that system as a result of suspending pullbacks?

Lynn A. Peterson -- Chairman of the Board, President and Chief Executive Officer

Yeah, Irene, this is Lynn. I will tell you I think we've all got our allocations. I think there will be some adjustments to those allocation as rigs move around the basin in different areas. We certainly designed our budget to keep our allocations at a sustained level. So I don't think it's going to fluctuate greatly.

Irene Haas -- Imperial Capital -- Analyst

Okay, great. Thank you.

Lynn A. Peterson -- Chairman of the Board, President and Chief Executive Officer

Thank you.

Operator

Our next question comes from John Aschenbeck with Seaport Global Securities. Please state your question.

John Aschenbeck -- Seaport Global Securities -- Analyst

Good morning. Thanks for taking my questions. So my first one, I was hoping to dig a little deeper on the gas processing expansions over the next couple of years, and I'm mostly curious about the larger Bighorn plant, Plant 12, which is going to be brought online in several phases. I think, Lynn, you kind of touched on that on your prepared remarks. Was curious how you see the general timing and magnitude of those capacity additions being layered in during 2020 or beyond? Thanks.

Lynn A. Peterson -- Chairman of the Board, President and Chief Executive Officer

Well, I'd probably refer to you to DCP's announcement here, that was last week. They did announce Q2 for the first phase of that Bighorn plant. We understand it could be built in three phases. I think there's still a lot of flexibility around that. And but I think the most important part here is DCP's enthusiasm, and we're certainly encouraged by their commitment of capital. And I think we'll progress and kind of get us over the hump as we look at 2020.

John Aschenbeck -- Seaport Global Securities -- Analyst

Okay, great. Fair enough. And then a bigger picture question. Really hoping you can entertain me here. I was curious what you see as an optimal level of terminal activity maybe to frame it in terms of number of rigs and frac spreads. And I guess I'm specifically trying to understand at what point you see yourself graduating more so from a growth strategy and then into a state where you begin generating more free cash flow? And then with that, would love to get your thoughts on how you think about potential uses of free cash flow once you reach that state? Thanks.

Lynn A. Peterson -- Chairman of the Board, President and Chief Executive Officer

Yeah. There's a lot of questions there. We'll try to take a shot at this and, Jimmy, jump in here with me. But really, I think we're looking at 2019, our whole budget was pretty much built around our ability to produce our gas and really a better efficient use of our capital. I think as we look at these other plants getting opened up, we would look to go back to kind of our standard two-rig program, one that have completion crews, kind of the cadence we've had over the last couple of years. Again, we got to get to 2020. So, we're still little ways off, but I think that's what we're envisioning as we look for a longer-term plan. As far as use of our free cash flow, if we get asked at all everyday and I kind of say, let's get there first. And we're going to reduce the debt that's going to be our first go around. I think once we get this to a sustainable 10% growth whatever number you want to pick, then we'll look to do some other things on those proceeds, Jimmy, you got any?

James P. Henderson -- Executive Vice President and Chief Financial Officer

Yeah, I think that's fair enough. We expressed with many of our investors that we're certainly not opposed to returning cash to investors, and it's just going to depend on the environment that we're in at the point that we get there, what opportunities we have in the best uses of our cash. We still believe that reinvesting and growing the company in the core area is a good -- is a high return investment for us and our investors. So really just have to wait and see what the environment is like when we get there.

John Aschenbeck -- Seaport Global Securities -- Analyst

Okay, great. Appreciate that. Maybe just following up real quickly, more so just thinking of it, from an operational perspective, if you were you know unconstrained to call it from a gas infrastructure standpoint. What do you think is your most efficient level of activity as it kind of a three-rig, two-frac spread count or maybe a little higher than that?

Lynn A. Peterson -- Chairman of the Board, President and Chief Executive Officer

Yeah. It's going to be always an evolving situation too as we'll get more and more efficient with all of our work. I mean, Mike's team on the completion side has done phenomenal as far as reducing time. So yeah, like I said, I think initially, we're looking at two-rig, 1.5, I guess, at some point. And again, you got inventory, you got cash outspend, you got all kinds of things to consider in that statement. So we're probably going to keep a little bit of ability to be flexible.

John Aschenbeck -- Seaport Global Securities -- Analyst

Okay. Understood. I appreciate the color. Thank you for the time.

Lynn A. Peterson -- Chairman of the Board, President and Chief Executive Officer

Yeah.

Operator

Thank you. Ladies and gentlemen, there are no further questions at this time. I'll turn the floor back to management for closing remarks. Thanks.

Lynn A. Peterson -- Chairman of the Board, President and Chief Executive Officer

Thank you. We realize that the continuation of political uncertainties to our investors, our employees, our contractors as well as many local businesses and mineral owners that rely on our healthy energy sector in Colorado. Our industry is pulled together and is actively engaged with the political system. We will continue to help all Coloradans understand the benefits of a healthy energy industry and the work that we do to ensure safe and healthy environment for our employees, as well as communities where we operate.

To wrap this up, our 2019 activity will be driven largely by ability to process our produce gas. We want to recognize that capital investment by DCP Midstream to expand their gas process and capacity. However, our activity level will continue to be moderated to operate within these constraints while always acknowledging the commodity price environment. We'll be attending several conferences over the coming quarters. So we look forward to seeing many of you at those events. In the meantime, if you have further questions, you can reach out to John Richardson.

Before signing off, I would like to once more state that the demise of the Colorado oil and gas industry has been greatly exaggerated, and we remain a strong viable industry. This concludes our conference. And thank you for your time.

Operator

Thank you. All parties may disconnect. Have a great day.

Duration: 23 minutes

Call participants:

John Richardson -- Investor Relations Manager

Lynn A. Peterson -- Chairman of the Board, President and Chief Executive Officer

Welles Fitzpatrick -- SunTrust -- Analyst

Nick A. Spence -- Executive Vice President and Chief Development Officer

Irene Haas -- Imperial Capital -- Analyst

John Aschenbeck -- Seaport Global Securities -- Analyst

James P. Henderson -- Executive Vice President and Chief Financial Officer

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