VAALCO Energy, Inc. (EGY) Q3 2016 Earnings Report, Transcript and Summary

Good morning. My name is Becky and I will be your conference operator today. At this time, I would like to welcome everyone to the VAALCO Third Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. Chief Accounting Officer, Liz Prochnow, you may begin your conference.

Thanks operator. And on behalf of the management team, I welcome all of you to today's conference call to review VAALCO's third quarter 2016 operating and financial performance. After I cover the forward-looking statements, Cary Bounds, VAALCO's COO and Interim CEO, will review key highlights of the third quarter along with operational results. I will then provide a more in-depth financial review and updated 2016 guidance. Cary will then return for some closing comments before we take your questions. During our questions session, we ask that you limit your questions to one with a follow-up. I would like to point out, that we posted an updated Investor Deck on our website this morning that has additional financial analysis, comparisons and updated guidance that should be helpful. With that let me proceed with our forward-looking statement comments. During the course of this conference call, the Company will be making forward-looking statements. We caution you that any statement that is not a statement of historical fact is a forward-looking statement. Forward-looking statements are those concerning VAALCO's plans, expectations, future drilling and completion activities, expected capital expenditures, sources of future capital funding and liquidity, future strategic alternatives, prospect evaluations, negotiations with governments and third parties, reserve growth and other operations. Statements made during this conference call that address activities, events, or developments that VAALCO expects, believes or anticipates, will or may occur in the future are forward-looking statements. These statements are based on assumptions made by VAALCO based on its experience, perception of historical trends, current conditions, expected future developments and other factors that believe are appropriate in the circumstances. Such statements are subject to a number of assumptions, risks and uncertainties, many of which are beyond VAALCO's control. Investors are cautioned that forward-looking statements are not guarantees of future performance and that, and that actual results or developments may differ materially from those projected in the forward-looking statements. VAALCO disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, you should not place undue reliance on forward looking statements. These and other risks are described in yesterday's press release and in the reports we filed with the Securities and Exchange Commission, including the third quarter 2016 Form 10-Q that was filed yesterday. Please note that this conference call is being recorded. Let me turn the call over to Cary.

Thank you, Liz. Good morning everyone and welcome to our third quarter 2016 earnings conference call. The third quarter 2016 results show a sustained strength in our financial performance as we remain focused on enhancing existing production, controlling costs and operating safely. We generated $2.9 million in operating income, reported income from continuing operations of $0.2 million and generated $4.2 million in adjusted EBITDAX. Revenues decreased versus the prior quarter due primarily to lower volumes related to pump failures we encountered earlier this summer which resulted in temporarily shutting in two wells. However, we were able to decrease production expense and G&A allowing us to partially offset some of the decline in revenue. I will spend the next few minutes reviewing our third quarter operational results and expand on recent and near-term operational events, and in a few minutes Liz will go into more details regarding the financials. VAALCO's total production decreased 20% from 4,796 barrels of oil equivalent per day in the second quarter of 2016 to 3,836 barrels of oil equivalent per day in the third quarter of 2016, which was at the midpoint of our guidance for the third quarter. The primary reason for the production decrease was the failure of electric submersible pumps or ESPs that occurred in two wells on Avouma platform. The South Tchibala-2H well was producing over 400 barrels of oil equivalent per day, net to VAALCO prior to being temporarily shut-in due to the failure of both ESPs in late June. In late July, the Avouma 2-H well also experienced a failure in its primary ESP. In August, the secondary pump was successfully started but only remained operational for 10 days before also experiencing a failure. Prior to the primary ESP failure, the Avouma 2-H well was producing over 650 barrels of oil per day net to VAALCO. The combined impact of the two wells being shut-in was a reduction of over 800 barrels of oil equivalent per day on average during the quarter. We are mobilizing a hydraulic workover unit to the Avouma platform to recover, inspect and analyze the failed ESPs in the Avouma 2-H well and the South Tchibala-2H. The workover operations should commence in November and we will be making real-time decisions as we gather information from those activities. The failed ESPs will be sent to the manufacturer's facility for further diagnostics to determine the cause of the failure. We intend to replace the failed ESPs, but we may not immediately install new ESPs if we have evidence that the replacement pumps would experience a similar failure. I would like to point out that utilizing the hydraulic workover unit compared to using a drilling rig will reduce costs associated with workovers by approximately 50% and in the future, this will allow us to economically extend the life of our premier asset the Etame field. Due to the uncertainty of the production impact associated with the workovers, our fourth quarter guidance is based on the assumption that neither well will produce significant volumes in the quarter. As mentioned in the earnings release, we expect the closing of our previously announced acquisition of an additional 3.23% working interest from Sojitz to occur before yearend. While the transaction will be effective August 1, none of the production will be included in our reported volumes until after closing the transaction. The financial benefit from production between August 1 and closing will be recognized as a purchase price adjustment. The planned effective date of the sale of the U.S. properties is November 1, so we will continue to recognize production through the closing date. With all these factors taken into consideration, we estimate our fourth quarter production volumes will be in the range of 3,300 to 3,600 BOE per day. Despite the production challenges we face recently, we're still on track to meet our annual production guidance of 3,900 to 4,300 BOE per day. Now let me review our production expenses that reflect our cost containment efforts over the last year. Total production expense excluding the effect of workovers decreased by 9% from $8 million in the second quarter of 2016 to $7.3 million in the third quarter of 2016. While actual costs declined compared to the prior quarter, the costs per BOE of sales rose from $18.16 per BOE to $21.04 per BOE quarter-over-quarter due to lower sales volumes. Despite the lower production, our costs continue to reflect the positive impact of the cost containment initiatives that we have executed over the last 15 months and production expense has come in at the low end of our cost guidance. Our commitment to capturing savings in every aspect of our business is a key goal is it allows us to enhance operational cash flow and prolong the life of Etame field. As I mentioned in the past, none of our cost reductions have impacted our asset integrity programs, safety programs or environmental performance. VAALCO has now gone over 15 months without a recordable incident and we are proud of our strong safety culture. Just as important as our current operational results, we have recently taken several key strategic steps that should allow us to enhance shareholder value to our operational focus and by further reducing our costs. Last quarter we announced the acquisition of an additional interest in Etame from one of our partners Sojitz Etame Limited. As I mentioned earlier, we expect the transaction to close by yearend with an effective date of August 1, 2016. Expanding our position in Etame field is the first step in our strategy to grow the Company through low risk, accretive acquisitions within our core area of expertise. In an effort to sharpen our focus and reduce costs, we have decided to sell the majority of our small remaining interest in the U.S. and exit Angola. In the U.S., we recently entered into letters of intent to sell our interests in two Granite Wash wells in North Texas and our interest in the East Poplar Dome field in Montana for a total of $1.1 million. These two transactions are expected to close by yearend. In Angola, we decided to release our exploration block and have taken actions to begin closing the office in country which will lead to significant G&A savings in the future. We do not intend to conduct future exploration activities in Angola. As we have said for a number of years, our Angola acreage has significant prospectivity, but the drilling costs are high and the prospects carry high risks. We engaged in a lengthy process to identify partner to allow us to form down our acreage, reduce our capital costs and reduce our risk exposure while maintaining significant upside potential. Although, we had detailed discussions with a number of interested parties, including the majors and large global independent E&P companies, high potential exploration has been severely curtailed throughout the industry and we did not receive any viable offers. At this point in the commodity price downturn, we believe that it is best to exit Angola and focus our efforts on opportunities to develop discovered resources and not on exploration. This is why we believe that in the current environment it makes sense to concentrate our attention on low risk opportunities similar to Etame field in West Africa. Moving away from exploration allows us to concentrate on developing known resources with lower risk in areas where infrastructure is already in place, which will increase our confidence in delivering results that increase shareholder value. We have multiple development opportunities at Etame, as well as discoveries in the Mutamba permit on onshore Gabon and Block P offshore Equatorial Guinea all of which we can reevaluate as prices recover and our financial position strengthens. We believe that with the strategic steps we have taken in 2016, VAALCO is now on course to execute on what we have proven in the past we are successful at doing, and that is the profitable development of known discoveries in West Africa and other similar areas internationally, while driving down costs and operating safely. With that, I will turn the call over to Liz to discuss our financial results.

Thank you, Cary. Our third quarter 2016 operating income of $2.9 million showed marked improvement compared with a loss of $31 million in the third quarter of 2015 that was lower than the second quarter 2016 due primarily to lower sales volumes. Our oil sales volumes totaled 344,000 barrel down about $0.21 from the 436,000 in the second quarter. As Cary discussed, current quarter volumes were lower primarily due to ESP failures at Avouma. Our realized oil price for the third quarter of 2016 averaged $42.31 per barrel, essentially flat versus $42.13 in the second quarter of this year. As we disclosed in the earnings release, as a result of our decision to discontinued operation in Angola and withdraw from our production sharing agreement, the operating results of the Angola segment had been classified as discontinued in our financial statements for the current and all prior periods. Our loss from discontinued operations in the third quarter totaled $15.8 million or $0.27 loss per share. This loss is comprised almost exclusively of a non-cash accrual of $15 million related to the potential maximum penalty amount for not drilling the three remaining exploratory wells under our Angola production sharing agreement. As previously discussed in 2015, we wrote off essentially all of our investment in Angola. We have evaluated the penalty provisions of the joint operating agreement and believe that a substantial portion of that penalty amount has been reduced due to exploration expenditures already made by us in the past. We are providing support for our determination to Angola government authorities and we anticipate further discussions on this matter. However, due to the uncertainty of the resolution of this issue, we accrued $15 million during the third quarter which represents what we believe to be the maximum amount potentially due. As a result of our notification that we plan to withdraw from the joint operating agreement and exit Angola, the $15 million in restricted cash reported in previous quarters as other non-current assets is now included in current cash and cash equivalents. For continuing operations, we reported $0.2 million for the third quarter of 2016 or nil per share. Our adjusted EBITDAX totaled $4.2 million. As we disclosed in previous quarters to partially limit our commodity price risk in April, we entered into put contracts on 36,000 barrels of oil per month for the period from June 2016 through February 2017 at dated Brent pricing of $40 per barrel. We have not added any additional puts or other derivatives since then that continue to evaluate our position. The existing puts provide downside protection if prices fall below $40, while retaining price upside for our investors. We have no future out-of-pocket cash costs associated with these puts, if prices continue to rise, but will benefit if prices fall below $40. Each quarter, we perform a non-cash mark-to-market valuation for financial reporting purposes. Turning to expenses, total production expense for the 2016 third quarter was $7.2 million, which includes the benefit of $0.2 million revision to the estimated accrual for prior period workover expenses. Ongoing production expenses excluding workovers totaled $7.4 million or $21.04 per BOE of sales. This compares to $7.9 million or $19.55 per BOE in the third quarter of 2015 and $8 million or $18.16 per BOE in the second quarter of this year. Our third quarter 2016 production costs were at the low end of our guidance range. While actual costs were down compared with the prior quarters, the rate per BOE rose due to lower sales volumes during the quarter. For the fourth quarter, we expect our ongoing production costs to average $22 to $24 per BOE, excluding $3 million to $4 million in workover cost at Avouma net to VAALCO. DD&A for the third quarter of 2016 was $1.6 million or $4.60 per BOE. This compares to $8.3 million or $20.34 per BOE in the 2015 third quarter and $1.9 million or $4.39 per BOE in the 2016 second quarter. We are maintaining our prior guidance of $4 to $6 per BOE for DD&A in the fourth quarter. The lower rates in 2016 reflect the lower depletable costs primarily due to impairments we recorded in 2015. General and administrative expenses for the third quarter of 2016 totaled $2.4 million compared to $2.7 million recorded in the same period a year ago and $3.7 million in the second quarter of 2016. The decrease is primarily a result of lower stock-based compensation expense. General and administrative expense includes a negative $0.5 million of non-cash compensation expense for the September 2016 quarter. This compares to non-cash compensation charges of $0.7 million and $0.8 million for the September 2015 and June 2016 quarters, respectively. The negative amount for the current quarter is as the result of forfeitures related to employee departures. Our updated 2016 full year guidance for G&A expense attributable to continuing operations is expected to be in the range of $11 million to $13 million, with non-cash G&A totaling about $1.5 million. Interest expense for the third quarter of 2016 was $0.3 million compared to $0.5 million in the third quarter of 2015 and $1.5 million in the second quarter of 2016. As previously reported, second quarter 2016 interest expense included a write-off of $0.9 million of deferred financing costs in connection with the conversion of the IFC loan from a revolver to term loan in June. Net of the interest incurred on the IFC credit facility was capitalized in the second and third quarters of 2016. While a substantial portion of the interest expense incurred was capitalized in the prior year. Income tax expense for the third quarter of 2016 was $2.2 million compared to $2.7 million for the same period in 2015 and $2.9 million in the second quarter of 2016. The decrease in tax is attributable to lower revenues in Gabon. Turning to the balance sheet, unrestricted cash and cash equivalents totaled $26.9 million at the end of the quarter. This excludes an additional $0.8 million in restricted cash included in cash in current assets primarily related to deposits in Gabon and $0.8 million restricted cash classified as a long-term asset. At September 30, 2016, debt net of deferred financing costs of $1.7 million totaled $14.4 million of which $6.3 million was classified as current, reflecting the repayment terms of the new loan agreement with the IFC. Before turning the call back to Cary, I want to update you regarding our continued listing on the New York Stock Exchange. As we previously disclosed, we received a notice from the exchange on August 9th that our stock had fallen below the minimum listing standards, which requires that average closing price of our common stock be not less than $1 per share for a period of over 30 consecutive trading days. We had notified the NYSE of our desire to regain compliance with their continued listing standards within the required six month period. During this period, the Company's common stock will continue to be traded on NYSE. With that, I will now turn the call back over to Cary.

Thanks Liz. To wrap up today's call, I would like to reemphasize that our focus is on pursuing value added growth opportunities and unlocking the potential that exists across our Etame assets. As we have said before, our flagship asset Etame was originally forecasted to produce 30 million barrels of oil. However, after several new discoveries and expansion programs, we have recovered over three times that amount already. We believe Etame have significant upside potential remaining and our expanded offshore infrastructure provides a solid foundation for future growth. We have identified 21 low risk development and step-out drilling opportunities, representing an estimated total of over 65 million barrels of gross un-risked recoverable contingent resources. We have also identified several additional drilling opportunities with a higher risk profile that can be examined and potentially derisk in a more stable and higher pricing environment. As an example of the potential that exists on our acreage, we have identified low risk development opportunities in the Southeast Etame field where we drilled the Southeast Etame 2-H well in July 2015. This well came online at an initial rate of 3,400 gross barrels of oil per day, higher than our initial forecast and has produced over 1.4 million barrels of oil in its first 16 months and continues to produce approximately 3,200 gross barrels of oil per day. We will continue to evaluate all of the opportunities in our inventory Etame and make our decisions based on the economic merits of each individual project in the current environment. We have controlled our capital spending in 2016 and we expected to be less than $1 million for the full year having already spent the majority on facility enhancements. While we have not finalized the 2017 capital program with our partners and the Gabon government, we do have several low risk development wells we can drill with solid returns in this price environment. We will monitor oil price expectations and our balance sheet over the coming months to determine when the appropriate time will be to being our next drilling program. We will also continue to look for additional discovered resource opportunities in shallow water offshore West Africa and similar areas internationally where we can leverage our technical expertise. In summary, with the recent strategic steps we have taken and our commitment to safely achieving strong production results and lowering our overall cost structure, we believe we are doing the right thing to benefit our shareholders in this low oil price environment. Thank you. And with that, operator we are ready to take questions.

[Operator Instructions] We have a question from Matt Dane.

Hello Matt.

Hi. How are you doing?

Doing well. How are you?

Good. I was curious, you mentioned that the closing of the Angola office would save some significant G&A. I was hoping you can qualify that or quantify that to an extent and share with as how much that may be?

Sure. We sure can. Once we get the office closed and we fully exited Angola, we're expecting around $0.5 a year in G&A savings.

Okay. I appreciate it.

Let me add to that. If you look in our – once you had a chance to look at the 10-Q, there is a footnote disclosure on the discontinued operation and it will break out and give some details on what in that number, including a breakout at the G&A costs that were incurred and it will give you comparable to all the prior year periods.

Okay. Great. Thanks. I appreciate it.

You're welcome, Matt.

[Operator Instructions] And there are no additional questions.

All right. Well, with that I'd like to say we appreciate everyone participating in the call today. Thank you. Goodbye.

This concludes today's conference call. You may now disconnect.