VAALCO Energy, Inc. (EGY) Q4 2016 Earnings Report, Transcript and Summary

I would like to welcome everyone to the VAALCO Energy Fourth 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] And now at this time, I would like to turn today's program over to Liz Prochnow, Chief Accounting Officer. Please go ahead.

Thanks, Carmen. And on behalf of the management team, I welcome all of you to today's conference call to review VAALCO's fourth quarter 2016 operating and financial performance. After I cover the forward-looking statements, Cary Bounds, our chief executive officer will review key highlights of the fourth quarter, along with operational results and year end reserves. I will then provide a more in-depth financial review and 2017 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 and 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 to 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, proposed 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 those 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 2016 Form 10-K 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 fourth quarter 2016 earnings conference call. Let me begin by thanking all our employees who work diligently during the year to ensure that we continued to operate safely, optimize production and reduce operating and general and administrative costs. In 2016 VAALCO faced some significant challenges, but throughout the year we met those challenges head on and we were able to achieve a very meaningful results. These results demonstrate our commitment to executing the company strategy and have allowed us to build a foundation of sustainable financial strength. First and foremost is safety, as a leading operator in Gabon it is our responsibility to operate in a safe and environmentally responsible manner, and we at VAALCO are proud to announce that we did not have a recordable incident in 2016. We also continually look to innovate and drive down costs. This is evident with our most recent workovers utilizing the hydraulic workover unit versus the traditional and more costly method of mobilizing a drilling rig. These two workover allowed us to restore over 1000 barrels of oil per day of net production in our Etame Marin block offshore Gabon. We are also persistent in our pursuit of targeted acquisitions that can create value, similar to the one we closed in the fourth quarter of 2016 for the additional interest at Etame. In the year when we spent no capital drilling new wells, we were able to replace approximately 87% of our Gabon reserves through performance additions and the acquisition of an additional interest in Etame. To remove distractions and sharpen our focus, we completed the sale of our US producing properties and we discontinued our operations in Angola, which were high risk exploration prospects. Again, these actions sharpened our focus, which is centered around utilizing our technical expertise and operational infrastructure to maximize and expand our existing development and exploitation opportunities at Etame and seek similar opportunities elsewhere in West Africa. I will spend the next few minutes reviewing our fourth quarter operational results and expand on recent and near-term operational events, and then, in a few minutes Liz will go into more details regarding the financial results. VAALCO's total production decreased 4% from 3,836 barrels of oil equivalent per day in the third quarter of 2016 to 3,682 barrels of oil equivalent per day in the fourth quarter of 2016. The result was above the high end of our guidance for the fourth quarter, as we discussed previously, the largest factor contributing to the production decrease was the failure of the ESPs that occurred in two wells on the Avouma platform. The South Tchibala-2H well was temporarily shut-in due to the failure of both ESPs in late June, while the Avouma 2-H experienced a failure in its primary ESPs in late July, and then in August, the secondary pump failed after being operational for only 10 days. Both of these wells remain temporarily shut-in throughout the remainder of the third quarter and into the fourth quarter, reducing our production by approximately 1000 net barrels of oil per day. In the fourth quarter, we mobilized 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 2-H well. Both workover operations were conducted safely and efficiently with no injuries, no environmental incidents and all personnel and equipment utilized during the combined operations on the two wells were demobilized in January. The wells were brought back online at a combined rate in excess of 1000 net barrels of oil per day which boosted our total company production to approximately 4600 barrels of oil per day in January. With this strong momentum, we believe production in the first quarter of 2017 will be in the range of 4500 barrels of oil per day to 4600 barrels of oil per day. The failed ESPs were sent to the manufacturer's facility and also an independent inspection company for a root cause investigation to determine the cause of the failure. I would like to point out that by utilizing the hydraulic workover unit compared to using a drilling rig, we significantly reduced our overall workover costs. Based on our success using a hydraulic workover unit, during these workovers, we will continue to use this more cost effective and efficient procedure in the future, which will economically extend the life of our premier asset the Etame Marin block in Gabon. The acquisition of the Sojitz interest in Etame impacted both our production and reserves at year-end and will continue to do so moving forward. The acquisition increased our production and reserves by approximately a 11% in the field we know extremely well, and enhances our option value due to the significant upside potential we believe exists in the Etame Marin block. Despite the production challenges we faced in 2016, we were able to optimize production and averaged 4,214 barrels of oil equivalent per day for full year 2016 at the high end of our annual production guidance of 3900 to 4300 barrels of oil equivalent per day. For the full-year 2017, we expect our production to be in the range of 3700 to 4300 barrels of oil per day. Later in the call, I will discuss in detail our near-term goals and potential development opportunities that we believe can add production reserves and value to the company. Let's now discuss our reserves for year end 2016, and specifically, our Gabon reserves. We have shown through recent transactions - transactions that our focus is squarely on West Africa, and in particular our Etame field offshore Gabon. With the closing of the US property sale and acquisition of additional interest in Etame, 100% of our year-end 2016 reserves are at – are at Etame block in Gabon and 100% of our reserves are oil. In 2016, despite no capital spending on drilling new wells and falling oil prices, we were able to replace 87% of our production in Gabon, primarily through performance additions and the acquisition of additional interest at Etame. With the recovery of oil prices, our year-end reserve pricing should improve in 2017 extending the economic limit of the Etame field and we would expect higher pricing to favorably impact our reserves. Our year-end 2610 PV10 valuation for proved reserves was $9.4 million at SEC pricing of $40.35 per barrel of oil. At the year end strip price of approximately $50 per barrel of oil, that PV10 increases significantly to $37.3 million. We also have potential development opportunities with attractive returns at the current strip price and more opportunities that become economic in a higher pricing environment, further extending the economic life of the Etame asset. Now let me review our production expenses that reflect our cost containment efforts over the last year. Total production expense, excluding work over costs increased by 4% from $7.3 million in the third quarter of 2016 to $7.7 million in the fourth quarter of 2016. This also excludes non-recurring regulatory costs associated with operating in Gabon that were incurred in the fourth quarter. With a slight increase in absolute costs and the decline in sales compared to the prior quarter, the cost per BOE of sales rose from $21.04 per BOE to $23.39 per BOE quarter-over-quarter which was near the midpoint of our fourth quarter guidance. Despite the lower production, our costs continue to reflect the positive impact of the cost containment initiatives that we have executed over the last 18 months. Our commitment to capturing savings in every aspect of our business is a key goal as it allows us to enhance operational cash flow and prolong the life of the Etame asset. As I have mentioned in the past, none of our cost reductions have impacted our asset integrity programs, safety programs or environmental performance. I would like to briefly touch on our free cash flow analysis for 2017 that you can see on slide 10 of the presentation on our website. In our calculations, we are using our expected midpoint cash costs for operating expense, G&A, CapEx and abandonment funding on a per BOE basis, as well as our expected Gabonese taxes and interest expense. As you can see in a rising price environment, our free cash flow per barrel increases significantly from approximately $10 per BOE at $50 realized oil price in 2017 to approximately $19 per BOE at $60 realized price. The slide also shows the importance of our expanded Put contracts that places floor on approximately 60% of our production at $48.46 per barrel. Our put hedges allow us to limit downside commodity price risk, while preserving the upside, allowing us to capture the additional free cash flow in a rising price environment. In closing, our operational successes, coupled with the execution of several key strategic steps in 2016 has allowed us to build a strong foundation heading into 2017. With our continued ability to execute and deliver results, VAALCO is poised to add value to our shareholders now and into the future. With that, I will turn the call over to Liz to discuss our financial results.

Thank you, Cary. Our fourth quarter 2016 operating income at $0.8 million compared very favorably with a loss of $64.7 million in the fourth quarter of 2015, which included a $52 million non-cash impairment charge, primarily due to lower oil prices. Fourth quarter 2016 operating income was lower than the $3.7 million in the third quarter of 2016, primarily due to workover expenses of $3.4 million reported in the fourth quarter of 2016. Fourth quarter sales totaled 326,000 net barrels compared with 457,000 net barrels in the same period a year ago and 344,000 net barrels in the third quarter of 2016. This decline in sales volumes was primarily due to the Avouma wells that were temporarily shut-in. Our realized oil price for the fourth quarter of 2016 averaged $46.62 per barrel, up 19% from $39.18 per barrel in the fourth quarter of 2015, and up 10% from $42.31 in the third quarter of 2016. Beginning with our third quarter earnings, the operating results of our Angola segment have been classified as discontinued operations in our financial statements. This was the result of our decision in September of 2016 to discontinue operations in Angola and withdraw from our production sharing agreement. Our loss from discontinued operations in the fourth quarter totaled $0.3 million. For continuing operations, we reported a loss of $3.4 million for the fourth quarter of 2016 or $0.06 per share. Our adjusted EBITDAX totaled $2.2 million. The loss from continuing operations includes a non-cash mark-to-market charge related to our Put contracts of $0.9 million. To limit our commodity price risk and protect our cash flow, we entered into additional Put contracts in the fourth quarter on 792,000 barrels of anticipated oil sales from the period January through December 2017 at a weighted average price of $48.46 per barrel. We have not added any additional Puts or other derivatives since year end 2016 that continue to consider the merit of increasing our position. We had no future out-of-pocket cash costs associated with these Puts. If prices continue to rise, that will benefit if prices fall below $48.46 per barrel. Turning to expenses, total production expense for the 2016 fourth quarter was $11.8 million, which includes $3.4 million in workover expenses on the two of Avouma wells, as well as approximately $0.7 million related to non-recurring regulatory cost associated with operating in Gabon. Ongoing production expenses, excluding workovers and the non-recurring cost totaled $7.7 million, or $23.39 per BOE of sales, compared to $9.2 million or $19.99 per BOE in the same quarter of 2015, and $7.3 million or $21.04 per BOE in the third quarter of 2016. The increase in per BOE costs was primarily due to lower sales volumes in the fourth quarter of 2016. For the first quarter of 2017, we expect our ongoing production cost to average between $20 and $23 per BOE with no workovers planned for that quarter. For the full year, we expect production costs to average between $20 and $23 per BOE, and we anticipate workover expense for the year to total $3 million to $5 million with that activity planned for later in the year. DD&A for the fourth quarter of 2016 was $1.1 million or $3.45 per BOE. This compares to $9.5 million or $20.56 per BOE in the 2015 fourth quarter and $1.6 million or $4.60 per BOE in the 2016 third quarter. We do not expect our DD&A rate to change materially in 2017, and we believe it will be in the range of $4 to $5 per BOE for the first quarter and full year. General and administrative expenses for the fourth quarter of 2016 totaled $1.7 million compared to $2.9 million reported in the same period a year ago and $1.6 million in the third quarter of 2016. We continue to see the benefit from the cost containment actions we have taken over the last 18 months. Non-cash compensation expense totaled $0.1 million in the fourth quarter of 2016 and $0.8 million in the same quarter in 2015, but was a credit of $0.9 million in the third quarter of 2016, which includes a $0.8 million adjustment related to the new stock-based compensation guidance. And to the newly adopted guidance, stock-based compensation related to forfeitures is being recognized in the period in which the forfeitures occur. For the full year 2017, we anticipate cash G&A expanse to be in the range of $10 million to $12 million, with non-cash G&A totaling about $3 million. In the fourth quarter of 2016, we recorded a credit of $1.1 million in other operating expense, which reflects our favorable settlement on estimated prior year Gabon payroll tax obligations which we accrued for in the second quarter of 2016. Income tax expense for the fourth quarter of 2016 was $2.4 million, compared to $4.2 million for the same period in 2015, and $2.2 million in the third quarter of 2016. The decrease in tax compared with a year ago is attributable to lower revenues in Gabon. Turning to the balance sheet, unrestricted cash and cash equivalents totaled $20.5 million as of the end of the year. At December 31, 2016, debt, net of deferred financing costs, totaled $14.4 million, $7.5 million of which was current, reflecting the repayment terms of the new loan agreement with the IFC. One last matter, I would like to discuss before turning the call back to Cary. As we announced in early February, the New York Stock Exchange accepted our plan of compliance for continued listing. As a result, our common stock will continue to be listed on the NYSE, subject to quarterly reviews by the NYSE's listing and compliance committee. Additionally, we regained compliance with the $1 per share market price requirement, as of January 31st, 2017. With that, I will now turn the call back over Cary.

Thanks, Liz. To wrap up today's call, I would like to discuss 2017 and VAALCO's focus moving forward. As we look to 2017, it should be very clear that our focus is Gabon in West Africa implementing a strategy that leverages our technical and operational expertise, as well as our operational infrastructure. This positions VAALCO to efficiently develop our Gabon assets and provides the foundation for us to expand into new development opportunities in West Africa. While we continue to focus on the day-to-day operations, including maximizing production, driving down costs and operating safely, there are several key goals that should add value to our shareholders. As we have said before, our flagship asset Etame was originally forecasted to produce 30 million barrels of oil. After several new discoveries and expansion programs, we have already recovered over three times that amount and still see substantial upside potential. With this in mind, our first goal is to secure an extension on our existing license in Gabon. While the current Etame license expires in June 2021, we believe that with the recovery in oil prices and the potential for additional development drilling, the block could produce for many years beyond to 2021. Our operations team has identified several near-term economic development drilling opportunities that will utilize our current offshore infrastructure and extend the economic life and reserves at Etame. As an example of the potential that exists on our acreage, we have identified 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 3400 gross barrels of oil per day, higher than our initial forecast and has produced over 1.6 million barrels of oil in its first 18 months. Today, the well continues to produce over 2700 gross barrels of oil per day. We will monitor oil price expectations and our balance sheet over the coming months to determine when the appropriate time might be to begin our next drilling program. However, the extension of the license goes hand-in-hand with additional development opportunities, and we believe that the combined impact of both will establish a solid foundation of value creation for 2018 and beyond. Another key strategic step we have taken recently has been to divest of our non-core US-based asset and our exploration assets in Angola. We have discontinued our operations in Angola to focus on development opportunities in Gabon and elsewhere in West Africa. We continue to talk with Angolan officials to resolve the question of any potential penalty that could be assessed for not drilling the three remaining commitment wells. But and there is nothing new to report at this time, we have evaluated the penalty provisions and believe that the penalty amount can be reduced by prior exploration expenditures. We would like to settle this issue quickly and remove the $15 million liability from our balance sheet. This would strengthen our balance sheet and could potentially lead to an increase in our borrowing capacity. With our focus now on increasing recoverable reserves at Etame, strengthening our balance sheet, raising capital for development projects and continuing to deliver solid operational results, VAALCO is poised to add significant value to our shareholders in 2017 and beyond. Thank you. And with that, operator we are ready to take questions.

[Operator Instructions] First question comes from the line of Matt Dane with Titan Capital.

Thank you. I was hoping that you could walk us through your focuses with business activities and how active conversations are currently and how we should think about the likelihood of something happening this year with that?

Sure. Thanks, Matt. I'll take that question. We are out there looking for opportunities, that like I said earlier, our technical expertise and our operational skill set, so we are looking – we are focused really in West Africa right now. We did like to leverage our operational expertise in West Africa. But we're – you know, we're opportunistic. We're looking at anything that would be accretive even if it's not in West Africa. But you know, those conversations are underway right now. We're looking at several opportunities. I can't talk about the details. But what we hope to do is land in acquisition, like I said, that fits our technical expertise and our operational expertise.

That’s helpful. Thank you, Cary.

[Operator Instructions] At this time just we have no further questions. I'll turn the call back over to management.

All right. Well, thank everyone for joining us for our teleconference call. Goodbye.

Thank you again for joining us today. This concludes today's conference. You may now disconnect.