VAALCO Energy, Inc. (EGY) Q2 2017 Earnings Report, Transcript and Summary

Good morning. My name is Sia, and I will be the conference operator today. At this time, I would like to welcome everyone to the VAALCO Energy Second Quarter 2017 Earnings Conference Call. [Operator Instructions]. At this time, I would like to turn the conference over to Liz Prochnow, Chief Accounting Officer. Please go ahead, ma'am.

Thanks, operator. And on behalf of the management team, I welcome all of you to today's conference call to review VAALCO's second quarter 2017 operating and financial performance. After I cover the forward-looking statements, Cary Bounds, our Chief Executive Officer, will review key highlights of the second quarter, along with operational results; Phil Patman, our Chief Financial Officer, will then provide a more in-depth financial review. Cary will then return for some closing comments before we take your questions. [Operator Instructions] 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 it believes 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 file with the Securities and Exchange Commission, including the Second Quarter 2017 Form 10-Q that was filed yesterday and the previously filed 2016 Form 10-K. 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 Second Quarter 2017 Earnings Conference Call. During the second quarter of 2017, we continued to add value by delivering solid production results and positive earnings. Our average production for the quarter of 4,363 barrels of oil per day net was at the high end of our guidance range. We reported income from continuing operations of $2.5 million or $0.04 per share, which compared very favorably with a loss from continuing operations of $0.01 per share in the same period last year. Our second quarter 2017 results were less than the first quarter of 2017 when we reported income from continuing operations of $0.07 per share that benefited from higher oil prices. In the second quarter, we also generated operating income of $5.6 million and adjusted EBITDAX of $8.6 million. Our 2017 results demonstrate our ability to increase our financial strength by maximizing production. I will spend the next few minutes reviewing our second quarter operational results and expand on recent and near-term operational events. And then, in a few minutes, Phil will go into more details regarding our financial results. VAALCO's total production decreased 6% from 4,622 barrels of oil per day in the first quarter of 2017 to 4,363 barrels of oil per day in the second quarter of 2017. We closely monitor our wells and make every effort to maximize production, but we will continue to experience natural production declines, which may be offset by workovers to restore production in existing wells or by drilling additional development wells. In July, we undertook our planned annual Etame full field shutdown for maintenance and inspection of our FPSO and 4 platforms at Etame. The field is back online producing approximately 15,000 barrels of oil per day gross following the 9-day shutdown that was completed with no safety or environmental incidents. The results of the maintenance and inspection work confirmed that our asset integrity programs continue to be effective. The next turnaround will be in mid-2018. On July 18, the electric submersible pump or ESP in the South Tchibala 2-H well on the Avouma platform failed, resulting in the well being temporarily shut-in. The well was producing approximately 1,300 barrels of oil per day gross or 350 barrels of oil per day net to the company prior to being shut-in. VAALCO is mobilizing a hydraulic workover unit in the third quarter to move onto the Avouma platform and replace tne ESP system in the well, which is expected to be back on production by fourth quarter 2017. The company successfully utilized a hydraulic workover unit to replace the ESP in the same well late last year at a significantly lower cost rather than mobilizing a jackup rig. Working closely with the equipment manufacturer, we believe we have isolated the components that caused the 2016 ESP failures in this well. These components were subjected to unexpected corrosion while in operation and the equipment manufacturer has redesigned the components using a different material that should not experience the same level of corrosion. A dual ESP system utilizing the newly designed components will be installed in the South Tchibala 2-H well during the upcoming workover campaign. While we have the hydraulic workover unit mobilized in the field, we will take the opportunity to perform a workover on the South Tchibala 1H-B well. The South Tchibala 1H-B well is currently shut-in after experiencing an ESP failure in mid-2016. Prior to the ESP failure, the well was producing 900 barrels of oil per day gross or 245 barrels of oil per day net to the company. Now, I will spend a few minutes talking about production guidance for the third quarter and full year. Taking into account production declines, the impact of the planned maintenance turnaround completed in July and the downtime associated with the South Tchibala 2-H well for the third quarter of 2017, we expect our production to be in the range of 3,500 to 3,800 barrels of oil per day net. Given the strong production we had in the first half of 2017 and taking into account the planned turnaround and ESP downtime, we are updating our full year 2017 guidance to 3,900 to 4,200 barrels of oil per day. Later in the call, I will discuss in detail our near-term goals, which includes potential development opportunities at Etame that we believe can add production, reserves and value to the company. Now, let me review our production expenses. Total production expense, excluding workover costs, increased to $9.7 million in the second quarter of 2017, up from $8 million in the second quarter of 2016. The year-over-year increase in production expense was primarily due to VAALCO's increased working interest following the Sojitz acquisition, onetime regulatory costs and cost escalation associated with the FPSO. Coupled with the increase in absolute costs, our production declines have contributed to an increase in unit cost per BOE of sales from $20.44 per BOE in the first quarter of 2017 to $23.41 per BOE in the second quarter of 2017. While we have made strides to reduce costs over the past few years, with declining production and costs associated with the FPSO, it is becoming difficult to lower unit costs on a per BOE basis. Our commitment -- our continuing commitment to capturing savings in every aspect of our business remains a key goal and we are dedicated to enhancing operational cash flow and prolonging the life of the Etame asset. I would like to briefly touch on our free cash flow analysis for 2017 that you can see on Slide 9 of the presentation on our website. We continued to generate strong operational income in the second quarter of 2017 and, for the first half of the year, we have generated about $14 million in operating income. In our calculations, we are using our expected midpoint cash costs for operating expense, G&A, CapEx and abandonment funding on a unit basis per BOE as well as our expected Gabonese taxes and interest expense. This slide also shows the importance of our put contracts that place a floor on approximately 60% of our projected sales net of taxes at $50 per barrel. Our put hedges allow us to limit downside commodity price risk while preserving the upside in oil price by capturing the additional cash flow in a rising price environment. Our capital expectations for 2017 remain unchanged. We have the capital budget range of $1 million to $3 million that is earmarked for small operational and maintenance projects. With our continued ability to execute and deliver operational success, VAALCO is poised to add value to our shareholders now and into the future. With that, I will turn the call over to Phil to discuss our financial results.

Thank you, Cary. Our second quarter 2017 income from continuing operations was $2.5 million or $0.04 per share, adjusted EBITDAX totaled $8.6 million and operating income was $5.6 million. Our Q2 2017 income compared favorably with the loss of $0.5 million from continuing operations in the second quarter of 2016, but was down $4.4 million in this year's first quarter primarily due to lower oil prices and increased production expense. Second quarter oil sales totaled 414,000 net barrels compared with 436,000 net barrels in the same period a year ago and 394,000 net barrels in the first quarter of 2017. Our realized oil price for the second quarter of 2017 averaged $46.83 per barrel, up 15% from $40.79 in the second quarter of 2016, but down 10% from $51.99 in the first quarter of 2017. Beginning with our third quarter 2016 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 2016 to discontinue operations in Angola and withdraw from our production sharing agreement. Our loss from discontinued operations in the second quarter of 2017 totaled $163,000. In order to limit VAALCO's commodity price risk, in 2016, the company hedged its oil sales by purchasing oil puts. As of June 30, 2017, VAALCO had unexpired crude oil put contracts covering 360,000 barrels of anticipated sale volumes for the period from July 2017 through December 31, 2017 at a weighted average price of $50. The company recorded a noncash mark-to-market gain of $130,000 related to the puts during the second quarter of 2017, which was included in other net in the consolidated statements of operations. We received cash payments of $144,000 in July in settlement of our June put contract when prices fell below the floor provided by our puts. The company has not entered into additional derivative contracts since December 2016. However, we will continue to actively evaluate the desirability of increasing and extending the production -- the protection provided by put and other hedge transactions. Turning to expenses. Total production expense, excluding workovers, for the 2017 second quarter was $9.7 million or $23.41 per BOE of sales compared with $8.0 million or $18.16 per BOE in the same quarter of 2016 and $8.1 million or $20.44 per BOE in the first quarter of 2017. Second quarter 2017 production expense, excluding workovers, increased year-over-year in part due to the 11% net increase in working interest from the Sojitz acquisition costs as well as onetime local regulatory costs and cost escalation in the FPSO. Production expense, excluding workovers, increased quarter-over-quarter primarily due to higher personnel costs and cost escalation in the FPSO. For the third quarter of 2017, we expect our production costs, excluding workovers, to be approximately $26 to $28 per BOE. This reflects the lower anticipated volumes for quarter 3 due to the field-wide shutdown and ESP failure during the quarter. For the full year, we now expect production costs, excluding workovers, to average $22 to $24 per BOE. We expect to perform 2 and perhaps 3 workovers between now and the end of 2017 and our expected full year workover cost range is $3.5 million to $6.0 million. DD&A for the second quarter of 2017 was $2.0 million or $4.76 per BOE. This compares to $1.9 million or $4.39 per BOE in the 2016 second quarter and $1.9 million or $4.74 per BOE in the first quarter of 2017. We continue to believe DD&A will be in the range of $4 to $5 per BOE for 2017. General and administrative expenses for the second quarter of 2017 were reduced to $3.0 million or $7.36 per BOE compared to $4.0 million or $9.06 per BOE recorded in the same period one year ago and $3.1 million or $7.94 per BOE in the first quarter of 2017. These G&A costs include noncash compensation expense totaling $0.6 million in the second quarter of 2017, $1.0 million in the same quarter in 2016 and $0.2 million in the first quarter of this year. Given our first half 2017 G&A expenditures, we are lowering our full year G&A guidance to be in the range of $11 million to $13 million, of which $1 million to $2 million will be noncash. Income tax expense for the first quarter of 2017 was $3.1 million compared to $3.0 million for the same period in 2016 and $3.2 million in the first quarter of 2017. Our income tax expense is determined based on our revenue in Gabon. Turning to the balance sheet. Cash and cash equivalents totaled $20.6 million as of June 30, 2017. Net working capital improved by $1.7 million since March 31. At June 30, debt, net of deferred financing costs, totaled $13.0 million, of which $8.3 million was current. This reflects $2.1 million in principal payments since March 31 as provided under the repayment terms of the amended term loan agreement executed with the IFC in June 2016. And with this, I will now turn the call back over to Cary.

Thanks, Phil. As we look to the future, we remain confident in our premier Etame asset and believe that we can add value through development drilling, all the while leveraging our existing infrastructure and technical expertise to pursue attractive acquisition opportunities. As we have mentioned before, there are several key goals that we will continue to move forward in the near-term. One of our primary goals is to secure an extension on our existing license in Gabon. We continue to have constructive discussions and working sessions with the Gabonese government on these matters and are encouraged by the progress we are making. 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 2021. We continue to evaluate several near-term economic development drilling opportunities that will utilize our current offshore infrastructure and extend the economic life and reserves at Etame. 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. The additional Etame development drilling opportunities, combined with the license extension, will establish a solid foundation of value creation for 2018 and beyond. Another key strategic step we have continued to progress forward is the divesture of non-core assets. We have discontinued our operations in Angola to focus on development opportunities in Gabon and elsewhere in West Africa. We continue to have productive meetings with Angolan officials to resolve the question of any potential cost that could be assessed for not drilling the remaining commitment wells. We will resume discussions after the Angolan elections in August. We would like to settle this issue quickly and are targeting the second half of 2017 or early 2018 to come to an agreement that will allow us to 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. In early April, we closed the sale of non-core U.S. assets, the East Poplar Unit in Montana, for cash and the transfer of the asset retirement obligations. With these divestitures, our focus is squarely 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. And with that, operator, we are ready to take questions.

[Operator Instructions]. And we do have a response from Matt Dhane with Tieton Capital Management.

I was hoping to discuss, if we could, the maintaining of the production guidance even though you have the well that went out on South Tchibala. What in particular -- what fields, what areas have performed above your expectations year-to-date that allowed you to maintain your production guidance even in the face of this well going out again here?

Great. Matt, this is Cary. And to answer your question, there is really no one specific well or one specific area that is outperforming another area. The first half of 2017, we experienced very, very little unplanned downtime and that's what's put us ahead even in the face of losing the South Tchibala 2-H well on the Avouma platform. And so going forward, we still have to make an assumption that there will be some unplanned downtime events, but we had a good run in the first half of the year.

Great. And in regards to the FPSO, the cost escalation that's impacting your costs here going forward, I don't -- I guess, I don't understand fully what is causing that. What's -- is it your contract with the FPSO [indiscernible]? What's led to that cost escalation for the production costs here for the rest of this year?

Right. Under our current contract, every couple of years, we negotiate a day rate escalation. And I'll use -- I'll emphasize the word negotiate. And those negotiations are underway. And so we're -- it's part of our contract and we're working with the FPSO operator to minimize any future cost increase and work with them to keep their operating cost down. We've -- all of our vendors have been able to find ways to reduce costs and we expect the same from our FPSO operator.

So even in the current pricing environment, there is a real chance that the FPSO costs are likely to increase though?

Right. They may increase and we built that into our -- well, we've accrued for those increases, yes, and -- but we're still negotiating the final day rate escalation.

[Operator Instructions]. And at this time, there are no further responses.

All right. Thank you, everyone, for joining our quarterly conference call and have a great day.

Ladies and gentlemen, thank you for participating in today's conference call. You may now disconnect.