Talos Energy Inc. (TALO) Q3 2017 Earnings Report, Transcript and Summary

Good morning. Thank you for standing by and welcome to the Stone Energy third-quarter 2017 earnings conference call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] I would now like to hand the floor over to James Trimble, President and interim Chief Executive Officer. Thank you, Mr. Trimble. I hand the floor to you.

Thank you, LaTonya, and welcome, everyone, to Stone Energy's third-quarter 2017 earnings conference call. I am joined by Ken Beer, Executive Vice President and Chief Financial Officer. Ken will read the cautionary forward-looking statement and then he will review our financial performance for the quarter. He will then give the floor back to me to provide an operational update. With that, Ken?

Yes, thanks, Jim. In this conference call, we may make forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934. These forward-looking statements are subject to all the risks and uncertainty normally incidented to the exploration, development, production, and sales of oil and natural gas. We urge you to read our 2016 annual report on Form 10-K and the third-quarter 10-Q that was filed yesterday for a discussion of the risks that could cause our actual results to differ materially from those in any forward-looking statements we may make today. In addition, in this call we may refer to financial measures that may be deemed non-GAAP financial measures as defined under the Exchange Act. Please refer to the press release we issued yesterday for a reconciliation between the differences between these financial measures and the most directly comparable GAAP financial measures. With that, we will assume everyone has seen the third-quarter press release and the attached financials, so I will just try to focus on some of the highlights. As you know, we implemented fresh start accounting at the end of February, so the third-quarter financial statement format continues to show predecessor versus successor results as of March 1, 2017, which add some complexity to our presentation. Our third-quarter results showed net income of $1.3 million or $0.06 per share. This quarter was pretty straightforward; however, we did recognize net derivative expense of $6.7 million, which was comprised of 1.2 million of derivative income from cash settlements for the quarter and 7.9 million of non-cash expense for mark to market adjustments to our derivatives. We also received a federal royalty recovery totaling about $14.1 million as part of a multiyear federal royalty refund claim, of which approximately 9.6 million was recognized as other operational income, 4.5 million was a reduction of LOE. And in connection with this royalty refund, we paid 3.9 million in a success-based consulting fee, which resulted in an overall net gain of just over $10 million, $10.2 million. And finally, we recognized 4.6 million of incentive compensation expense, representing the accrual of three-fourths of the estimated annual incentive following the Board's approval of this incentive and retention program in July of 2017. Our discretionary cash flow for the quarter was $45.5 million or around $2.20 per share, driven primarily by greater-than-expected production, lower cost, and the $10 million net cash from the royalty recovery. It is important to highlight that over the past six months, we have added about $30 million to our cash position. At September 30, we had over $280 million of cash and no credit facility debt. Production for the third quarter was 19,200 barrel equivalents per day, which was at the upper end of our third-quarter guidance of 17,500 to 19,500 barrels per day. And this included one week of scheduled downtime at Pompano to remove the platform rig and reinstall living quarters during the month of July. In October -- so in the fourth quarter, in October, we experienced five full days of downtime from Hurricane Nate, which caused virtually no damage, but did delay production and revenue. Additionally, we plan to shut in the Pompano platform for 10 days in November -- actually, starting yesterday -- to replace a compressor engine. So including the five-day hurricane shut-in and the 10-day Pompano downtime, we are forecasting fourth-quarter 2017 volumes to be in the 17,000 to 18,000 barrel equivalents per day. For the third quarter, our crude and natural gas liquids represented about 79% of our third-quarter volumes, with gas at about 21% -- I said thousand. That 79% liquids and 21% gas, and we expect this to remain pretty constant. On the pricing side, our quarterly oil price realization was around $48 per barrel. Our hedges provided a slight benefit for the quarter, adding the $1.2 million in additional cash realizations. Remember, we no longer designate our hedges for hedge accounting, so both the current cash and the mark to market fair value adjustments run through the derivative income or expense line item. As mentioned in the quarter, our net derivative expense was $6.7 million, which did include the $1.2 million of income from cash realizations and the $7.9 million of non-cash expense tied to the change in valuation of the future hedges. Our gas price realization was just under $2.50, slightly below the Henry Hub, as the premium price for our liquids rich gas was offset by fuel use and some shrinkage. On the cost side, we continue to show attractive LOE per BOE for our Gulf of Mexico properties. Our LOE was down to $6.66 per BOE in the third quarter, which included $6.7 million of planned major maintenance and the previously mentioned royalty recovery credit of $4.5 million. Based on the year-to-date results and our fourth-quarter outlook, our full-year LOE guidance has been further reduced to $58 million to $60 million for the year, which includes the planned major maintenance scheduled for the fourth quarter. The transportation, processing, and gathering expense totaled $1.1 million for the quarter and we expect this to be around $1 million for the fourth quarter as well. Our DD&A rate for the third quarter was down to just over $15 per BOE. And we expect the DD&A rate to remain between $14 and $16 per BOE for the fourth quarter as well. Our SG&A expense of $15.9 million for the quarter included the previously mentioned success-based consulting fee of $3.9 million related to the federal royalty recovery as well as approximately $3.5 million to $4 million of advisory fees tied to the Board-requested strategic review, but excluded about $2.6 million in capitalized G&A. We expect our quarterly G&A cash run rate, excluding fees associated with the strategic review, to be around $10 million or $11 million in the fourth quarter, with about 17% to 18% of this amount capitalized. Our other operational expense for the quarter totaled $700,000, which included a $400,000 stacking charge for the platform rig at Pompano in July. As this project is complete, we expect to incur minimal other operational expense in the fourth quarter. The reported interest expense for the third quarter remained approximately $3.5 million, net of $1.2 million of capitalized interest, as the restructured balance sheet has the $236 million in debt, made up of the $225 million of 7.5% second lien notes and the other $11 million is a building mortgage. We expect the interest expense to remain pretty static in the fourth quarter. Regarding taxes, based on year-to-date results, we no longer expect to pay any cash taxes for 2017. And therefore show a tax benefit of $1.6 million for the quarter, which reverses our previous tax liability estimate as of the end of the second quarter. Additionally, we expect to collect $27.7 million of federal income tax refunds over the next couple of quarters, which will further improve our cash position. Our CapEx for the third quarter was approximately $34 million or just under $100 million spent through the 9 months. Much of it tied to abandonment operations at Amethyst and other P&A projects. We expect to spud our Mt. Providence well in December. And there's several other P&A projects scheduled for the fourth quarter, although some of that P&A spending may roll into 2018. Our 2017 Board-authorized CapEx budget remains at $181 million, but we now expect to spend less than this amount due to scheduling changes. At September 30th, we had just over $245 million in unrestricted cash, $37 million in restricted cash for P&A expenditures, and our $150 million available borrowing base remains undrawn except for the $12.6 million in LCs. So we have plenty of near-term liquidity and we are fully compliant with all of our financial covenants under the credit facility. We are currently in discussions with our bank group on our borrowing base redetermination and expect a resolution in early November, this month. We expect to settle on a $100 million borrowing base figure, reduced purely due to the production concentration around the Pompano platform. I believe that wraps it up with the financial overview. And with that, I will turn it back over to Jim for additional comments.

Thank you, Ken. As Ken highlighted, we have a number of initiatives that are moving forward. And excited to progress our deepwater drilling program. The Rampart Deep well reached its total depth in August, and as reported, it encountered approximately 130 gross feet of pay, which equates to about 107 net vertical feet of liquid rich natural gas pay in three primary zones. We believe the Rampart Deep results reduce the exploration risk of our Derbio prospect. The completion of the Rampart Deep has been delayed in conjunction with the Derbio drilling results. We expect that Derbio will be spudded in the first half of 2018, and if successful, first production from the Rampart Deep Derbio project is expected in late 2019. And we expect development to include a multiwell tieback to our Pompano platform. Stone owns a 40% nonoperating working interest in both the Rampart Deep and Derbio prospects. Also, we plan to spud the Mt. Providence well in December of 2017. This well should take about two months to drill. And assuming success, the well will be tied back to our Pompano platform, with first production expected toward the end of the second quarter of 2018. Stone is the operator and holds 100% working interest in this prospect. We continue to evaluate several development projects around the Pompano and Amberjack platforms and are looking at several low-risk exploration prospects where we would have multi-partners, both operated and non-operated. We have succeeded in selling down our working interest in some of our higher-risk prospects to spread out our risk and our capital, which allows us to participate in more projects. Our technical teams continue to work to leverage our assets, our seismic coverage, and our technical talents by focusing on projects within the Gulf of Mexico that are attractive in this sub-$50 oil price world. We continue to look at property acquisitions in the Gulf of Mexico to help balance our production portfolio from the concentration at Pompano and Amberjack. As noted earlier, our balance sheet is in good shape, with over $245 million of unrestricted cash and $236 million of long-term attractive priced debt. We have no draw on our $150 million available borrowing base, with the exception of the $12.6 million in letters of credit. As Ken previously mentioned, we have increased our cash position over the last six months, which is a testament to our spending discipline. Our management team and our Board are working to maximize shareholder returns and continue to review various strategic and tactical options. Our industry continues to face the challenges associated with a volatile commodity price. However, we are seeing the benefits of the tough decisions we made earlier this year. A strong balance sheet and a liquidity position gives us the flexibility to pursue projects that will drive growth. We appreciate your interest in Stone today and thank you for participating in this morning's call. We are now happy to take any questions.

Thank you [Operator Instructions]. And your first question comes from the line of Richard Tullis with Capital One Securities.

Going back to some of the deepwater wells planned for the next couple of quarters, could you give some of the specs at what you are looking at? Predrill reserve estimates, cost estimates at the gross level, etc.?

Rich, I don't have those right at my fingertips right now. But I would be glad to get back to you on that. I think what we've got planned are several wells, and a lot of this is in the planning stage. So other than Mt. Providence, Derbio, we don't have anything that's firm at this point. We have got several things we are working on. And so I would say that it would be a little premature to tell you some specifics.

Yes, I can jump in, just give you a -- these are more ballpark. But in the case of Mt. Providence, that's 100% Stone. And probably the drilling cost there, and it will lap from both 2017 and go over to 2018, but you are looking -- and these are rough numbers -- kind of roughly $20 million, a little over $20 million to drill. Another 20 million to probably complete. There is also some facilities work and some work that -- we are actually going to tie it into our Template facility, so there is another $15 million-odd that will be needed with success. And in the case of Derbio, recognize that we have only got 40% interest in that well. The initial cost of the well is going to be in that roughly $50 million-odd. We will also get -- some of our lease costs will be reimbursed. This is a prospect that we put together, but we have Deep Gulf as the actual operator of the prospect.

Thanks, Ken. Jim, as you look at the landscape of potential acquisitions, I know you talked about it a little bit in the opening comments. What sort of things are on the table? What size would you be comfortable with? Is it mainly producing assets that you would focus on?

Yes, that's really what we are doing is we are proactively, I would say, talking to the majors about assets that they have that might be getting to the end of the life for them, but would be very attractive operations for us that had a PD. Well, we are looking for stuff that has a proved developed producing component but has some upside potential for work-overs and drilling.

[Operator Instructions] And your next question comes from the line of Hassan Ahmad with Serengeti.

Good morning, guys. Just looking at your guidance, I think what I am backing into Q4 is going to be probably the third quarter in a row of production decline. I know there is some noise in the numbers based off of maintenance work and whatnot, but what would you say is your base rate decline at the moment? And then what would you also say is your maintenance CapEx? If I look at some of the prospects in the next couple of years, they are not going to come online for some time. So I'm just trying to model 2018 here.

Go ahead, Ken.

Yes, if you would, I will jump in. And you are right. The production is -- if you think about production, it's actually relatively flattish. You are correct; we had some planned downtime in the second quarter. We also then had some in the third quarter. And now in the fourth quarter, the guidance is going to tell you that between Hurricane Nate and then 10 days out at Pompano, we will have some downtime. If you look at it -- if there was no downtime, actually the production would be relatively flattish. There is just natural decline that we have to address. If you look out to 2018, we will actually look -- we will experience some of that natural decline, but some of that will be offset really by the Mt. Providence well, which hopefully will be online sometime in the second quarter. We really don't have volumes hitting the first quarter, but in the second quarter, we would hope to have Mt. Providence on. And then as Jim highlighted, the whole Derbio Rampart project should look to come online sometime in 2019, late 2019. In the interim, we certainly are looking at some potential acquisition projects or prospects that might help us with additional production. Because at least right now, we have been generating cash and have a cash buildup. So we do have a balance sheet that can look at some of the acquisition of projects that might be out there.

And is that something you would be looking at to do purely with the cash on the balance sheet? Or would you use some stock or is everything on the table? I know you guys are exploring strategic alternatives and every which way. So what is your thought process on capital allocation?

Yes, I'd say what we are looking at is something that -- we are not looking at something that's so big that we would have to use stock to make an acquisition. I think what we are looking for is the smaller platforms that the majors have that we would be able to pick up, operate around. And we are really focused in the Mississippi and Green Canyon area. We are not expanding across the entire Gulf of Mexico. We are really focused in our backyard.

Last question, I think you said that you are expecting a borrowing base redetermination decision soon. Did you say that $100 million is kind of what you were targeting in the fourth quarter? Pro forma?

That is at least our expectation, correct.

Okay. Thanks, guys. That's all for me.

At this time, there are no further questions.

Well, thank you very much. And I'd like to just say thanks, everyone, for participating with us this morning and we'll look forward to next quarter. Thanks very much.

Thank you for your participation in today's Stone Energy third-quarter 2017 earnings conference call. You may now disconnect.