Earnings Call: Q2 2019

Aug 8, 2019

Good morning, and welcome to the Talos Energy Second Quarter 2019 Earnings Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would like to now turn the conference over to Sergio Maiwam, Investor Relations. Please go ahead. Thank you, operator. Good morning, everyone, and welcome to our Q2 2019 earnings conference call. Joining me today to discuss our results are Tim Duncan, President and Chief Executive Officer and Shane Young, Executive Vice President and Chief Financial Officer. Before we get started, I'd like to take this opportunity to remind you that our remarks today will include forward looking statements. Actual results may differ materially from those contemplated by these forward looking statements. Factors that could cause these results to differ materially are set forth in yesterday's press release, on Form 10 Q for the quarter ended on June 30, 2019 filed with the SEC yesterday, and on Form 10 ks for the year ended 2018 filed with the SEC on March 13, 2019. Any forward looking statements that we make on this call are based on assumptions as of today and we undertake no obligations to update these statements as a result of new information or future events. During this call, we may present both GAAP and non GAAP financial measures. A reconciliation of GAAP to non GAAP measures was included in yesterday's earnings press release, which was filed with the SEC and which is also available on our website attalusenergy.com. And now, I'd like to turn the call over to Tim. Thanks, Sergio, and thank you, everyone, for joining our call. We also welcome our new Executive Vice President and CFO, Shane Young, to the call. Shane was a senior investment banker for over 20 years, including stops at Morgan Stanley and Goldman Sachs prior to leaving banking to become our CFO in 20 14 'fifteen, and we're thrilled to have him back. It's a pleasure to discuss our Q2, one of our busiest and most productive in the history of Talos. We're certainly happy with our operating metrics highlighted by Talos' best quarter in terms of production and adjusted EBITDA with and without the impact of our hedges. When we look back a year ago, the Q2 of 2018 was our 1st publicly reported quarter. At that time, we discussed the pro form a results, which included the then recently closed business combination with Stone Energy and the Ram Powell asset transaction in our Mississippi Canyon core area. It was our expectation back then that in the following 12 months, if we continue to allocate capital toward drilling activities in and around the assets we owned, focused on asset management and relentlessly pursued the synergies we knew existed in the combined portfolio, we would have a more efficient company with greater scale and diversity. We expected to see continued improvements in our balance sheet and liquidity position and we hoped we'd be well positioned to maximize opportunities that we believe were available both inside our portfolio and through external business development efforts in the U. S. Gulf of Mexico and offshore Mexico. And in the Q2 of 2019, we're very pleased to report that we have achieved all of that plus additional great milestones. We think you can now see the potential of what we have built to date. We'll talk about the specifics shortly, but in summary, we achieved record levels production and adjusted EBITDA in the Q2. This was achieved despite a lower commodity price environment compared to the same period last year and was mainly driven by reductions in total expenses year over year despite slightly higher service costs in the market now versus a year ago. In fact, our unhedged adjusted EBITDA margin in this quarter is the highest we have achieved in a single quarter, including 2013 2014 where the oil market was over $100 a barrel for a long period of time. Because our drilling program continues to focus on adding value around our previously acquired assets, we realized significant operational synergies by bringing new production on stream through our existing facilities, which already have a high percentage of cost as fixed. As I mentioned earlier, this quarter and the entire first half of the year actually was very active for Talos. Our capital program included 5 rigs in the first half of the year, including 3 deepwater rigs. The rig count has already decreased from that and will decrease further to just one shallow water rig by the end of the Q3. However, even with this high level of activity, our U. S. Gulf of Mexico business generated meaningful free cash flow, which was reinvested into our offshore Mexico position as budgeted, including the highly successful appraisal of our Zama discovery. Finally, our reserve base is very proved developed heavy, leading to an additional $250,000,000 of bank commitments and our unanimously reaffirmed 8 $50,000,000 borrowing base which was supported by addition of 3 new banks into our facility. With that, our liquidity position has recently increased over 600,000,000 dollars So let's go through the quarter highlights and then expand within the core areas. Production was 59,000 barrels equivalent a day, which was 75 percent oil and 81 percent total liquids and led to revenue of $286,600,000 WTI prices in the period averaged $59.81 a barrel, but our realized price was $64.13 a barrel after various deductions. So over a $4 premium to WTI, which represents one of the benefits in our asset base, the quality of our oil and access to infrastructure which leads to the premium pricing. Adjusted EBITDA for the quarter inclusive of our hedge settlements was 2 $106,900,000 It was $216,500,000 excluding the realized impact of our hedges. The EBITDA margin or cash margin was $38.54 of BOE hedged and $40.32 of BOE percent unhedged adjusted EBITDA margin is the highest we have ever achieved in a quarter. As we continue to highlight, our capital program was front end loaded with our rig operations peaking in the Q2. This will substantially wind down in the 3rd quarter. As such, we spent $187,400,000 in 2nd quarter inclusive of our P and A activities. Of this value, dollars 156,200,000 was spent in the U. S. Gulf of Mexico, while $31,200,000 was spent in the efforts in offshore Mexico, most of which was in the Zama appraisal. Our liquidity position has recently grown. Our leverage metrics and credit statistics continue to improve and continue to be amongst the best in our peer group. We also have added more hedges to our portfolio to further protect against commodity price exposure, which Shane will go over in more detail. In U. S. Deepwater, we brought on stream 2 wells in the Phoenix complex during the quarter, Tornado 3 in early April and Boris 3 in late April, both contributed to our significant Q2 production levels. We also had success in our Bulleit prospect. Looking ahead, we will soon be appraising our Orlov prospect, which is also discovered in the Q2. Finally, we brought on stream 2 wells in our shallow water drilling program in the Ewing Bank 305 field, 1 in May and the second more recently in July. We plan to add a 3rd producing well by year end in what has been a very successful program there. We successfully completed our Zama appraisal program in Block 7 contract area in offshore Mexico collecting an unprecedented amount of data ahead of schedule and maintaining the urgency intended with the energy reforms in Mexico. In the last few days, we've also had encouraging results in our first well in the Block 31 contract area, which will continue to appraise in the 3rd quarter. Let's walk through some additional highlights in our 4 core areas. In the Mississippi Canyon core area, which includes Pompano, Amberjack, Ram Powell and the Gunflint field, we had total net production of 20,700 barrels equivalent a day in the Q2. We've been working diligently on remapping and looking for an additional value in the Pompano field area. Very recently, we completed 2 asset management activities in the field. These recompletions added 3,700 barrels equivalent a day gross and 2,500 barrels equivalent a day net, which will impact the 3rd quarter, a production cost conversion rate of $3,200 per barrel equivalent a day. We expect drilling activity in the Pompano area as part of our 2020 and we're excited about our progress there. Additionally, we have recently finished some light construction work on our Ram Powell platform as we work to host the production from a 3rd party discovery nearby. This will allow us to benefit from production handling fees that will add positive cash flow and offset part of our operating expenses on the facility, a further benefit to owning infrastructure in areas where there is active industry exploration activity. The Green Canyon area includes the Tornado field and the broader Phoenix complex as well as our Green Canyon 18 field, which accounted for net daily production of 23,900 barrels equivalent a day and included initiating production from our Tornado III and Boris III wells. Both subsea wells were brought online within 3 to 6 months after drilling operations were concluded, which is a credit to our operation teams for driving fast cycle times. We also were able to announce a successful oil discovery in our Bulleit prospect on Green Canyon 21, where we logged approximately 140 feet of net TVD Pay in the shallow objective called the DTR-ten sand and then we logged an additional 110 net feet of TVD Pay in the deeper geo pressured MP sand. We operate the Bulleit prospect with a 50% working interest. Both pay sands and the Bulleit discovery are historical producing intervals in fields throughout the region, including the Green Canyon 18 field, which we also own. In fact, the Bulleit discovery will be a subsea tieback to our Green Canyon 18 facility. Because the operating costs are covered by the existing production in the Green Canyon 18 facility and also because we will receive production handling fees as the 100 percent owner and operator of the host facility, we effectively do not have any incremental operating cost to produce the Bulleit well and the new production will materially drive down the lifting cost structure in the overall field. We also previously announced encouraging results in our Orlov prospect, finding pay in the main objective in the Miocene interval and 2 shallower zones along the same trap. Our operating partner, Fieldwood Energy currently has a rig on location at Orlov to drill an appraisal sidetrack to optimize the resources and we look forward to those results in the Q3. Our shallow water and other core area accounts for both our legacy shallow water assets as well as some small deepwater assets. This core area produced 14,400 barrels equivalent per day. After bringing on the Ewing Bank 305A2 sidetracked very early in the second quarter at a rate of 1,700 barrels a day gross 1,400 barrels a day net, we then had success in our drilling and completion operations in our Ewing Bank 305A-twenty sidetrack. This well came online with a sustained rate of 2,600 barrels equivalent a day gross and 2,100 barrels equivalent a day net. We own 100% working interest in both wells and operate. Our final well in the already successful shallow water drilling program is the Grand Isle 80 2, A-twenty 2 well, which will also be drilled from our Ewing Bank 305 platform with the goal of reaching total depth in the Q3 and is successful establishing 1st production in the Q4. As I wrap up the discussion regarding our U. S. Gulf of Mexico assets, it should be noted that there are some short term challenges that will impact the Q3. Hurricane Barry's path managed to cover most of our asset base as it did much of the U. S. Gulf of Mexico with approximately 70% of Gulf of Mexico oil production shut in for the better part of a week. Specific to Talos' assets, although no significant damage occurred, we had to shut in approximately 85% of our production for almost a week. That also included disconnecting DHP-one and relocating the vessel out of the hurricane's path, which will impact downtime in the Q3. Moving the discussion to offshore Mexico, our appraisal of Zama was in full swing in the Q2. Early in the second quarter, we wrapped the Zama-two sidetrack well 1.4 miles north of the original discovery location. In this well, we logged 8 73 feet of gross pay and performed 2 flow tests in 3 different perforated intervals adding up to an unstimulated 7,900 barrels equivalent per day gross which is 94% oil reinforcing our belief that peak production from the Zama field once fully developed can be greater than 150,000 barrels equivalent per day gross. Our final appraisal location was the Zama three well drilled up 1.5 miles south of the original discovery location, finding another 1,000 feet of TVD gross sand and 748 feet of gross TVD pay with better than expected net to gross ratios in some of the best rock properties we've seen to date, providing comfort as we bring this data to our independent reserve auditors that the contingent resource should land in the upper half of our original gross recovery resource estimate of 400,000,000 to 800,000,000 barrels equivalent. All told, in the 4 penetrations drilled to date our Zama discovery, we've logged over 3,300 feet of gross pay collected over 200 pressure sample points, 59 fluid samples and over 1400 feet of whole core to better define this resource. But what we are most proud of is that we've now worked over 600,000 man hours with the INSCO 8,503 rig with personnel from both the U. S. And Mexico without a single lost time incident. Now that the appraisal is complete, we turn our attention to our FEED work with our consortium partners and IO Oil and Gas Consulting, which is a joint venture between Baker Hughes GE and McDermott. Our goal is to further narrow our various development concepts to one prevailing design that will ultimately be submitted as our final development plan. We also continue to work with Pemex on unitization with the goal of reaching FID in 2020. In Block 2 and Block 31 in shallow water Mexico, we are progressing in our 4 well drilling program there. In this program, we own 25% working interest alongside our partner Pan American Energy. On Block 2, we drilled the Yaluk prospect, which found non commercial amounts of hydrocarbon and was plugged and abandoned. The rig then moved to the Omeka project, which is a shallow water oil and gas play in our Block 31 contract area. The first well was the Shashamani II exploration well, which is originally set up and log is set up by Logpay in the Shashamani I well drilled in 2,003. The Shoshamani-two well just reached total depth in recent days with encouraging results. A short drill stem test will be performed in this well before the rig moves to drill the Tolteka prospect with similar objectives. We still have work to do here and we will follow-up with these results of this work when the operation is complete, but the initial results are positive. I'll now turn it over to Shane to discuss the details of our financial results. Thank you, Tim. It has been wonderful to be back at Talos for the past 3 months, and I couldn't be more excited to have rejoined such a well positioned company with a great team and great assets. Talos has grown tremendously over the past several years and accomplished much since I was here last. That said, I couldn't have rejoined at a more exciting time, and I look forward to substantial opportunities for value added growth that lie ahead for the company. I'd like to take a minute to review the 2nd quarter results and then touch on liquidity and hedging. As Tim highlighted, Talos recorded adjusted EBITDA in the quarter of approximately $207,000,000 inclusive of an $8,500,000 federal royalty refund. This equated to a $38.54 margin per BOE or 72% margin. These results reflect our record quarterly production, the pricing premium we realized relative to WTI and the continued focus on cost control throughout the entire business. Net income for the quarter was approximately $95,000,001.74 per share. From a balance sheet perspective, we ended the quarter with just under $800,000,000 of total debt. This includes approximately $87,000,000 for the finance lease on the HP-one. Adjusting for cash of approximately $89,000,000 our net debt to LTM adjusted EBITDA was less than 1.2x and our net debt to 2nd quarter annualized EBITDA was less than 0.9x. As was previously noted, capital expenditures for the quarter, including just over $28,000,000 for P and A, were approximately $187,000,000 This figure includes a little more than $31,000,000 spent in Mexico during the Q2. Recall, our 2019 capital program is front end loaded for the year, and therefore, we spent just over 70% of our budget during the 1st 6 months. With activity slowing in the U. S. And in Mexico, so will capital expenditures for the balance of the year. Turning to liquidity and hedging. At June 30, we had $359,000,000 of liquidity, including $270,000,000 of undrawn capacity under our RBL. In early July, we added 3 new lending institutions to our credit facility and with the support from our existing credit group, increased commitments by $250,000,000 to our current borrowing base of $850,000,000 This increased our pro form a liquidity position to just over $600,000,000 This strong endorsement from our lending partners is reflective of the focused conversion of reserves from PUDs to PDP since the business combination with Stone. To be clear, we do not currently have any near term plans to use this liquidity. However, we play substantial value in maintaining flexibility in a strong liquid balance sheet given the current market conditions. Moreover, to further strengthen our financial position and protect future cash flow, during the Q2, we added significantly to our 2020 crude hedge book. We hedged approximately 3,400,000 barrels of crude with a mix of swaps and collars that will protect revenues at an average swap or floor price of greater than $55 per barrel, while maintaining some upside to above $64 per barrel on our collars. Please refer to our 10 Q filed last night for additional details on our current hedge position. With that, I'd like to hand the call back over to Tim. Thanks, Shane. In conclusion, the second quarter was one of our best on record with production and adjusted EBITDA up, expenses down and margins at all time highs. Our U. S. Gulf of Mexico business continues to generate a significant amount of free cash flow, which is also expected to increase in the second half of the year and we have a peer leading balance sheet with one of the most conservative leverage profiles in the small mid cap universe. We are thrilled to have the recent drilling success in nearly all of our drilling wells that will continue to set us apart. We believe that Talos is very well positioned for a successful second half of the year and beyond. And with that, I'll now open up for questions. The first question comes from Jeff Grampp with Northland Capital Management. Please go ahead. Good morning, guys. Good morning, Jeff. I was curious, Tim, as oil kind of catching a bid today, but kind of leaking down towards the $50 range. How do you think about positioning Talos as you start to put together the $20 plan in a $50 world versus say a $60 world? What are kind of some of the gives and takes or just a said it in his remarks, I mean, one of the first things, one of the things we did in the last, I would say, 3 to 6 months is, we can't position this company to rely on being long oil. I think obviously that hasn't worked out for some folks in the past. And so when we have a number that we think we can hedge into, we want to hedge into this. So from a protected balance sheet, maintain a certain level of liquidity, have flexibility, I think Shane made all the right moves in the Q3 in that regard. As we think about next year and typically we do our budgeting process at this time of the year, we start thinking about it, we get through 2nd quarter earnings. Keep in mind, there's not going to be as much spend in Mexico. And so you can take a little bit of that off the board. We're going to spend a lot of time in unitization, a lot of time on our development plans and we want to get to FID and those are great milestones for 2020, but there's some capital that comes out of the system there. And then I think we look at really where the rig market is and what are some of the things we're trying to achieve next year. We want to hook up our discoveries. And so you kind of get into what's the maintenance capital look like and then what do you want to do or what do you need to do on top of that. But I think we can be flexible in our capital approach. We may not have that as much spending in Mexico and I think we got a good hedge book and I think all that sets up well for 2020. Got it. Appreciate those details. And for my follow-up, speaking of Mexico here, Block 31, obviously, had some nice success there. I was just wondering, given the shallower depths and the early success, could that potentially produce before Zama? I mean, I understand you don't want to front run the operator, but just from a high level perspective, what does the timeline look like from if that was FID to First Oil you think and how does that kind of relate to your Zama operations? Yes, yes, you're right in the fact that I don't want to front run the operator there. But I think look it is in very shallow water. It's very close to shore. It's a shallow oil play and it's very, very fresh. I mean, there's a lot to do just in getting through the rest of the year on that project. It's nice to have a little bit of encouraging results. Yes, it could. I don't want to signal that it will, but it could just because of those water depths. There isn't a unitization discussion, which is one of the things that we have to work through on the Zama process. All of the resource there is fairly constrained to the contract area. So there are some parts of that that are simpler to navigate. At the same token, we're just now scratching the surface on it. And obviously, if you look at what we've done in the appraisal of Zama, that discovery is fairly fully appraised. And so different projects, different timeline. Certainly, there's a case there, but probably too early for us to have specifics on that. The next question comes from John White with Roth Capital. Please go ahead. Good morning, guys, and congratulations on a strong quarter. Thanks, John. On the Bulleit prospect, you've got the DTR-ten and the MP fan. Is that well going to be dual completed? Or can you offer some more color on? Yes. That's a so we have pay in 2 zones. And I would tell you, this actually, you can almost go back to Jeff's question. I mean, I think one thing we have to sit down and ask is, it's great to have 2 thick sands. Rock properties in both those sands are very good, oil content in both those sands. So that checks all the boxes. I think the question is, do you want to potentially drill 2 wells and hook that up? Or should you pull back one well and have 2 completions? And a lot of that gets into the question that Jeff alluded to. What's the price environment? Where do you want to see your capital spend? Where can you get your best returns? And those look, we just logged the deeper pay over the weekend. And I think we got to take that in and process that and make a plan relative to where we think the market is, relative to where we think costs are. And then we'll probably guide that certainly by the end of the year, maybe even sooner than that. But we have to probably pull that in and figure it out. I think the broader takeaway though, Don, it's nice to have something 10 miles from something we own. I mean, I think really that well is more of an application as much of an application of the strategy as it is the project itself. Yes. You've got a big pile of sand there. It's very encouraging. Congratulations again. Yes. Thanks. All right. Thank you. I'll turn it back. The next question comes from Marshall Carver with Heineken Energy Advisors. Please go ahead. All right. All right. Pretty close on the firm name. Yes. I was thinking about that, Marshall, but how are you? I'm doing fine, doing fine. Tim, I'll ask a big picture question. How do you feel the business is going a year after the combination with Stone Energy? Yes. It's interesting because certainly sometimes you have to separate the market and it's obviously a difficult and choppy market and then the business itself. And putting the market aside, again, Jeff had a good question on where do you see the commodity going, etcetera. When I look back at the business, a year ago, you're taking a private company, you're kind of reversing into a public company, you're pulling that business combination together. We quickly added a disregarded asset by a major, pulled that in. And the question is, can we make all that excel? You hunkered down on cost savings, tried to look for prospects doing the reprocessing around those that infrastructure. And you fast forward a year, on a 75% unhedged margin, it's actually pretty interesting for us when you look back 3 years and we couldn't achieve that margin in an almost $100 environment. It really speaks to the paradigm shift of what I think is the right strategy for this basin. And even though there's a little more capital we wanted in the Q2, when you look at that golf business, it's ripping off quite a bit of free cash flow. We're reinvesting that in a discovery in offshore Mexico that what Mackenzie calls one of the best ones on the planet and one the lowest breakevens on the planet. So from where I sit, I really like what we're doing. I like how hard the team is working. I like what the cash flow these assets are producing and I like the margins we're achieving. We've got to just figure out how to continue to put that story out there and obviously we got to make sure we protect what we've built, so we can withstand a choppier commodity environment and general capital markets environment. But stepping back from that, I couldn't be more proud of what we've done to you later. Thank you. Thanks, Marshall. The next question comes from Richard Tullis with Capital One Securities. Please go ahead. Sure. Thank you. Good morning, everyone. Tim or Shane, if you could, where we sit now, what are the next steps expected toward moving toward FID at Zama, including the unitization process? Kind of how do you see it potentially playing out over the next couple of quarters? Yes. Hey, Richard. Look, we're in the middle of those discussions almost on a weekly basis with Pemex. And obviously, they haven't been able to drill their well yet. We hope they do. We still have a commitment to share the data. We do that quite often. And look, we have a lot of data we need to process. I know you heard my comments on how much data that was. I wouldn't underscore. I've been doing this a long time and Steve Heitzman is here, he's been doing it much longer than I have and we've never collected this much data. I mean it's a ton of data. We're putting it all together. We're sharing it with our consortium partners. We're going to share with Northland and Sewell. We're sharing with Pemex. And we've got to kind of get through that unitization hopefully by the end of the year. And then we've got to put all that in front of the government. We've worked well with them and then that has its own process. So that's why we've talked about that's really an objective for next year and that's also why you're not going to see us spend a lot of money on that project over the next year. I mean, there's a lot to do there, this kind of non capital intensive. The road map is there and we're trying to execute the road map. I wish I could tell you lock it down, we'll be done with unitization in X number of days. But there's a it's a different jurisdiction. There's an ebb and flow and there's a lot of data to process and a lot of decisions to be made. But I can just tell you that we are deep in those conversations right now. That's helpful, Tim. And just my follow-up, when you look at the M and A market, how do you see things currently given where we are with oil prices, the investor environment and really what properties are available currently? How do you see things right now? Yes. Look, I mean, we as you know, we're always looking. It's trickier, I think, for folks to think it's not as tricky when you don't have as robust of a public equity market it is. And so you have to be thoughtful about what you can get accomplished and what you might not be able to get accomplished and you only have so many resources in the office, you want to use them effectively. So you're looking at maybe smaller deals, You're looking at obviously want things that are accretive from a cash flow basis. We want things that fit our strategy to give us access to upside. I mean, we want the same things we've always wanted. We just have to kind of be a little more creative on what those deals might look like. We have to talk to more people. You got to work a little harder when the sources aspect of a sources and uses transaction isn't as easy to procure as it normally would be in a more robust market. So we've got a team as you know that's dedicated. It's all they do. These are guys who have been with us a long time, some of them through multiple companies and they know what works for us. But we've never not been in the market. I think it's rare we've been through a year and not transacted. Sometimes those are real material transaction Richard that you're aware of and sometimes they're smaller transactions. I think Bulleit prospect has really benefited from a very small transaction we did in the Q3 last year, but that made perfect sense for us. And so we'll see what the rest of the year brings, but it's certainly not as easy as it would be. But yet in theory, there's potentially more opportunities. You just have to be a little more creative. All right, Tim. Thanks so much. I appreciate it. All right, Richard. Thank you. This concludes our question and answer session. I would like to turn the conference back over to Tim Duncan for any closing remarks. No, I don't have anything in particular. I want to thank everybody for joining the 2nd quarter call. Obviously, we're very proud of the quarter. The team is working very hard and we look forward to continuing to provide updates throughout the rest of the year. So thanks for everyone's attendance. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.