Talos Energy Inc. Q3 FY2020 Earnings Call

Good morning and welcome to the Talos Energy Third Quarter 2020 Earnings Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Sergio Maiworm, Vice President of Finance, Investor Relations and Treasurer. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to our third quarter 2020 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 and in our Form 10-Q for the quarter ending September 30th, 2020, filed with the SEC yesterday. Any forward-looking statements that we make on this call are based on assumptions as of today and we undertake no obligation 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 at talosenergy.com. And now, I'd like to turn the call over to Tim.

Thank you, Sergio. Good morning to everyone and thanks for joining us today. I'll first address some key highlights in the quarter. Our production for the quarter averaged 48,600 barrels of oil equivalent. It was approximately 67% oil, 74% total liquids and 26% natural gas. Production for the quarter was substantially impacted by weather-related shut-ins, which we'll discuss in more detail later in the call. Our focus on cost controls throughout 2020 continues to show further results with lease operating expenses totaling $62 million for the quarter, which includes additional storm-driven costs and G&A expenses of approximately $14 million for a total lifting cost structure of approximately $17 per BOE. However, we expect the lifting cost structure will decline significantly from here with a more normalized production rate across the same largely fixed cost assets. For example, the same cost structure, assuming the midpoint of our expected exit rate of 71,000 to 73,000 barrels of equivalent a day would equate to under $12 per BOE. We ended the quarter with a leverage debt of 1.8 times net debt to the last 12 months EBITDA and with over $350 million of liquidity. We also put in place additional hedges for the next 24 months, which Shane will provide in more detail later on the call. Obviously, the most significant challenge of the third quarter was managing through an extraordinary hurricane season. Thus far this year, we've been impacted by eight named storms, with five of those in the third quarter alone. Managing weather-related risk offshore is part of our business. And this season is a reminder of the unique operational skill set that it takes to succeed in our basin. While extended shut-ins and evacuations impacted revenue and added costs and delays on development projects, we kept our employees and contractors safe throughout the season. And we were fortunate not to incur meaningful damage across our production facilities. Weather-related downtime in our businesses averaged five to seven days a year over the last seven years. But as of today, Talos has had approximately 35 weather-related downtime days this year. So it has been significant. We expect to see production return to normal shortly and our attention is focused on doing just that as we wind down this hurricane season. Although COVID continues to dampen commodity prices, disrupt our broader supply chain and cause operational delays, I'm very proud of how our various teams have responded to the situation and how we've managed to keep our employees and contractors safe. Despite these challenges, I’m extremely proud of both our offshore and corporate teams for preserving and continuing to deliver in a tough environment. As we complete our capital projects for the year, we look forward to getting the full complement of projects online in the fourth quarter. We're seeing great results from our Tornado water flood project with increased bottom-hole pressure and increased production from the producing wells. This project will shift significant value into a proved developed producing reserve category and ensures that this asset will remain a key contributor for years to come. We achieved first oil from our Bulleit development and we discovered significant resources from our Kaleidoscope project, from which we expect first oil later this month. Each of these projects utilizes unused capacity and facilities we own and operate. So the new incremental production introduces minimal additional operating cost and thereby is accretive to our margins. Repairs were also concluding in our Ram Powell facility, which we expect back online this month. This is a production facility where not only do we have impactful production that has been down for several months, but also where we host third-party production volumes and receive associated volume-based handling fees in addition to sharing in the OpEx of the facility, none of which is reflected in our third quarter results as a result of that shut-in. Finally, we expect BP to be on location this quarter in our Puma West exploration project, which could be an impactful value-creating catalyst as we exit 2020. Even with the delays, our budget goal for the year was to add diversity to our asset base utilizing the current production facilities we own, show significant additions to our producing reserve value and lower our operating cost structure. We believe this has bolstered the value of our assets. It makes us more resilient as we enter 2021 and instead of driving higher margins. In Mexico, we remain very active in unitization discussions with Pemex regarding our Zama discovery, and we're still very hopeful we can conclude that process in the coming months, allowing us to submit development plans and move closer to the final investment decision, or FID, in 2021. We continue to believe this project will have an enormous impact for Talos stakeholders and the Mexican economy, and we look forward to advancing Zama toward first oil. At the corporate level, it's worth highlighting that our first-ever ESG report was released last week, which we think tells a great story about the level of safety and environmental responsibility of our business as well as the multitude of initiatives we have in our community outreach efforts. I encourage you to read the report when you have the opportunity. We've always prided ourselves in being good operators, good corporate citizens, and good neighbors, and this report showcases that. With that background for the quarter, I'll turn the call over to Shane to discuss some further details of the financial results.

Thank you, Tim. And thank you again, everybody, for joining the call this morning. I'd like to first discuss the results for the third quarter in greater detail. Production averaged 48,600 barrels of equivalent per day for the quarter, which was at the high end of our revised guidance. Production included significant impact from storm-related deferrals and the Ram Powell shut-in, which was also extended by storm-related activity. Again, the production mix for the quarter was 74% liquids and 26% natural gas. Realized pricing for the quarter was up from the second quarter and averaged $39 per barrel and $1.78 per MMBTU, excluding hedges. Revenue was over $154 million, inclusive of approximately $19 million impact of realized hedge gains. Operating expenses and G&A continue to reflect the substantial cost savings due to the measures we implemented during the year. As a result, the company generated adjusted EBIT for the quarter of approximately $79 million, equating to margins of $17.59 per barrel. Capital expenditures for the quarter totaled approximately $132 million, inclusive of plugging and abandonment EPS for the quarter was an adjusted net loss per share of $0.52. As Tim noted earlier, we expect these margins to expand as we bring on shut-in production and start our new wells in the fourth quarter and will benefit from a high oil mix. Turning to our balance sheet, we ended the quarter with a net debt-to-LTM EBITDA ratio of approximately 1.8 times, pro forma for the acquisitions we closed in 2020. Despite significant shut-in volumes for the quarter, liquidity at September 30th was over $350 million, inclusive of $335 million available under our RBL credit facility and $32.4 million in cash, less outstanding letters of credit. We've recently begun our fall borrowing base redetermination process with our bank group and expect to successfully complete the semi-annual process by the end of the month, consistent with prior redetermination cycles. Additionally, we remain keenly focused on extending our debt maturity runway and, despite challenging market conditions in 2020, we continue to evaluate various opportunities to address the 2022 maturity of our existing notes. Our hedge position remains strong and we continue to opportunistically add both oil and natural gas hedges through the quarter. In addition to the high level of hedges for the balance of 2020, we have approximately 8 million barrels of oil and over 23 Bcf of natural gas hedges in 2021 at average prices of approximately $41.59 per barrel and $2.56 per MMBTU. We also have a solid base of hedges through 2022 on both the oil and natural gas side. The first nine months of 2020 have presented significant challenges, however, our people and our assets are resilient and we continue to anticipate exiting the year with a strong production rate, including the results of our successful 2020 capital program as well as the return to production of our Ram Powell facility and the return of other storm-related shut-in volume. This should drive strong results as we exit the fourth quarter and head into 2021 as a result of improved per unit cost from both our realized cost reductions during 2020 as well as materially increased volumes relative to the third quarter. With a strong fourth quarter, a healthy balance sheet and the completion of our borrowing base redetermination, we will be well positioned to start 2021. With that, I'd like to hand the call back over to Tim for final comments.

Thank you, Shane. The quarter presented numerous challenges for us beyond our control, including storms and COVID-related issues. But I reiterate my compliments to our team for pushing through these difficulties. We have continued to move forward despite these challenges while keeping the core business strong as well as retaining our ability to continue to drive meaningful value creation. We believe we'll end the year with a more robust set of assets and be better positioned to manage any commodity price scenario of 2021 with a better cost structure across a larger, more diversified asset base than we were when we entered 2020. And with that, operator, we'll open the line for Q&A.

Thank you. The first question comes from Michael Scialla with Stifel. Please go ahead.

Yes. Good morning, guys. I'm wondering if it's possible if you could characterize the kind of meetings you're having with Pemex at this point. Is it meetings with their technical folks or more with senior management? Anything you can say there?

I think it's fair to say that we've always had meetings with the technical teams throughout this process. I've mentioned that in previous calls. There are work groups where we share ideas and plans, which has been very positive. At this stage of the negotiations, we are elevating discussions to higher levels within the organization. Senior management is getting involved, and my involvement has increased as well, leading to more frequent meetings. The discussions are progressing as we hoped, especially during this critical period where we were instructed to make every effort to unitize. I'm encouraged by the dialogue we're having, with almost weekly calls focused on pushing us across the finish line. Everyone is working very hard, and we feel confident about the contributions we’re making and the data we’re presenting. The pace of our meetings has picked up significantly in the last couple of months, although there's no guarantee.

It's encouraging, Tim. I know there's a million things up in the air right now, but any preliminary thoughts you could provide on what 2021 might look like in terms of your activity?

Yes, it's interesting. I believe this is a time for wrapping up our plans. However, we would like to take a bit more time. We originally aimed for our capital program to conclude around September, ensuring a clean fourth quarter to build up some free cash flow and possibly reduce our debt a bit. The storms have delayed the completion of that capital program to November. I hope we can achieve a strong exit rate and generate substantial free cash flow over the next few months. Therefore, I am not eager to start another capital program immediately after finishing this one. Additionally, we do not have long-term contracts in place. We've expressed confidence about our operating cost structure coming out of this year, giving us some time to consider our approach for 2021 and our objectives for the year. I don't anticipate 2021 being a year focused on production growth; instead, it will likely be about maintaining our current levels. I expect our capital expenditure to decrease next year rather than increase. We aim to advance Zama's value alongside other projects that interest us, and we are seeing a positive response from our water flood project, which we will revisit. There are foundational elements to work with, but we want to conclude this year's capital program, take a breath, and then define our goals for 2021. While previous years may have had clearer plans, this year we want to maintain the flexibility that comes from not having long-term contracts.

That makes sense. I have one last question, perhaps for Shane as well. I understand you're currently going through the re-determination process. Could you provide any insights into what you're requesting in that regard? Are you aiming to increase the borrowing base or simply keep it steady? Any information that could help us understand the direction of that process would be appreciated.

Yes, Michael. Great question. So, as I sort of indicated a second ago, we are still in early days there, but you asked the question probably the right way, which is kind of what are we looking for out of what we'd like to do. I think, two things that I kind of put into that. One is, what's happened with the business. And again, we've got a successful capital campaign. So that's all sort of going into the mix. Obviously prices have rebounded a little bit since the spring. So that's going into the mix as well. And then I look and see what else is going on in the marketplace. And again, we tend to be a little bit later in the cycle. So you get a look at sort of how all those are coming out. And I think, by and large, most of those have been concluding either flat or maybe down kind of single digits a little bit. And look, I don't think our process will be outside of those bounds in terms of where we ultimately end up.

Look, I'd add to that. Obviously we lowered our capital program year-over-year like everybody else in the market. I think what we kept in the capital program is focused on kind of growing that value. And so, I think that's what we want to bring to the table in this borrowing base redetermination season.

That helps. Thank you, guys.

All right. Appreciate the questions.

Thank you. The next question comes from Richard Tullis with Capital One. Please go ahead.

Hey, thanks. Good morning, everyone. Tim, going back to the Zama unitization at a high level, is there any one discussion point or area that is making better progress or maybe is going a little slower, whether it might be reserve split, decision on operatorship, anything along those lines that you might be able to tell us?

No, I don’t want to reveal anything too specific here, Richard. However, it's common for every operator involved in a unitization to face similar tendencies. First, you have a significant contract at play. This means you're negotiating not just the unit but also a complete operating agreement. You need to consider the asset in the context of its entire lifecycle, which brings various concepts to the table. While there are key points regarding operatorship and equity splits, we also need to think about how we might revisit those equity splits to ensure all parties feel there is fairness. These are fundamental aspects of any unitization discussion. Additionally, it involves forming a new partnership and creating a new operating agreement, alongside all the necessary components. For those who have participated in large international projects, and ultimately will be four partners—three on our side and then Pemex—there's a lot to discuss in a document like this. The process has its natural ebb and flow, with some information kept closer to the vest as deadlines approach. Those of us experienced in negotiations understand this. While I don’t want to preview anything specific, we certainly have our priorities, which you can probably guess, and I believe other parties do too. As the deadline nears, things will start to move more quickly. These negotiations are not unlike others I’ve been a part of in different jurisdictions.

Thank you. I appreciate that. Just secondly for me, we've seen a good amount of M&A activity on the onshore area over the past couple of months. What are you thinking the opportunities might be in the offshore area, say, over the next several quarters, Tim?

I often receive questions about mergers and acquisitions and whether I see opportunities in the market. My usual response is that there is always something available for sale. This could range from a major player considering the sale of certain assets to smaller, tactical opportunities that we have previously pursued, such as acquiring single assets or small entities with a few assets. I believe there are always opportunities to explore. We categorize our deals into two types: strategic and tactical. I anticipate that we will have some tactical opportunities within the next six months, as there frequently are. While these deals may not have a large impact on the business, they are usually beneficial on a local level around our assets. Strategic deals, on the other hand, tend to be more complex in the current environment. You might have noticed that larger, investment-grade companies are navigating these challenges more easily, especially since smaller firms face issues like change of control that complicate the process. We remain active in the market and are continuously looking for opportunities, although it is difficult to predict what may materialize in the next six to twelve months due to varying market conditions. I believe stakeholders are aware of these conditions, and we need to be patient as we assess the landscape. Our team is dedicated to this focus, constantly monitoring the market, although forecasting specific deals can be challenging.

Well, that's all from me. Thank you, Tim.

All right. Thanks, Richard.

Thank you. The next question comes from Steven Dechert with KeyBanc. Please go ahead.

Hey, guys. I just wanted to see, with the project delays announced and the operational update, what do you see as the impact to 4Q production?

I think it's interesting that we felt confident in restoring our production to pre-hurricane levels, as mentioned during the call regarding the downtime. We anticipated those impacts in the third quarter before this recent storm series. However, with another storm potentially looming, we may need to reassess. Each storm requires us to evacuate around 300 personnel and relocate a rig, whether it's a floater or a fixed rig, which introduces delays that could affect our key projects related to our exit rate. While we remain optimistic about our exit rate, we also need to consider the quarter ahead. There's still some uncertainty, but we feel positive about our cost structure and other aspects discussed on the call. Delays do play a role, and even when it seems like we've moved past the storm season, it may not be over yet. If necessary, we will revisit this situation when the time is right. Our exit rate is contingent on new projects, some of which are experiencing delays, but we'll continue to work diligently and reevaluate when needed.

Got it. Okay. And then, just as a follow-up, is there any additional color you can give on potential bond refinancings here in the near term? Thanks.

Yes, certainly high priority. Let Shane maybe give some thoughts on that.

Yes. Yes, good question. So, look, I'd say a couple of things on that. Number one, from my seat and the team on the finance side, obviously that's one of our highest priorities. So we spent time thinking about it. Number two, look, if you look at the course of this year, maybe not as much in the third quarter, but we've reduced over $40 million of that maturity. So, in some ways, in effect we have been addressing it, although not necessarily refinancing the entirety of the deal. Number three, look, I think there's a variety of options to do that. We evaluate all that and we're well aware of them. And our priority has been trying to do a regular way new money issue. And just with the state of the market year-to-date, we haven't been able to do that. But we're still hopeful to get to that end.

Okay, great. That's all for me.

All right. Thanks.

Thank you. The next question comes from John White with ROTH Capital. Please go ahead.

Good morning. Thanks for taking my question.

Hey, John. How are you?

I'm good. Good. Since you're comfortable with the exit rate, does that by implication mean you're happy or satisfied with the way the midstream and infrastructure repair and restoration is going?

Regarding our Ram Powell asset, we have some repairs that are being addressed further downstream in the broader Gulf of Mexico.

Yes. Further downstream, you addressed it.

Yes. The Ram Powell asset is where the export riser is located. As we process our production, the oil riser eventually leads to a sales point, and there is a very minor repair needed, but it's offshore. Even small repairs require significant manpower and time. This crew has probably mobilized four times already. We'll get that repair done and feel confident about it; we just can't seem to find a suitable weather window, as calm sea conditions are necessary. Once that’s finished, we look forward to getting our production back online. Additionally, we've effectively commercialized our facility and are hosting third-party volumes, which help to offset our operating costs. You mentioned midstream and downstream issues, which is a valid point when considering shut-ins. After hurricanes, we assess our facilities and are fortunate not to have sustained damage. However, we may experience delays in bringing our production back online due to pipelines requiring extra time to accept our oil or gas, or because a gathering facility, like the terminal that handles much of our production, may have faced damage. We do our best to understand the impacts and predict how long it will take to resume operations; sometimes we can come back in 48 hours, other times it takes four days, and that varies. Everything seems to be stabilizing now, and we're gradually restoring production. The key will be to reach a consistent run rate so we can produce over longer periods, allowing for a clean quarter. This year has been challenging, as illustrated by 35 days down when historically we averaged five to seven days over the past seven to eight years. It's difficult to integrate that into guidance, and I believe this is a concern for all offshore operators moving into next year.

Well, thanks a lot. And let's hit this hurricane season goodbye.

I'm looking forward to it. Take care.

Thank you. There are no further questions at this time, I would now like to turn the conference back over to Mr. Duncan for any closing remarks.

Thank you for joining the call. 2020 has certainly been an interesting year, especially with the campaign bringing our base into focus. I believe things are starting to calm down. We faced challenges with COVID, which impacted our workforce and supply chain management, along with a historically difficult hurricane season this year. While these factors haven't made our business any easier, we are proud of our current position and optimistic about how we will finish the year and our prospects going into 2021. We are confident about the opportunities ahead of us. Our team has successfully navigated crises before, including commodity pullbacks and other basin challenges, and they are once again executing effectively. We look forward to concluding this year and discussing plans for 2021 as we approach that time. Thank you for your support and for the questions. I look forward to speaking with all of you again soon.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.