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Talos Energy Inc. (NYSE:TALO)
Q1 2020 Earnings Call
May 7, 2020, 11:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Talos Energy First Quarter 2020 Earnings Call. [Operator Instructions]

I'd like to turn the conference over to Sergio Maiworm, Vice President of Finance, Investor Relations and Treasurer. Please go ahead.

Sergio L. Maiworm -- Vice President --Finance, Investor Relations and Treasurer

Thank you, operator. Good morning, and welcome to our first quarter 2020 earnings conference call. Speakers on the call today 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 on our Form 10-Q for the quarter ending March 31, 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 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-GAP measures was included in yesterday's 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.

Timothy S. Duncan -- President and Chief Executive Officer

Thank you, Sergio. I look forward to discussing are results for the quarter as well as recent developments with the company and the industry. The combined effects of the COVID-19 pandemic and the associated sudden drop in global demand across all sectors of the economy have rapidly resulted in an unprecedented situation for our industry. The environment is challenging, but it is a challenge we are working every day to meet and emerge as an even stronger and better-positioned company that before. Our first and foremost priority is always the health and safety of our employees, our contractors and the community. In recent weeks, we bolstered our offshore HSE procedures to include daily temperature scans, consistent use of face masks and social distancing in their daily work and health surveys and other advanced screening techniques as we onboard new crews. To date, we have not encountered any COVID-19 cases among our offshore workforce. We also quickly moved our corporate staff to work-from-home status. As various jurisdictions in which we operate begin to reopen, we stay vigilant to continue to protect our people, their families and our broader network of suppliers and partners in the community. I still believe Talos is well positioned to weather this current commodity downturn.

As I mentioned in our last call, we entered March with the right ingredients to manage an abrupt decline in oil prices. We have low leverage, high liquidity, robust hedges and minimum long-term commitments. With our recently expanded asset portfolio following the closing of our acquisition, our asset base is more diverse and resilient than ever with a broad production base across the asset life cycle, highly competitive margins and a flexible portfolio of opportunities that utilize our infrastructure, allowing us to generate material free cash flow in the first quarter and still remain free cash flow positive for the full year 2020, even at current strip prices in combination with our hedges. With respect to the acquisition, that transaction closed on February 28 of this year. The transaction brings interest in numerous high-profile Gulf of Mexico assets, such as Marmalard, Odd Job and Claiborne. It also substantially increases our exposure in our Mississippi Canyon core area while introducing new partnerships with other high-quality operators throughout the Gulf of Mexico. At closing, we benefited from the free cash flow adjustment from the effective date of July 1, 2019, which reduced our cash consideration at closing. We also used our equity to finance a large part of the transaction, with the number of common shares issued to the seller being fixed when we signed the contract in December of 2019. For the last 12-month period ending March 31, 2020, these acquired assets generated an average daily production of just over 19,000 barrels equivalent a day and continue to produce an average of 19,700 barrels equivalent a day in the first quarter of 2020. The transaction is also providing encouraging near term upside, such as the successful drilling of the Claiborne #3 development well that was recently announced. We expect that well to be online by midyear this year. You've also seen the announcement of an impactful third-party discovery in the region, Equinor's Monument discovery, that may unlock value from our offsetting primary term acreage that we acquired in the transaction that is on trend with this announced discovery.

However, as we entered March, the markets deteriorated during the spread of COVID-19 and the associated government-mandated economic shutdown, and we've rapidly responded to the evolving situation by reducing our capital spending and deferring or canceling growth projects, reducing our operating costs and reducing our G&A expenses. When considering the assets we currently own, on a pro forma basis, our capital budget is now 40% lower than the capital program across the same set of assets in 2019. On a similar basis, total operating and G&A costs are down 15%, and we expect to continue to find more savings as we work with our suppliers and service providers. We expect to continue to benefit from our strong hedge book throughout the year, and we have continued to opportunistically add additional hedges. Looking forward to the second quarter and second half of 2020, we will continue to execute on our adjusted and reduced capital plan, which focuses on previously committed or already commenced projects that remain attractive even in the current environment. Each of these projects utilizes existing infrastructure that we either operate or have access to. That allows for a quick turnaround to production, leads to improved margin profile within our own infrastructure and increases the collateral value of our portfolio, resulting in the best possible liquidity position to withstand any uncertainty with respect to the direction of the commodity markets.

So with that backdrop, let's turn to our highlights of the quarter. And as a reminder, all figures include one-month of results from the recent acquisition. Production for the quarter totaled 58,100 barrels equivalent a day. Production in March was 70,300 barrels equivalent a day. The 58,100 barrels equivalent a day ties to an EBITDA which remains strong at $148 million, inclusive of hedges. Capital expenditures for the quarter, inclusive of P&A, totaled approximately $73 million and included a $7.6 million Seismic change of control expenditure from our 2018 Stone Energy transaction. We have positive $0.27 adjusted earnings per share, continuing a trend of six straight positive adjusted EPS quarters. Free cash flow for the quarter totaled approximately $49 million and was our third straight quarter of solid free cash flow. As we move into the second quarter, the flexibility provided by a broader and more diverse portfolio gives us more optionality to respond to the current price environment while maintaining a healthy production base. In recent weeks, we've initiated production shut-ins in several fields in order to either accelerate previously planned maintenance and upgrade activities or reduce production where it makes sense to do so in the near term. The company has not yet encountered any required production shut-ins resulting from midstream or storage capacity constraint. Approximately half of the current shut-ins are driven by the acceleration of various maintenance and other activities planned throughout 2020, which should better position the company later in the year as prices improve. Importantly, we are continuing to monitor the market environment and work with other operating partners from our in our nonop assets regarding additional potential shut-ins and production planning in the near term. As mentioned in our earnings release, Talos recently took delivery of both a Helmerich & Payne platform rig as well as the Transocean Discoverer Inspiration drillship. Both rigs are conducting previously planned relatively low-risk projects, including the Kaleidoscope exploitation well near our Green Canyon 18 platform, the hookup of our Bulleit discovery and then our Tornado waterflood project. Upon completion of these projects, Talos currently plans to release the rigs, utilizing the flexibility from our short-term contract.

While we focus on the immediate environment and best positioning our business for the near term, we're also continuing to advance our Zama discovery toward a final investment decision as we push the delivery of our engineering and design work. In the coming weeks, we expect completion of a key regulatory step to declare Zama a shared reservoir, following by a directive and the time line from the government to complete unitization. We are continuing to progress on the project to reach FID as soon as possible, and we look forward to moving our world-class discovery to the next phase and eventual first oil.

I'll now turn it over to Shane to discuss the details of our financial results.

Shannon E. Young -- Executive Vice President and Chief Financial Officer

Thank you, Tim. I'd like to provide some further details on our financial performance during the quarter. In the first quarter, we continued to maintain strong margins, low leverage and good liquidity, which included the impact of our acquisition of assets, which we closed on February 28. As prices declined in the second half of the quarter, our strong hedge book began to provide material cash flow benefits, helping to sustain strong EBITDA margins of over 80%.

Highlighting a few key results for the quarter. As Tim mentioned, Talos generated production of 58,100 barrels of oil equivalent per day in the first quarter of 2020, including one-month of results from the assets acquired in the ILX transaction. For the month of March, we produced over 70,000 barrels of oil equivalent per day, including the impact of the transaction after closing. The company received an average realized price of just under $45 per barrel of oil, roughly in line with the average WTI prices over the same period.

Talos generated adjusted EBITDA for the first quarter of $148 million, representing a margin of $28 per barrel of oil equivalent and an 81% of operating revenue. Talos generated free cash flow for the quarter of approximately $49 million, after capex of approximately $73 million. We closed the quarter with a liquidity position of $593 million, including $486 million available under the company's RBL credit facility and approximately $107 million of cash on hand. The company also ended the quarter with a conservative leverage position of approximately 1.2 times LTM EBITDA on a pro forma basis, inclusive of a full 12 months' impact from the acquired assets, calculating EBITDA in accordance with our credit agreement.

Talos has recently begun its next biannual borrowing base redetermination process and, as is the normal course, expects to announce results around the end of the month. Clearly, bank pricing has come down in the current environment. But we have supportive partners in our bank group, our assets have performed well, and we have solid reserve adds to the borrowing base. Our early read is that while we will see some reduction in the borrowing base, it will be very manageable as it relates to maintaining strong liquidity, and it will be more than sufficient in the current market environment. One reason it was nice to go into the downturn with $600 million of liquidity was to be positioned to absorb some volatility.

Following our initial 2020 financial guidance provided on February 18 this year, global demand for oil deteriorated substantially, resulting in a dramatic drop in crude prices. As a result, Talos has responded by aggressively reducing 2020 capital and operating costs, including deferring or eliminating noncommitted capital projects, reducing LOE and G&A expenses and other cost-saving measures. In aggregate, we have taken over $200 million of capital, operating and overhead costs out of the system for 2020 and reduced capital alone by approximately 40% relative to pro forma 2019 levels. The impact of these project deferrals and approximately 6,000 barrels per day in the second quarter of temporary outside operated shut-ins has been roughly 8% on production for the full year. And we feel we will remain cash flow positive for 2020 at current commodity prices, inclusive of our hedges. Finally, Talos continues to benefit from its strong hedge book throughout 2020. For the remainder of 2020, the company currently has approximately 10.3 million barrels of oil hedged or over 80% of our expected oil production for the remainder of the year at a weighted average price of $47.29 per barrel. We have recently added gas hedges to our book for both the second half of 2020 and the full year 2021 and feel good about where we are on gas as well.

With that, I'd like to hand the call back over to Tim.

Timothy S. Duncan -- President and Chief Executive Officer

Thank you, Shane. In closing, we're pleased with our financial performance for the quarter. On a broader level, despite the immediate commodity market backdrop, we must take stock that we are a stronger, more diverse and better-positioned company than this time a year ago. We successfully appraised and advanced a world-class international discovery. We consistently executed operationally with a busy drilling and development calendar, and we completed a major acquisition that significantly increased our production reserve base and inventory for the future. We've done all this while maintaining a consistent low leverage profile, increasing liquidity and better positioning the company for the current environment we now find ourselves in. And we've quickly responded with the reallocation of capital and significant cost reductions.

Even though, we expect a pullback for the entire industry, including Talos, in the second quarter, we're still focused on generating positive free cash flow for the year, inclusive of our hedges, even if the current strip holds. Our team has deep experience in our basin through multiple commodity cycles, including successfully navigating the 2015 and 2016 downturn, and we are confident in our employees, our assets and our ability to persevere despite the abrupt shift in oil prices in the near term. While we continue to take prudent steps and prepare for any environment in the coming months and year, I still believe that Talos is in a position to thrive as we look toward the future.

And with that, we'll now open up the line for Q&A.

Questions and Answers:

Operator

[Operator Instructions] Our first question today will come from Jeff Grampp with Northland Capital Management.

Jeff Grampp -- Northland Capital Management -- Analyst

Morning, guys.

Sergio L. Maiworm -- Vice President --Finance, Investor Relations and Treasurer

Hey, Jeff.

Jeff Grampp -- Northland Capital Management -- Analyst

Hey. Tim, I was hoping I appreciate the remarks on Zama, and I know that's kind of fluid and, ultimately, kind of hard to predict. But can you, as best as you can, kind of walk us through timing of next events? And in particular, I guess, wondering, when does the decision ultimately need to be made on operatorship to allow you guys to kind of continue to move forward to FID?

Timothy S. Duncan -- President and Chief Executive Officer

Right. Yes. Well, look, thanks for the question. And by the way, I hope you're doing well out there in California. But the case in Mexico has always somewhat been the same. We knew when we went down there that our role is going to be important. Obviously, it's an oil-producing nation. It relies on oil revenue as part of its treasury, and we knew we had to execute and we had to execute well. And we think we've done that. And now we've kind of entered this space because of the discovery that will be certainly maybe even bigger than we thought, and part of that discovery, we believe, goes on to that lease next door. We had an obligation under our contract to make this filing that we call an Aviso. It lets the government know that by our analysis, after the appraisal that we believe we have a shared reservoir. It feels like common sense. But look, it's a filing we had to make. We made that filing with SENER, which is the equivalent of the energy department down there. Obviously, there's a technical element to that filing. So then they lean on CNH, which is the technical regulator and the leasing regulator, who then renders a decision on our information of, yes, that is or isn't in a shared reservoir. Now these are filings that we would make, Jeff, if it was BP on the other side or Shell and BP on next door leases. So this part of it doesn't have really anything to do with Pemex specifically being our neighbor.

Now along the way, we've been talking with Pemex. We have a preunitization agreement with Pemex. I would call that kind of a parallel process, and that has its own cadence. I've talked about that in the past. It has its own speed. Certainly, COVID slows that down. It's a culture where face-to-face is helpful. So in the interim, we're going through these filings. We believe the CNH will render a decision fairly quickly that it's a shared reservoir, which then takes that back to SENER. And then SENER says, look, we formally want to see you guys engage and wrap up this unitization discussion process. So there's a little more, I would say, government emphasis on wrapping up the process then maybe there would be if we were just normally, through normal business practices, trying to negotiate the unit.

So again, hopefully not too confusing, but we've been running down these parallel tracks. Those parallel tracks are going to merge into something that the government has an expectation we try to wrap up. Now that doesn't mean it gets wrapped up in four and six weeks, Jeff, it could take anywhere between three and six months to wrap that up. And that does push maybe the FID to where we wanted it to be maybe in the middle of this year toward the end of the year. It's just a reality of: one, the negotiations; two, I think, the inconveniences and inefficiencies of COVID. It just kind of is what it is. Now once we get that wrapped up, the process is then, and I think we've had graphics to show this, we file our development plan because, again, you want to file the development plan as a partnership. And then part of what unitization does, it pulls that partnership together. We file that development plan that has a ruling, and then you've reached FID and you start construction. So we've always said it's around 2.5 years post FID to construct and get to first oil. That's that to me is less uncertain, if you will. It's always been about pulling this process and pulling this partnership together kind of in the unitization.

And so the progress is, I think, we're seeing a little more tightening from a government process so that we don't have just simply an independent negotiation, you have something that's coming together with a little bit of oversight, which we think is just net helpful through the process.

Does that answer your question?

Jeff Grampp -- Northland Capital Management -- Analyst

Got it. Yes. Super helpful. And then my follow-up on the shut-ins and the deferred production that you guys are looking to implement in 2Q. Can you guys just talk what's assumed in guidance in terms of bringing that shut-in production online? I assume the accelerated maintenance is pretty straightforward and that will come on when that's done, but what are you guys kind of seeing on the shut-in front?

Timothy S. Duncan -- President and Chief Executive Officer

Yes. It's interesting. I'm sure it's a hot topic as you go around the portfolio of companies you cover. And I would tell you, just when you think about it offshore, it's, actually, maybe just a little bit trickier. Onshore, obviously, they've got a lot of things they think about. They think about their basis differential, they've got onshore wells, their proximity to their handling facilities is pretty quick and pretty short. When we go offshore, you have a different range of assets. You can have a subsea well that flows 20 miles that might just have variable costs. You could have a platform that you operate that's got 40 people on it that has a higher fixed cost. And so we shut-in offshore all the time. We have downstream maintenance issues if we have a third-party pipeline shut-in, if we have to shut in for a named storm. So we're not unfamiliar with shutting in. I think shutting in for extended periods of time, as you think about our reservoirs, is something you have to think about in terms of the long-term health of the reservoirs. But we do it every 2.5 years in the Phoenix deal for dry dock.

But I do think our fixed cost structure tends to be a little higher. Now there are areas for us where we have production handling agreements to create revenue in our facilities. So the Phoenix area, our Pompano area, Green Canyon 18. We actually have revenue we get by handling third-party production that drives down our breakeven, that's helpful. But I think the overarching emphasis is on liquidity. Are these decisions to shut in liquidity accretive? Are they liquidity enhancing? And it's not those calculations really vary from asset to asset offshore, I would say in a more complicated way than they do onshore. And I think because of that, as things start to rebound, I suspect you'll see these decisions to bring offshore assets back up quicker than maybe you will see on onshore where they just have a little more flexibility. So we expect, and which is why we try to do make our best attempts in our guidance, we expect to, obviously, see quite a bit of shut-in in May. Those may persist through June. We would expect some of those we would expect things to start running a little closer to normal in the second half of the year.

Jeff Grampp -- Northland Capital Management -- Analyst

I appreciate the time. Tim, thank you.

Timothy S. Duncan -- President and Chief Executive Officer

All right, thanks for the question.

Operator

[Operator Instructions] Our next question comes from Marshall Carver with Heikinen Energy Advisors.

Marshall Carver -- Heikinen Energy Advisors -- Analyst

Yes, good morning and Thank you for the updates, and I'm glad that you don't have any COVID cases in the company, that's good to hear. I guess, my question, you've had that prudent reduction in spending and really a rapid response this year reducing your spending quite a bit from the original guidance to now. How should you've given guidance around 2020 production, how should we think about the lower spend this year is impacting next year? I know you haven't given any guidance for next year. But how should we any color you have on that? And do you have as a follow-on to that, do you have a maintenance capex that we should think of for your company?

Timothy S. Duncan -- President and Chief Executive Officer

Yes. Well, look, I think on the maintenance question, I would almost argue, you're looking at it in the new guide, if you will. Again, less, obviously, shut-ins that when you think about building a budget, you don't think about those shut-ins as a general matter. So if you look again, I think what I talked about in the transcript and in the earnings release and in my quote, if you look at the assets we own, let's just take March because March was kind of a clean rate with the assets that we purchased, you think about those assets and pull those assets back to 2019, I think that, that total capex spend and you would have to reconcile this with our capex and then our announcement deck, Marshall, but I think I would take you to about $600 million. And so now you have the midpoint of this updated guidance somewhere around $360 million, $370 million, so that's where you get to the 40%. If not for the if not for some of the shut-ins that obviously are here for various reasons and the dramatic drop in oil price, you would be somewhere around a flat number. So that gives you maybe a little color around maintenance.

But thinking forward to next year, here's what I would tell you, we and I think we've talked about this in the past and maybe I've talked about it in previous calls, you think of our capital program somewhat like a tower and you stack in the obligations. And obviously, there's some P&A we have to do every year, we can try to have some flexibility around that. But there's some compliance related to P&A offshore, that's a certain part of our program. In a full year, maybe that's 12% to 13%. As we pull some back, move the timing around, maybe it's 8% to 10%. There might be some other things that we spend money on, but we pull a lot of that back. So we're going to pull back the G&G. We're going to pull back some of the leasing, maybe have some minimum dollars in there. We you noticed, in the first quarter, we had a previous G&G payment on Seismic related to the merger in Stone in 2018. So there might be a little bit of that in the system. We do like to do asset management. That's typically been somewhere around 15% of our capital program because those help the profitability of our assets. They help us manage P&A. You know what those are, Marshall. They're are kind of recompletion, changing out pumps, things of that nature. So that asset management stays in there.

And then we get to the drilling. And look, as much as we like to explore, and trust me when I say we like to explore, we know we have to pull some of that back when we're in a softer commodity environment. Obviously, those are the first things that we had to cancel and, hopefully, just defer, frankly, from this year to next year, we might have to defer those further. And it's one of the reasons we try to keep contracts short, so we don't find ourselves forcing ourselves into wells that you ought to defer, which, again, is the exploration stuff. What we try to keep in the system are those things where we're utilizing our infrastructure in a very quick way. And so the Bulleit well, we found it, we're hooking it up. The well we're drilling on Green Canyon 18 with a platform rig, if we have success, we're immediately hooking that up. The waterflood project is a well that kind of immediately has impact. And the reason we do that is because we're taking either reserves that aren't booked that we think are low risk or we're taking reserves in PUD, and we're putting those into the proved development category to kind of raise the collateral value of our assets. And that's one thing, I think, Marshall, we're constantly focused on, isn't just low leverage, it isn't just liquidity, but to maintain that liquidity, do we have a reserve base that's highly developed, it's got high collateral value that we can work with our bank group?

And so those investments, to the extent we can keep them in, are going to stay in. And that recipe is going to be repeated depending on the environment next year. So you can kind of guarantee that those key elements we're going to keep in are probably going to stay. And the question is, will we get the price support to add back some of the elements that, obviously, we needed to cancel this year.

Did that make sense?

Marshall Carver -- Heikinen Energy Advisors -- Analyst

Yes. Okay. Yes, thank you very much.

Operator

[Operator Instructions] Seeing no further questions, this will conclude our question-and-answer session. I would like to turn the call back over to Tim Duncan for any closing remarks.

Timothy S. Duncan -- President and Chief Executive Officer

Right. Thanks, operator. Look, we want to thank everybody for joining the call. We know there was an array of calls this morning as all of us are putting out our guidance in a similar time frame. Certainly, it's unprecedented times. It's we've navigated several of these cycles before. We have a team in place that is used to this. This one clearly is different. Everyone is working as hard as they can. We feel very good about the position we're in. We feel good about our response to the crisis, our commitment to keeping our folks and our community safe, but we're also mindful of making the right decisions to keep this company in the right footing that it makes it through this crisis and, frankly, comes out the other side in a position to flip from defense to offense.

And so we're going to keep working very hard. We appreciate your support of the company, and thanks for participating in the call.

Operator

[Operator Closing Remarks]

Duration: 28 minutes

Call participants:

Sergio L. Maiworm -- Vice President --Finance, Investor Relations and Treasurer

Timothy S. Duncan -- President and Chief Executive Officer

Shannon E. Young -- Executive Vice President and Chief Financial Officer

Jeff Grampp -- Northland Capital Management -- Analyst

Marshall Carver -- Heikinen Energy Advisors -- Analyst

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