Talos Energy Inc.
Q3 2008 Earnings Call Transcript

Published: 6 Nov 2008

[Operator:]

Good afternoon. My name is Erin and I will be your conference operator today. At this time, I would like to welcome everyone to the Stone Energy third quarter 2008 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions) I would now like to turn the call over to your host, Mr. David Welch.

[David Welch:]

Thank you very much, Erin. Hello everyone and welcome to our third quarter conference call. Joining us this afternoon is Ken Beer, our Senior Vice President and Chief Financial Officer. First, Ken will read the forward-looking statement warning and then briefly walk you through the financials. Then I'll come back and make a few general comments about the quarter and the future. Following that, we'd be happy to take your questions. Ken?

[Ken Beer:]

Thank you, Dave. Let me start with the forward-looking statement. 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 uncertainties normally incident to the exploration for and development, production and sale of oil and natural gas. We urge you to read our 2007 annual report on Form 10-K 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 to be non-GAAP financial measures as defined under the exchange act. Please refer to the press release we issued yesterday, which is posted on our web site for a reconciliation of the differences between the financial measures and the most directly comparable GAAP financial measures. Rather than go through the financials in great detail, I'll assume everyone has seen the press release and the attached financials. This was a very unusual quarter with a lot of moving parts. The biggest news item of the quarter was obviously the Bois d'Arc acquisition on August 28. A $1.65 billion transaction which was paid for using $935 million in cash and the remainder which was $11.3 million SGY shares valued at $63 per share at the signing date in late April. The second biggest news item was the double hurricane impact especially on production. Unfortunately, due to the September hurricane shut-ins, the Bois d'Arc had minimal impact on production and minimal impact on the quarterly income statement. However, the impact on the balance sheet was significant, which I will walk through shortly. Our quarterly net income totaled around $34.1 million or $1.04 per share. The discretionary cash flow is around $164 million. The cash flow figure was bolstered by deferred taxes of about $67 million. Production for the quarter came in at 129 million cubic feet equivalent per day, well under the second quarter rate of 196 million cubic feet a day. Yet this decrease was primarily the result of the September volumes lost due to the hurricane shut-ins. This impact was estimated at around 77 million cubic feet a day for the quarter. As noted in the release, production now has climbed to over 210 million cubic feet a day and we estimate production to exit the year around 275 million cubic feet a day, as third-party pipeline repairs are completed. Oil and gas price realizations for the quarter came in at around $107 per barrel and $10.72 per Mcf or very attractive blended rate of over $14 per Mcfe. I do not expect to these realizations in the fourth quarter because of the dramatic decline in prices in October. However, we do have some price protection in the fourth quarter of '08 with about 80 million cubic feet a day of gas protected at an average price of $8.75 and we have oil floors which are in the $60 to $70 per barrel range. Additionally, we have what appears to be attractive hedges in place for 2009 on a portion of our volumes. Our current hedge schedule is included in the release. We had $5 million in recognized derivative income and $120 million positive swing in accumulated other comprehensive income in our equity line due to the increase of the value of our hedges over the quarter. A small silver lining to the declining oil and gas prices. Our third quarter LOE was flattish with second quarter reduced LOE activity caused by the hurricane downtime was offset by the added LOE from the platform repairs and added Bois d'Arc LOE. For the fourth quarter, we would expect an increase as we have the Bois d'Arc properties for the full quarter and will be burdened with an incremental of roughly $15 million in LOE tied to hurricane repairs. In the quarter, we also recorded $8.8 million non-cash impairment on our investment in Bohai Bay which reduces our net investment in China to around $12 million. The third quarter tax rate was about 37.5%. The nine-month rate was 35% which should be a better rate to use for the fourth quarter. The big swing in the third quarter was the negative current tax and the significant deferred tax recorded. This is due to both lowered oil and gas prices and lower production leading to a lower expected cash tax. In fact, we’re now projecting virtually all of our reported tax for 2008 might be deferred. This is another small silver lining to the decline in oil and gas prices. As previously mentioned, the swing in deferred taxes boosted our cash flow for the quarter by about $67 million. Our CapEx for the quarter was about $70 million which was less than projected due to hurricane downtime. One plan drilling program scheduled to start in September was deferred as the targeted rig to be used was actually destroyed in Hurricane Ike. Moving to the balance sheet, there are number of significant items to mention which were the result of the Bois d’Arc acquisition. First is the increase in oil and gas properties to over $3.2 billion, up from the $1.2 billion in the June quarter. You’ll also noticed there’s $338 million in goodwill recorded and an increase of over $600 million in deferred taxes, all up from the June quarter. The roadmap to get to these figures will be provided in our third quarter 10-Q which should be filed in the next day or so. In connection with the Bois d’ Arc transaction, we entered into an amended $700 million credit facility with a $700 million borrowing base and took down $425 million at closing. This loses [ph] with our own $230 million in availability after adjusting for the outstanding letter of credits. Cash dropped from $568 million in June to $173 million in September as we utilized most of our cash in Bois d’ Arc acquisition. Given current pricing, our current cash position and projected cash inflows and outflows, we would not anticipate needing to access our credit facility through the end of the year. We also experienced a material increase in our asset retirement obligations due to two factors. First, the addition of Bois d’ Arc ARO obligations and second, an increase in the previous ARO estimate due to the incremental expected cost having to plug and abandon the wells associated with the down platforms. As noted in the press release, the expense in performing this task in an open water procedure versus using a standing platform is significantly higher, sometimes five or ten times higher depending upon water depth and complexity. Although the removal of the down platforms were substantially covered by insurance, the cost to plug and abandon the idle wells were not covered and may cost upwards of $75 million albeit spread over several years. Lastly, we did initiate our stock repurchase program by spending $4.2 million for 100,000 shares of SUY stock during the third quarter and we’ll continue to evaluate this option. As you can see, we have updated our 2008 guidance section which includes a number of changes as our guidance now does include adjustments from the Bois d’Arc acquisition effective August 28, 2008. And with that, I will turn it over Dave.

[David Welch:]

Okay, thank you very much, Ken. As you’ve heard through the numbers, this was a very eventful quarter for Stone as we completed the merger with Bois d’Arc, August 28. You saw the price of hydrocarbon is roughly cut in half. We’re hit with two hurricanes and saw the financial markets in turmoil. So how do these events balance out for the future of Stone? Here’s a few comments on each of these happenings. First, the Bois d’Arc merger. The merger increased our production reserves by over 50% and importantly gave us a drilling inventory of five to six years. As well, it created the participation of agreement with Gary Blackie and several members of his exploration team where we have the future option to participate for 50% on future exploration prospects they generate. We paid full value for these reserves and opportunity that they will provide the cash flow and the time bridge to enable us to achieve larger successes in the deep water and price advantaged onshore gas resource plays. Before the transaction closed, Bois d’Arc went from a debt position of owing about $56 million to a positive cash position of $20 million. In addition during this time, Stone grew cash from about $500 million at the time of the merger agreement to over $600 million at the time of closing. So when we closed the merger, we still had a very manageable debt to total capitalization ratio of 35% and that 35% excludes the goodwill. If you were to include that, we’d be down around 31%. We presently retained about $230 million of unused liquidity by our revolver. We also have about 75% of the projected Bois d’Arc volumes hedged through the end of 2009 and we’re at presently attractive prices. The exact hedges are shown in the table Ken alluded to in the press release and total about 90 million cubic feet per day for next year. We believe that the counterparties are solid. Our hedges have been executed through JP Morgan Chase, BNP Paribas and Bank of America. Given the historical price we’ve seen since announcing the deal, the hedges and script pricing, we would anticipate an average realization of over $10 per Mcfe on the production we will have added with Bois d’Arc from the closing through the end of 2009. Secondly, the commodity price pullback. First of all, there’s no doubt that a lower commodity price will result in lower cash flow. We’re planning accordingly. We should have the flexibility to adjust our capital spending as prudently required. We do not have any long-term contracts in place that might materially hamper our flexibility. Although not completely finalized our capital budget at this point, we expect to plan our spending roughly consistent with our cash flow in 2009. We would also expect that over time, the cost of goods and services on the shelf and onshore would have to follow the price of the commodity. So we may not see as much of an activity reduction as we do of capital reduction. No doubt there’ll be a lag time for some of this to happen, but a few of the items such as fuel have already shown a direct correlation to the price of oil and gas. We’ll also be re-looking at our major contracts for rigs, boats, helicopters, etc., over the next few months as the industry adjust to the new price environment. Thirdly, the hurricanes. The main impacts from Hurricanes Gustav and Ike were production deferral and additional cost. We shut in essentially all of our production at the end of August and are ramping back up as we speak. We’re presently producing over 210 million cubic feet a day equivalents which includes barging oil from the Amberjack platform, pending repair of downstream pipeline connections. We expect to continue ramping back up through the end of the year, and to exit the year producing around 275 million cubic feet a day. The day before the shut-ins, we were producing over 300 million per day. Most of the damage that we sustained from the storms was incurred on idle platforms. The damage to our producing platforms was not great. Our loss of reserves is estimated to be minimal. We do however expect that about 8 million cubic feet a day of net production from the one lost producing platform at Vermilion 122 may not be economic to restore. That’s unfortunate but it’s very manageable. Another impact from the storms is the acceleration in incremental cost associated with the abandonment of the other five idle structures that we lost in the storms. These facilities were on the list of structures to be abandoned, but the storm toppling them accelerated the timing. We have begun this effort and we’ll manage the time period consistent with regulatory requirements and prudent cash management. The other impact is the cost of the abandonment. The cost of abandonment has increased over normal abandonment cost because when structures topple, there is no work platform from which to access the wells. Boats and divers must be used and it’s more expensive than normal platform idle well abandonment. As Ken mentioned, our share of these costs could exceed $75 million spread over a multi-year timeline that we are presently developing for approval by the MMS. We’re also actively engaged in a program of accelerated idle well abandonment to mitigate the ongoing risk of future storms. Funds from this effort and the hurricane recovery will be managed within our normal capital budget. Finally, the financial turmoil. It’s good to have the balance sheet in good form given the financial turmoil that occurred in the third quarter and beyond. This crisis has tightened up both the debt and equity markets, and should favor companies like Stone who have manageable debt levels and excellent cash generating capability. There are a number of companies who have been funding growth through the issuance of both equity and debt. This has become much more difficult to accomplish today and many of those companies are turning to strategic partners such as Stone who could aid them in retaining their acreage. This is a win-win opportunity for both parties. The resource play acreage owner gets to hold their lease position together and Stone gets to earn a share of that acreage with the attendant reserves and production potential by providing both drilling dollars and technical expertise. We are engaged in a number of discussions with potential partners using this drill to earn model. For 2009, you can expect us to maintain a strong cash flow profile by continuing to invest in the offshore shelf development and exploration opportunities we’ve generated either internally or through the Bois d’Arc merger and participation agreement. We’ve also begun a balanced exploration program by participating in a few wells in our targeted areas in the deep shelf, deep water and in the Marcellus play in Appalachia. In Appalachia, we have about 30,000 net acres under lease and have thus far drilled four Marcellus vertical wells. Two wells are awaiting frac or testing and two wells are on production and appear to be commercial. We’re presently assessing commencement of the development program comprising four net development wells and an upgrade to the pipeline infrastructure in the area, offsetting the two wells that are already on production. So in summary, the Bois d’Arc merger is closed and the integration is substantially complete. We are flexible in adjusting our capital plans to the commodity price pullback. We’re making rapid progress on hurricane recovery and are looking forward and looking carefully for drill to earn opportunities in our focal areas. These are times of change and turbulence. By being calm and disciplined, yet flexible and open to opportunities that may present themselves, we feel like that’s the winning way for the next three to twelve months. So with that, we’ll now be happy to take your questions. Erin?

[Operator:]

(Operator instructions) Your first question comes from the line of Dave Kistler from Simmons & Company. Your line is open.

[Dave Kistler:]

Good afternoon guys.

[David Welch:]

Hi, good afternoon.

[Dave Kistler:]

Real quickly, you discussed a production exit rate of about 275 million a day. Can we just for the purposes of trying to get a handle on what CapEx might look like, run that forward through ’09 or do you think you’ll have incremental really redevelopment programs that can drive that materially higher?

[Ken Beer:]

This is Ken. Again, the exit of 275 is probably a pretty good starting point to look at ’09. Obviously we have not poured [ph] our budget, but in terms of trying to get incremental production on top of the 275, obviously we are looking to do that. But in terms of a starting point looking ahead to ’09, that is I think a pretty appropriate starting point and as we forward pour [ph] our budget and come out with guidance, full guidance on 2009, we’ll certainly adjust from that exit rate.

[Dave Kistler:]

Okay, and kind of building on that question a little bit, with Ewing Bank 305 where you had a drilling program in place, if I look at the results of Ship Shoal 113 and South Timbalier 100, can I expect to see a drilling program applied there and can you kind of walk me through the timing of that?

[David Welch:]

Well, the Ewing 305 program is nearing completion. That’s added about 40 million cubic feet a day to that program. On Main Pass 74, is that one you’re asking about David?

[Dave Kistler:]

Really Ship Shoal and South Timbalier, I’m just trying to think about when the development process might take place for those and how to think about the production we just spoke about and then when to think about where we could see production coming here?

[David Welch:]

Yes those are really right now tangled up in our budget process and as you can imagine we’re trying to make the trade-off between exploration and development drilling and it’s a little premature for us to give you any real insight into that.

[Dave Kistler:]

Okay, no problem, may be something a little bit closer to the right in front of you, in terms of Amberjack and time to actually tied that back into pipelines, so you don’t suffer variability of a barging situation if we experience regular winter weather.

[David Welch:]

Yes, we are seeing a little weather impact already in the barging and obviously we’d like to get this back on production as quickly as we can. That Amberjack production goes over the South Pass 49 platform and the riser going to shore from there, which I believe is a Chevron riser, has been parted by the storm. We have not yet been over to inspect our riser either. It’s possible that we may have another issue there, but hopefully not. But at any rate, we’re going to just have to work with Chevron to get them to do that as quickly as we can and there’s no forecast that that’s going to be done within the next couple of weeks. It’s probably going to be months rather than weeks I would guess.

[Ken Beer:]

Yes, I think that is correct. Again as you can appreciate David, a lot of the equipment, inspection equipment, has been in very high demand in that some equipment that we just now – both in demand as well as there’d been some weather issues even getting equipment to different spots throughout the Gulf. In that scenario, obviously it's very important to us and so we’re trying to get as much information on both the cost and timing of the downstream pipeline repairs. But in the Interim, our operations guys to their credit jumped on the concept of barging. We did spend some incremental dollars a couple years ago when we bought Amberjack and put in the facilities to allow for barging and this is obviously now coming back to help us out and certainly there will be weather variability but at least we’ve got production flowing out of one of the more important properties we own.

[Dave Kistler:]

Great, and then last question, I will hop off. Looking at the Bois d’Arc acquisition and given that you guys went through a formal reserve audit earlier this year, I’m imagining we can expect to see the same thing now with the integrated Bois d’Arc, but I’m just trying to get a handle on timing around that in terms of when we’d be seeing that and will you guys be breaking out 2P and 3P as well.

[David Welch:]

You’ll see that around the, just at the [ph] first of the year. Generally we’ll do that just as quickly as Neville and Sue [ph] who does our third-party work can get to it, typically late January or February timeframe. And yes, we will include our 2P and our 3P reserves.

[Ken Beer:]

And clearly we’ll incorporate all of the Bois d’Arc properties as well, so all will be under the same umbrella.

[Dave Kistler:]

Great, thanks so much guys. Appreciate the clarifications.

[Ken Beer:]

Thank you.

[Operator:]

Your next question comes from Pavel Molchanov from Raymond James. Your line is open.

[Pavel Molchanov:]

Hi, good afternoon guys. Quick question about a couple of cost items. LOE following the fourth quarter as your production run rate normalizes, any thoughts on what your LOE run rate should be?

[Ken Beer:]

Yes, this is Ken. If you reverse engineer everything and look at kind of the dollars that we are expecting might come in to the LOE line in the fourth quarter because of hurricane repairs and you use not the average for the quarter but rather the exit for the quarter, I think you’d come up with about a $2 per Mcf number. I mean I think that’s the reverse Math. And once similar to production, that’s probably not a bad starting point. Once again, we haven’t poured [ph] budget, we don’t have guidance or estimates out there, but at least that’s maybe an unfiltered number that you could look at the exit of the fourth quarter.

[Pavel Molchanov:]

Absolutely, and then same question for DD&A, should we assume $5 plus number for 2009 as well?

[Ken Beer:]

Yes, at least for now that is the case. Again, through the accounting standards, we end up with obviously a DD&A rate much higher than what we had before. We were at about $4 and obviously now we’re at or above the $5 number and a lot has to do with bringing the Bois d'Arc properties in and as we calculate the DD&A rate, we not only look at the acquisition cost but also fully burden it with all the future development cost. And so we were effectively taking a $4 number, averaging it was a $6 number with all the future cost coming up with the DD&A rate of about $5 plus. So the answer is yes going forward, I think that’s probably the place to start.

[Pavel Molchanov:]

That’s helpful. And just lastly, housekeeping item. Can you give us your share count as of September 30?

[Ken Beer:]

Just under 40 million shares. We’ll have that in the 10-Q to be filed, but if you use 40 million you’ll be right at it.

[Pavel Molchanov:]

Great. Thanks very much.

[Ken Beer:]

Okay.

[Operator:]

(Operator instructions) Your next question comes from the line of Nicholas Pope from JP Morgan. Your line is open. Nicholas Pope – JP Morgan Good afternoon guys.

[David Welch:]

Hey, Nick. Nicholas Pope – JP Morgan A couple of quick questions, could you break out the working interest, specifically on the Ewing Bank 305 but then on the other wells you’ve drilled, Main Pass, Ship Shoal, kind of what the (inaudible)?

[David Welch:]

Ewing 305, we’re 100% on that one. Ken, do you have the backed interested in [ph]?

[Ken Beer:]

Yes. The numbers that we have put out are net numbers. For the most part, the Bois d'Arc properties that came in are 100%; Main Pass is 74%, I think it's 100%. So, the numbers that we put in the release are the net numbers as well. Nicholas Pope – JP Morgan Okay. And then, I guess with the rigs – am I right, you’re drilling with four rigs right now and I guess – did you say yes?

[Ken Beer:]

Yes. We’ve got two to three rigs right now. We’re also non-opportunity, so that will be the fourth. So looking at the rig schedule, we’re about to bring two rigs on and that one rig goes somewhere right in the midst of going from three to four with also a non-op at the storage [ph] prospect being drilled and that's excluding onshore obviously. Nicholas Pope – JP Morgan The terms like the bigger potential wells, the deep shelf, deep water, what is, I guess, kind of – what can we look forward to in the next couple of months?

[David Welch:]

Yes. There are several wells that we hope to get going in 2009. The storage [ph] well that we have, we only have a 10% interest in that. But that’s a deep water prospect that is currently drilling. We have an interest in a prospect called La Pesada which is kind of a deep shelf well that’s actually projected back onshore in South Louisiana and then we hope to and believe that our partners will be drilling a couple of deep water wells in 2009. Nicholas Pope – JP Morgan All right. Do you foresee, with some of the hurricane damages, as you continue to make assessments, is there a potential that you could have some more write-downs in terms of reserves? Ken, what’s at risk at this point?

[David Welch:]

I think we've got a pretty good handle on the post-hurricane reserves and I would not anticipate any material revisions based on the storms.

[Ken Beer:]

Nick, just as Dave indicated, really except for that one platform, the other five platforms were virtually idle wells, so there was almost no – minimal less than a half – really almost no reserves associated with five out of the six and I think we have indicated in the press release – earlier press release that the sixth well that did go down and was on production had reserves of around 2 Bcfe. Nicholas Pope – JP Morgan And just to clarify, it’s Vermillion 122, is that right?

[Ken Beer:]

Yes, correct. Nicholas Pope – JP Morgan Okay. Thanks guys.

[David Welch:]

Thank you, Nick.

[Operator:]

Your next question comes from Tom Novak from Merrill Lynch. Your line is open.

[Tom Novak:]

Hi. Good afternoon.

[David Welch:]

Hi, Tom.

[Tom Novak:]

Just regarding the borrowing base redetermination, can you say what’s the prior price decks were used to come to the $700 million? And the second question is do you have any sense if the banks are going to be using materially lower price decks going forward to arrive at the borrowing base?

[Ken Beer:]

Yes, Tom. It’s Ken. As you know, the banks use their own price decks and it rarely is the current. It tends not to be the current price but rather the price that they are comfortable with on a long-term basis. Suffice to say that the $700 million facility, even though it was put in place in the summer, certainly did not anticipate oil prices going to $100. The banks have their own price deck but I think it’s fair to suggest that the drop from whatever price deck they were using in the summer versus what they would be using for the November redetermination is not nearly the drop that we saw in the absolute price from $140 down to $65. So certainly, there is probably some difference, but I think the difference is significantly muted by their original starting point which was not even anywhere close to $100 plus oil price that we experienced in the summer.

[Tom Novak:]

Okay, so given they're not cutting their price deck by 50%, it sounds like you still expect a reasonable reduction of borrowing base redetermination post this redetermination?

[Ken Beer:]

At this point, it is the bank’s lap. I’m not sure if there’ll be any reduction, but the point at least that we have projected is that we seem to be in good position. We’re not looking to access the facility for the remainder of the year despite being hit with two hurricanes and price is tumbling down, so we’ll just await the redetermination in November and then, as you highlighted, we’ll have a redetermination again May 1 of next year, so we’ll look to review this twice a year.

[Tom Novak:]

Great, okay, thanks a lot.

[Ken Beer:]

Okay.

[Operator:]

There are no further questions in queue.

[David Welch:]

Okay. Thank you very much, Erin and thank you everyone for joining our call.

[Ken Beer:]

Thank you.

[Operator:]

This concludes today’s conference call. You may now disconnect.