Business Context and Reporting Period
Talos Energy Inc. filed its Form 10-K for the fiscal year ended December 31, 2019. Talos is an independent exploration and production company focused on offshore assets in the U.S. Gulf of Mexico and Mexico, with substantially all proved reserves and production in the U.S. Gulf of Mexico. Comparability with 2018 is affected by the May 10, 2018 Stone Combination; pre-combination historical results primarily reflect Talos Energy LLC rather than Stone.
The filing also provides unaudited fourth-quarter 2019 data. Talos reported fourth-quarter revenue of $233.2 million, operating income of $47.0 million and net income of $0.3 million.
Financial and Operating Metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Revenue | $927.6 million | $891.3 million | +4.1% |
| Operating income | $213.1 million | $253.1 million | -15.8% |
| Net income | $58.7 million | $221.5 million | -73.5% |
| Operating margin | Approximately 23.0% | Approximately 28.4% | Down approximately 5.4 percentage points |
| Net margin | Approximately 6.3% | Approximately 24.9% | Down approximately 18.6 percentage points |
| Adjusted EBITDA | $614.2 million | $502.7 million | +22.2% |
| Operating cash flow | $393.7 million | $263.4 million | +49.5% |
| Total production | 19.0 MMBoe, or 52.0 MBoepd | 16.7 MMBoe, or 45.9 MBoepd | +13.2% |
| Lease operating expense | $243.4 million, or $12.84/Boe | $226.3 million, or $13.52/Boe | Cost per Boe improved |
| Capital expenditures | $470.4 million, excluding acquisitions | Not clearly provided in the selected data | — |
Revenue growth was driven primarily by higher oil production and volumes from the Stone Combination, new Phoenix Field wells and other development activity. Average realized prices excluding derivatives declined to $47.90/Boe from $53.24/Boe, while realized prices including derivatives increased slightly to $47.43/Boe from $46.60/Boe. Oil represented approximately 90% of revenue.
Net income was reduced by a $95.3 million loss from price risk management activities, comprising $86.5 million of unrealized derivative losses and $8.8 million of cash settlement losses. A $36.1 million income tax benefit, largely from releasing federal and state valuation allowances, partially offset the impact. The filing does not provide a clear GAAP gross margin value.
Balance Sheet, Debt and Liquidity
- Cash and cash equivalents were $87.0 million at December 31, 2019, compared with $139.9 million at year-end 2018.
- Total debt, net of discount and deferred financing costs, was $733.0 million, compared with $655.3 million in 2018. Debt consisted principally of $390.9 million of 11.00% senior secured notes, $6.1 million of 7.50% senior notes and $350.0 million drawn under the Bank Credit Facility before carrying-value adjustments.
- The Bank Credit Facility had a $950.0 million borrowing base, approximately $586.4 million of undrawn commitments after borrowings and letters of credit, and a May 2022 maturity subject to a springing maturity provision.
- Management reported compliance with all debt covenants at December 31, 2019. Key covenants included a maximum total debt-to-EBITDAX ratio of 3.00 to 1.00 and a minimum current ratio of 1.00 to 1.00.
- Available liquidity, defined as cash plus available Bank Credit Facility capacity, was $673.4 million at year-end.
- Asset retirement obligations totaled $369.5 million, including $61.1 million classified as current. Performance bonds totaled approximately $637.3 million, and letters of credit totaled $13.6 million.
Material Changes Versus the Prior Comparable Period
- Production increased 13.2%, led by assets acquired in the Stone Combination and new Phoenix Field production, despite a 57-day HP-I dry-dock shut-in that deferred approximately 3.3 MBoepd compared with 2018.
- Operating income declined despite higher revenue because of lower commodity prices, higher depreciation, depletion and amortization, and a $12.2 million non-cash impairment of unproved Block 2 Mexico properties.
- Cash flow from operations increased by $130.3 million, primarily because cash derivative settlements were $102.3 million lower and asset retirement obligation settlements were $37.6 million lower than in 2018.
- Investing cash flow changed from $37.5 million of cash provided in 2018 to $496.0 million used in 2019, reflecting higher capital spending and cash paid for acquisitions.
- Adjusted EBITDA increased despite the GAAP earnings decline, largely because 2019 included substantially lower cash derivative settlement losses and the measure excludes derivative fair-value volatility.
- Total proved reserves declined to 141.7 MMBoe from 151.7 MMBoe. Production and downward revisions, primarily related to Phoenix, Ram Powell and Pompano, more than offset extensions, discoveries and the Gunflint acquisition.
- PV-10 declined to $3.0 billion from $3.9 billion, and standardized measure declined to $2.5 billion from $3.3 billion, primarily reflecting lower SEC commodity prices and reserve changes.
Guidance, Outlook, Commentary and Unusual Items
- Management’s board-approved 2020 capital spending program was $520 million to $545 million. Management believed operating cash flow and Bank Credit Facility availability would fund the program, subject to commodity prices, operating performance and credit availability.
- The 2020 program included development of proved undeveloped reserves. Year-end PUD reserves were 43.8 MMBoe, with estimated future development costs of approximately $501.7 million.
- The Zama discovery offshore Mexico completed its three-well appraisal program in 2019. Front-end engineering and design was progressing, but the filing did not provide a clear initial production date or development cost estimate.
- On February 28, 2020, after year-end, Talos completed the ILX and Castex Acquisition for $385.0 million of cash and 110,000 shares of Series A Convertible Preferred Stock. The cash consideration was funded partly with additional Bank Credit Facility borrowings. The borrowing base and commitments increased to $1.15 billion, while drawn facility borrowings increased to approximately $650.0 million.
- The filing identified the early-2020 COVID-19 outbreak and associated demand and commodity-price risks as potential adverse events. It did not quantify the impact on 2020 results.
- Key risks include oil, gas and NGL price volatility; reserve and borrowing-base reductions; substantial debt maturities in 2022; offshore operational, hurricane, environmental and spill risks; BOEM financial-assurance requirements; regulatory and political uncertainty in Mexico; customer concentration; and decommissioning obligations.
- Shell Trading represented 58% and Phillips 66 represented 28% of 2019 oil, natural gas and NGL revenue, creating significant customer concentration.
- Talos had not declared or paid cash dividends and did not expect to pay dividends in the foreseeable future.
Important Facts for Investors to Verify
- Reconcile 2019 and 2018 results on a pro forma basis because the Stone Combination occurred partway through 2018.
- Verify the post-year-end ILX and Castex Acquisition purchase accounting, incremental debt, preferred-stock conversion terms and resulting leverage.
- Review 2020 commodity-price sensitivity, hedge volumes, hedge prices and derivative collateral or counterparty requirements.
- Assess the ability to fund the $520 million to $545 million 2020 capital program while meeting 2022 debt maturities and decommissioning obligations.
- Evaluate reserve replacement, the 2019 downward revisions and the concentration of production and reserves in Phoenix and Pompano.
- Monitor BOEM requirements for additional decommissioning financial assurance and the BSEE idle-iron directive requiring review and potential plugging and abandonment of wells by December 31, 2021.
- Confirm the timing, economics and regulatory treatment of the Zama development and any potential unitization with Pemex.
- Verify the effect of the $75.2 million valuation-allowance release and the sustainability of the resulting 2019 tax benefit.