TALOS ENERGY INC. quarterly report, Q3 FY2018

Talos Energy Inc. — Form 10-Q Summary

Business context and reporting period

Talos Energy is an independent offshore exploration and production company operating primarily in the U.S. Gulf of Mexico and shallow-water Mexico. This report covers the quarter and nine months ended September 30, 2018, and was filed November 5, 2018.

Results are not fully comparable with 2017 because Talos completed the Stone Energy combination on May 10, 2018. Talos Energy LLC was the accounting acquirer; pre-combination historical results primarily reflect Talos Energy LLC and exclude Stone. Talos also acquired Whistler Energy II on August 31, 2018.

Financial and operating highlights

Metric	Q3 2018	Q3 2017	9M 2018	9M 2017
Total revenue	$282.9 million	$100.0 million	$632.6 million	$297.2 million
Operating income	$91.4 million	$13.3 million	$179.2 million	$26.9 million
Operating margin	32.3%	13.3%	28.3%	9.1%
Net income (loss)	$13.1 million	$(36.2) million	$(84.7) million	$22.9 million
Net margin	4.6%	(36.2)%	(13.4)%	7.7%
Adjusted EBITDA	$157.0 million	$67.7 million	$344.0 million	$186.3 million
Net cash from operating activities	Not separately provided	Not separately provided	$143.7 million	$124.4 million

Q3 production was 54.9 MBoepd, including 38.1 MBblpd of oil, 73.7 MMcfpd of natural gas and 4.5 MBblpd of NGLs. Nine-month production was 43.3 MBoepd, up from 28.8 MBoepd in the comparable period.

Q3 realized prices, including derivatives, were $59.07 per oil barrel, $3.01 per Mcf of natural gas and $35.21 per NGL barrel. Nine-month realized prices were $56.25 per oil barrel, $3.02 per Mcf and $30.82 per NGL barrel.

Material changes versus prior comparable periods

Q3 revenue increased 183%, driven by higher production and realized oil and NGL prices, with Stone and Whistler assets contributing materially. Nine-month revenue increased 113%.
Q3 operating income increased 585%; however, operating expenses rose 121%, including higher depreciation, depletion and amortization, workover costs, accretion and corporate expenses.
Q3 net income improved to $13.1 million from a $36.2 million loss. The nine-month period moved to an $84.7 million loss from $22.9 million of income.
Derivative losses materially reduced earnings: price risk management expense was $53.3 million in Q3 and $196.5 million for nine months, versus $28.1 million and $56.8 million of expense and income, respectively, in 2017. Nine-month cash derivative settlements were a $94.8 million payment.
General and administrative expense rose to $21.7 million in Q3 and $61.1 million for nine months, including Stone transaction and integration costs of approximately $7.4 million and $27.6 million, respectively.
Cash flow from operations increased $19.3 million for nine months, while capital expenditures rose to $174.3 million from $92.0 million. Investing cash flow was positive because of acquisition-related cash received.

Balance sheet, debt and liquidity

September 30 cash and cash equivalents were $89.9 million; cash, cash equivalents and restricted cash totaled $91.2 million.
Total debt, net of discount and deferred financing costs, was approximately $654.8 million, including $380.6 million of 11.00% senior secured notes, $257.4 million drawn under the bank credit facility, $6.1 million of 7.50% Stone notes and $10.7 million of building-loan debt.
The $600.0 million reserve-based credit facility had approximately $329.0 million of undrawn commitments, after $265.0 million drawn and $6.0 million of letters of credit. Reported available liquidity was approximately $419.0 million.
The company was in compliance with its debt covenants at September 30, 2018. The credit facility requires, among other provisions, a total debt-to-EBITDAX ratio no greater than 3.00-to-1.00 and a current ratio of at least 1.00-to-1.00.
Stockholders’ equity was $699.8 million, compared with a deficit of $54.1 million at December 31, 2017, primarily reflecting the Stone combination and sponsor debt exchange.

Guidance, outlook, commentary and unusual items

Management expected cash flow from operations and credit-facility availability to fund the board-approved 2018 capital program of $430 million to $450 million.
Capital expenditures and plugging and abandonment for the remainder of 2018 were estimated at approximately $120 million to $140 million.
The Helix Producer I was scheduled for dry-dock inspection in the first quarter of 2019, with expected Phoenix Field production shut-in for approximately 45 to 60 days.
Management planned to drill and complete two Phoenix Field deepwater wells beginning in November 2018. Mexico exploration on Block 2 was expected to begin in the second quarter of 2019, subject to regulatory and operational matters.
Talos entered into a Mexico acreage exchange with Hokchi Energy. CNH approved the participating-interest transfer on October 30, 2018, subject to approval of the operatorship transfer.
Asset retirement obligations totaled $426.2 million, including $78.2 million classified as current. Performance bonds totaled approximately $647.0 million, primarily for plugging, abandonment, facility removal and Mexico minimum-work obligations.
Total contractual obligations were reported at approximately $1.49 billion, excluding the discounted asset retirement obligation. Major exposures include debt, derivative liabilities, capital leases, drilling-rig commitments, purchase obligations and Mexico minimum-work requirements.
The company adopted ASC 606 revenue recognition in 2018 with an immaterial cumulative-effect adjustment. It planned to adopt the new lease standard effective January 1, 2019.

Principal risks and contingencies

Commodity-price volatility affects revenue, cash flow, borrowing-base capacity, reserves and potential full-cost ceiling-test impairments. The company had a net derivative liability of $198.3 million at September 30, 2018.
Credit-facility borrowing-base redeterminations could reduce liquidity or create a borrowing-base deficiency requiring repayment, additional collateral or asset support.
Offshore operations face hurricane, equipment, well-control, spill, environmental, regulatory, transportation and third-party downtime risks. Phoenix and Pompano accounted for approximately 51% of Q3 production and 56% of Q3 commodity revenue.
BOEM could change financial-assurance requirements for Gulf of Mexico decommissioning obligations. Additional surety, cash collateral or letters of credit could materially constrain liquidity.
Asset retirement, plugging and abandonment obligations may exceed current estimates, particularly following hurricanes, regulatory changes or contractor-cost inflation.
Mexico operations involve evolving regulation, political uncertainty, minimum-work commitments, potential unitization of the Zama discovery and joint-and-several obligations with consortium partners.
Stone integration, transaction expenses, related-party arrangements and concentrated control by Apollo and Riverstone may create governance, execution and shareholder-alignment risks.

Investor verification checklist

Verify the final borrowing-base redetermination announced after the October 31, 2018 review and its effect on liquidity.
Reconcile reported available liquidity with outstanding debt, letters of credit, derivative settlements and required capital spending.
Assess the magnitude and cash timing of derivative losses and the company’s 2019 hedge positions.
Review Phoenix Field downtime and actual production impact from the first-quarter 2019 HP-I dry dock.
Monitor Stone purchase-price allocation finalization, integration costs and any remaining transaction-related liabilities.
Evaluate BOEM financial-assurance developments and the company’s $647 million performance-bond exposure.
Confirm progress, approvals and obligations associated with the Mexico Block 2/Block 31 exchange, Zama appraisal and minimum-work programs.
Review reserve estimates, proved undeveloped reserves, full-cost ceiling-test sensitivity and the $426.2 million asset retirement obligation.