VAALCO Energy, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions unless noted.
Business context
VAALCO is an independent crude oil company operating primarily in Gabon, with a non-operating interest in undeveloped Block P offshore Equatorial Guinea. Angola activities are reported as discontinued operations. Substantially all continuing revenue came from Gabon production.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Oil and gas sales | $25.3m | $18.2m | $77.3m | $59.9m |
| Operating income | $17.3m | $3.7m | $36.1m | $17.5m |
| Income from continuing operations | $78.6m | $(0.1)m | $88.2m | $6.7m |
| Net income (loss) | $78.6m | $(0.3)m | $87.8m | $6.2m |
| Net cash from operating activities | Not provided for quarter | Not provided for quarter | $36.0m | $3.2m |
- Q3 realized oil price averaged $75.40/bbl versus $51.10/bbl; net sales were 329 MBbl versus 336 MBbl. Nine-month realized price averaged $72.55/bbl versus $49.86/bbl; net production declined to 1,027 MBbl from 1,154 MBbl.
- Operating income margin was approximately 68.5% in Q3 (20.5% prior year) and 46.7% for nine months (29.1% prior year). The Q3 and nine-month net income figures were substantially boosted by a $66.6m deferred tax benefit; they do not represent operating cash earnings.
- Cash and cash equivalents were $33.7m at September 30, 2018, plus $1.9m current and noncurrent restricted cash. Cash flow reporting also includes $10.8m of abandonment funding. Current assets were $44.6m and current liabilities $47.3m.
- Total debt was zero at September 30, 2018, after repayment and termination of the IFC term loan in May. Nine-month investing outflows were $13.2m, principally the cash portion of the Gabon PSC signing bonus; financing outflows were $8.7m, mainly debt repayment.
- Total assets were $162.4m, including $68.8m of deferred tax assets; shareholders’ equity was $99.3m. Asset retirement obligations were $14.5m.
Material changes and unusual items
- Revenue rose 39% in Q3 and 29% for the nine-month period, primarily due to higher oil prices; lower sales volumes partly offset the increase.
- Net income included a $3.3m gain from revising asset retirement obligations after the expected abandonment timing changed. The liability was reduced by $6.5m.
- The Gabon PSC was extended for ten years from September 17, 2018, through September 16, 2028, with two optional five-year extensions. The cost-recovery share increased from 70% to 80% for the initial ten-year extension period. VAALCO’s share of the signing bonus was $21.8m, funded through cash, a VAT-receivable reduction, and a remaining accrued payment.
- Management recognized a $46.5m deferred tax asset related to the Gabon cost account and reversed $29.9m of U.S. valuation allowance, based on improved expected recoverability. The related tax accounting was described as provisional.
- Production expense increased 11% for nine months, mainly from $4.7m of workovers and higher fuel costs, while Q3 expense declined year over year. DD&A fell year over year, partly reflecting higher estimated reserves.
Outlook, commentary and risks
- Management expected cash on hand and operating cash flow at current prices to support operations and cash requirements through December 31, 2019. Capital spending in late 2018 and 2019 was expected to be funded primarily from cash and operations, with debt or equity financing possible if needed.
- The Gabon consortium was planning two wells and two appraisal well bores in Q2–Q3 2019, with a possible third well. The required program is due by September 16, 2020; VAALCO’s estimated share of well costs is $20.5m. Failure to fulfill the work commitment may require an indemnity for uncompleted work.
- The current crude oil sales contract, under which Glencore was the buyer, was due to end in January 2019. Management expected to renew or replace it on competitive terms. Glencore represented approximately 100% of revenue in the periods presented.
- Equatorial Guinea Block P remained suspended; VAALCO was working with the government to lift the suspension and evaluating future activity. Management said 2019 spending was not expected to be significant.
- Key risks include oil-price volatility, production and reserve uncertainty, drilling execution and costs, Gabon regulatory and audit matters, foreign-exchange exposure, derivative counterparty risk, and resolution of Angola obligations. The company accrued $15.0m for potential Angola drilling-obligation payments and was negotiating with Sonangol; management expected the eventual amount to be lower.
- VAALCO hedged approximately 285,000 barrels through June 2019; swaps had a $2.1m liability at quarter-end. Hedging reduces but does not eliminate price exposure and may limit gains if prices rise.
Most important facts for investors to verify
- How much of reported earnings and the $68.8m deferred tax asset can ultimately be realized, and whether provisional tax estimates change.
- Whether VAALCO renewed or replaced its oil sales contract before the January 2019 expiration, and the resulting pricing and offtake terms.
- Whether the 2019 drilling program proceeded on schedule and within budget, and how it affects production, reserves and liquidity.
- The final cost and resolution of Angola obligations, including the accrued $15.0m potential drilling payment.
- Whether cash generation remains sufficient after required abandonment funding, PSC commitments and other Gabon obligations.