VAALCO ENERGY INC quarterly report, Q2 FY2016

VAALCO Energy, Inc. — Q2 2016 Form 10-Q

Reporting period: Three and six months ended June 30, 2016; filed August 8, 2016. VAALCO is an independent oil and gas producer, with its principal producing operations offshore Gabon and additional interests in Angola, Equatorial Guinea and the United States. Amounts below are in U.S. dollars; financial statement figures are in millions unless stated otherwise.

Financial performance and position

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Oil and gas sales	$18.8	$27.1	$29.8	$45.4
Operating income (loss)	$4.6	$(1.0)	$(2.1)	$(36.3)
Net loss	$(0.3)	$(5.2)	$(8.3)	$(44.2)
Net loss per share	$(0.00)	$(0.09)	$(0.14)	$(0.76)

• Revenue declined about 31% in Q2 and 34% for the first half year over year. Lower realized oil prices were the main factor: $42.13/bbl in Q2 versus $59.16, and $35.79/bbl for the half versus $54.46. First-half net oil-equivalent sales were 828 thousand BOE versus 845 thousand.
• Q2 operating income improved from a loss, while the company remained loss-making for the first half. Lower DD&A and the absence of 2015 impairment charges benefited comparisons. Q2 pretax income of $2.7 million was more than offset by $3.0 million of income tax expense.
• Production expense was $7.3 million in Q2, down from $8.9 million; first-half expense was $18.6 million, broadly flat year over year. First-half G&A declined to $7.0 million from $7.7 million. Q2 G&A rose to $4.0 million from $2.8 million, partly because less overhead was recoverable from partners.
• Operating cash flow was $1.6 million for the first half, versus $27.0 million a year earlier. Investing cash outflow was $13.2 million, compared with $35.4 million; cash capital expenditures were $12.7 million. Cash and cash equivalents fell $11.7 million to $13.7 million. The filing reports unrestricted cash of $13.7 million and long-term restricted cash of $15.8 million.
• At June 30, total debt was $14.3 million, including $5.0 million current and $9.3 million long term, compared with $15.0 million at year-end 2015. Current assets were $38.6 million and current liabilities $46.4 million. Total assets were $91.7 million and shareholders’ equity $19.3 million.

Material changes and operating developments

• In June, VAALCO amended its IFC facility, converting $20 million of revolving capacity into a term loan; $15 million was outstanding, with a possible additional $5 million draw subject to IFC approval. The loan bears interest at LIBOR plus 5.75%, is secured by Gabon subsidiary assets and guaranteed by the parent. The net-debt-to-EBITDAX covenant limit was relaxed from 3.0:1 to 5.0:1 through year-end 2016; VAALCO reported compliance at June 30.
• VAALCO released its Gabon drilling rig early and agreed to pay $5.1 million net for unused rig days, plus demobilization costs, in seven monthly installments beginning July 2016. First-half other operating expense was $9.6 million, including rig-related costs and a $2.1 million accrual for potential Gabon payroll-tax liability.
• South Tchibala 2-H was shut in after its electrical submersible pumps failed on June 23. VAALCO planned a workover, expected to restore production by early Q4 2016, at an estimated net cost of $1.7 million.
• In March, Sonangol P&P paid amounts owed, including a $7.6 million receivable recovery and $3.2 million of default interest. These receipts supported first-half results and liquidity but are not recurring operating revenue.
• No proved-property impairment was recorded in the first half of 2016. The company recorded aggregate proved-property impairment of $11.2 million in 2015. The filing states a $5/bbl lower assumed oil price in the June 2016 impairment calculation would still not have triggered impairment.

Outlook, risks and contingencies

• Management estimated 2016 capital expenditures of $1 million to $4 million, mainly maintenance, and said no Gabon development drilling was planned in 2016 because it was uneconomic at then-current prices. If prices remained at Q2 levels, management expected 2016 cash flow to cover operating expenses; this is not a guarantee of adequate liquidity or funding for growth.
• The filing explicitly states that liquidity constraints raise substantial doubt about VAALCO’s ability to continue as a going concern. Management was evaluating financing, asset sales or farm-downs, reduced spending and cost reductions; there was no assurance these options would be available on acceptable terms. The statements were prepared on a going-concern basis.
• Oil-price sensitivity is significant: at recent quarterly sales volumes, a $5/bbl price decline was estimated to reduce quarterly revenue and operating income by $2.2 million and increase quarterly net loss by $1.9 million. Put options cover 36,000 barrels per month from June 2016 through February 2017 at a $40/bbl Dated Brent level, about one-third of forecast sales. They are not designated for hedge accounting; their Q2 fair-value loss was $0.6 million.
• VAALCO has a $17.3 million net estimated undiscounted Gabon offshore abandonment obligation; $5.1 million net had been funded by year-end 2015, and a further $2.6 million net funding was expected later in 2016. The company also disclosed a $134 million gross remaining minimum obligation under its FPSO lease guarantee.
• Three Angola exploration wells remain required by November 2017; failure to spud each could trigger a $5 million net assessment. VAALCO was seeking an extension, without assurance, and reported $15 million of restricted cash associated with the commitment.
• A Gabon tax audit remains unresolved and could result in a material liability. The company accrued $2.2 million net for potential payroll taxes relating to third-party contractor labor. Gabon VAT receivables are subject to collection risk; an agreement provides for monthly installments on the balance outstanding at December 31, 2015.
• After quarter-end, VAALCO agreed to acquire Sojitz’s 2.98% Etame Marin working interest, with closing expected within 90 days and payment primarily from cash on hand. The company also intended to request the additional $5 million IFC term loan.
• Management reported a continuing material weakness in internal control over financial reporting; disclosure controls were deemed ineffective at June 30. The CEO’s resignation was to take effect September 1, 2016, and the CFO had resigned effective June 2; interim leadership and finance arrangements were made.

Important facts for investors to verify

• Current unrestricted cash, restricted-cash availability, installment obligations and near-term liquidity needs, including the IFC loan draw decision and covenant compliance.
• Whether the company can sustain operating cash flow at prevailing oil prices, and how production volumes and realized prices evolve after the South Tchibala 2-H shutdown.
• Completion, funding and economics of the 2.98% Etame Marin acquisition, and whether it changes the company’s financing or capital-spending plans.
• Resolution and cash impact of Gabon tax matters, the contractor payroll-tax accrual, abandonment funding, and Angola exploration commitments.
• Progress in remediating the material weakness and the effect of senior management departures on financial reporting and operations.