VAALCO Energy, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019. VAALCO is an independent oil and gas company whose producing operations are concentrated in offshore Gabon; Equatorial Guinea is undeveloped, and Angola is reported as discontinued operations. Unless stated otherwise, financial amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q1 2019 | Q1 2018 / comparison |
|---|---|---|
| Oil and gas revenue | $19.8 million | $27.6 million, down 28.5% |
| Operating income | $5.5 million | $13.0 million |
| Continuing-operations income | $0.8 million | $8.7 million |
| Net income | $6.5 million; $0.10 per diluted share | $8.7 million; $0.15 per diluted share |
| Operating cash flow | $13.5 million total; $13.6 million from continuing operations | $15.1 million total |
| Cash capital expenditures | $0.8 million | $0.4 million |
- Revenue fell primarily because sales volumes were lower: price accounted for a $1.3 million decline and volume for a $6.6 million decline. Net production was 315,000 barrels versus 325,000; net sales were 297,000 barrels versus 393,000. The 2018 sales comparison included 95,525 barrels from a 2017 lifting completed in January 2018.
- Average realized oil price was $64.17 per barrel, versus $68.69. Three liftings occurred in Q1 2019 compared with four in Q1 2018.
- Operating margin, calculated as operating income divided by revenue, was approximately 28% versus 47%. General and administrative expense increased $1.8 million to $4.4 million, including higher stock-based compensation, legal and professional fees, and taxes. Production expense declined $2.7 million to $8.2 million; DD&A increased to $1.6 million from $1.1 million.
- Q1 2019 net income includes a $5.7 million after-tax gain from the Angola settlement. Continuing-operations income was $0.8 million; the quarter also included $1.9 million of net derivative losses and $2.8 million of income tax expense. The continuing-operations effective tax rate was 77%.
- Operating cash flow declined $1.6 million year over year. At March 31, cash and cash equivalents were $46.2 million, with $1.7 million of restricted cash and $11.4 million of abandonment funding shown separately. VAALCO reported no outstanding borrowings; its IFC term loan had been repaid in 2018.
- Total assets were $201.5 million and total liabilities were $85.2 million. Adoption of lease accounting added a $36.6 million operating lease asset and corresponding liabilities; total operating lease liabilities were $36.6 million, including $10.3 million current. The lease liabilities are not debt borrowings.
Material changes and unusual items
- VAALCO and Sonangol E.P. finalized an Angola settlement that terminates the company’s Block 5 rights, liabilities, and outstanding obligations. It requires a $4.5 million payment and cancellation of a $3.3 million receivable; payment is due within 15 days after an executive decree. The settlement reduced a previously accrued liability and produced the $5.7 million after-tax gain. Angola liabilities remaining on the March 31 balance sheet were $4.7 million.
- Effective January 1, 2019, the company adopted ASC 842. It recognized $38.9 million of right-of-use assets and corresponding lease liabilities at adoption. The filing says adoption materially increased assets and liabilities and reduced working capital, without a material impact on earnings or cash flows.
- Oil swaps generated $1.1 million of realized gains and $3.0 million of unrealized losses, for a $1.9 million net loss. The company had 68,000 barrels of swaps outstanding at quarter-end, with a $74 per barrel weighted-average price and expiration through June 2019.
Outlook, risks, and contingencies
- VAALCO planned to drill two wells and two appraisal well bores at Etame Marin beginning in the second half of 2019, with a possible third well in late 2019 or early 2020 subject to approvals. The required program is estimated at $20.5 million net to VAALCO by September 16, 2020. Management expected 2019 capital spending to be funded from cash on hand and operating cash flow, and said liquidity at current prices should support operations and cash requirements through June 30, 2020.
- Production was adversely affected by a late-March work stoppage by non-VAALCO FPSO employees, though VAALCO completed its March lifting. The company also cited oil-price volatility, operational and drilling risks, foreign-exchange exposure, and risks related to foreign-government actions and regulations.
- At March 31, the company held $10.0 million of undeveloped leasehold costs for Equatorial Guinea Block P. It is awaiting approval of its operator appointment and intends to seek a promoted partner to fund substantially all of an exploration well. Failure to drill within the required period could result in loss of the license and impairment of the recorded costs.
- VAALCO had commitments to fund abandonment activities in Gabon. Abandonment funds were transferred in March to the CEMAC central bank and converted into local currency under regulatory requirements; the company describes related currency and bank-reimbursement risks.
- Routine government and joint-interest audits continue. Management did not expect the Gabon audit to materially affect financial condition, results, or liquidity; a separate customs matter was resolved in January 2019 for $1.3 million net to VAALCO. Management said current litigation was not likely to have a material adverse effect.
- Disclosure controls were deemed ineffective because of a previously reported material weakness in reviewing the income-tax effects of significant, unusual, and infrequent transactions. VAALCO hired an employee with tax expertise and expected remediation during 2019, but gave no assurance that the effort would succeed.
Important facts for investors to verify
- Whether the Angola executive decree was issued and the $4.5 million settlement payment made.
- Progress, cost, timing, and approvals for the Etame drilling program, and whether management’s liquidity assumptions remain valid.
- Production and lifting volumes after the FPSO work stoppage, and any continuing operational disruption.
- Collection of Gabon VAT and joint-venture receivables, and the status and currency treatment of abandonment funds.
- Block P operator approval, partner funding, and exploration-well deadline, given the $10.0 million recorded leasehold value.
- Progress in remediating the tax-control material weakness and any resulting changes in reported tax expense.