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VAALCO ENERGY INC /DE/ - Quarter Report: 2005 March (Form 10-Q)

For the quarterly period ended March 31, 2005
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2005

 

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to             

 

Commission file number 0-20928

 


 

VAALCO Energy, Inc.

(Exact name of small business issuer as specified in its charter)

 


 

Delaware   76-0274813

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

4600 Post Oak Place

Suite 309

Houston, Texas

  77027
(Address of principal executive offices)   (Zip code)

 

(713) 623-0801

(Issuer’s telephone number, including area code)

 


 

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨.

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨.

 

As of March 31, 2005, there were outstanding 56,217,284 shares of common stock, $0.10 par value per share, of the registrant.

 



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VAALCO ENERGY, INC. AND SUBSIDIARIES

 

Table of Contents

 

PART I. FINANCIAL INFORMATION

    

CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

    

Consolidated Balance Sheet March 31, 2005 and December 31, 2004

   3

Statements of Consolidated Operations Three months ended March 31, 2005 and 2004

   4

Statements of Consolidated Cash Flows Three months ended March 31, 2005 and 2004

   5

Notes to Unaudited Consolidated Financial Statements

   6

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

   12

CONTROLS AND PROCEDURES

   17

PART II. OTHER INFORMATION

   19

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

(Unaudited)

(in thousands of dollars, except number of shares and par value amounts)

 

     March 31,
2005


    December 31,
2004


 

ASSETS

                

Current assets:

                

Cash and cash equivalents

   $ 32,001     $ 27,574  

Funds in escrow

     1,156       1,152  

Receivables:

                

Trade

     9,299       5,258  

Accounts with partners

     2,757       3,138  

Other

     551       209  

Crude oil inventory

     113       724  

Materials and supplies

     271       314  

Prepayments and other

     1,167       1,160  

Current assets of discontinued operations

     78       78  
    


 


Total current assets

     47,393       39,607  
    


 


Property and equipment – successful efforts method:

                

Wells, platforms and other production facilities

     33,775       32,960  

Work in progress

     6,611       6,508  

Equipment and other

     917       847  
    


 


       41,303       40,315  

Accumulated depreciation, depletion and amortization

     (15,533 )     (13,966 )
    


 


Net property and equipment

     25,770       26,349  
    


 


Other assets:

                

Deferred tax asset

     1,290       1,290  

Funds in escrow

     809       807  

Other long-term assets

     379       319  
    


 


TOTAL

   $ 75,641     $ 68,372  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                

Current liabilities:

                

Accounts payable and accrued liabilities

   $ 9,274     $ 9,280  

Current portion of long term debt

     2,000       2,250  

Current liabilities of discontinued operations

     1,787       1,927  

Income taxes payable

     —         140  
    


 


Total current liabilities

     13,061       13,597  

Long term debt

     1,000       1,500  

Asset retirement obligations

     1,350       1,330  
    


 


Total liabilities

     15,411       16,427  
    


 


Commitments and contingencies:

                

Minority interest in consolidated subsidiaries

     5,015       4,137  

Stockholders’ equity:

                

Convertible preferred stock, $25 par value, 500,000 shares authorized; 0 and 6,667 shares issued and outstanding at March 31, 2005 and December 31, 2004, respectively

     —         167  

Common stock, $0.10 par value, 100,000,000 authorized shares 57,277,626 and 33,244,244 shares issued with 1,060,342 and 418,294 in treasury at March 31, 2005 and December 31, 2004, respectively

     5,728       3,324  

Additional paid-in capital

     43,585       45,612  

Retained earnings/(accumulated deficit)

     6,168       (1,094 )

Less treasury stock, at cost

     (266 )     (201 )
    


 


Total stockholders’ equity

     55,215       47,808  
    


 


TOTAL

   $ 75,641     $ 68,372  
    


 


See notes to consolidated financial statements.

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

STATEMENTS OF CONSOLIDATED OPERATIONS

(unaudited)

(in thousands of dollars, except per share amounts)

 

    

Three months ended

March 31, 2005


 
     2005

    2004

 

Revenues:

                

Oil and gas sales

   $ 23,144     $ 8,160  

Operating costs and expenses:

                

Production expenses

     3,070       1,947  

Exploration expense

     149       116  

Depreciation, depletion and amortization

     1,587       813  

General and administrative expenses

     451       (13 )
    


 


Total operating costs and expenses

     5,257       2,863  
    


 


Operating income

     17,887       5,297  

Other income (expense):

                

Interest income

     160       48  

Interest expense

     (101 )     (135 )

Other, net

     62       27  
    


 


Total other income (expense)

     121       (60 )
    


 


Income from continuing operations before income taxes, minority interest and discontinued operations

     18,008       5,237  

Income tax expense

     9,876       1,344  
    


 


Income from continuing operations before minority interest and discontinued operations

     8,132       3,893  

Minority interest in earnings of subsidiaries

     (878 )     (434 )

Discontinued operations: (Note 6)

                

Income/(loss) from discontinued operations net of tax

     8       (206 )
    


 


Net income

   $ 7,262     $ 3,253  
    


 


Basic income per share from continuing operations

   $ 0.20     $ 0.16  

Loss from discontinued operations

     —         (0.01 )
    


 


Basic income per share

   $ 0.20     $ 0.15  
    


 


Diluted income per share from continuing operations

   $ 0.12     $ 0.06  

Loss from discontinued operations

     —         (0.01 )
    


 


Diluted income per share

   $ 0.12     $ 0.05  
    


 


Basic weighted shares outstanding

     36,911       21,438  
    


 


Diluted weighted average shares outstanding

     58,388       56,608  
    


 


 

See notes to consolidated financial statements.

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

STATEMENTS OF CONSOLIDATED CASH FLOWS

(Unaudited)

(in thousands of dollars)

 

    

Three months Ended

March 31,


 
     2005

    2004

 

Operating activities:

                

Net income

   $ 7,262     $ 3,253  

Depreciation, depletion and amortization

     1,588       813  

Exploration expense

     149       116  

Minority interest in earnings of subsidiary

     878       434  

Change in operating assets and liabilities:

                

Funds in escrow

     (2 )     (1 )

Trade receivables

     (4,041 )     43  

Accounts with partners

     381       (1,289 )

Other receivables

     (342 )     342  

Crude oil inventory

     611       (441 )

Materials and supplies

     43       80  

Prepayments and other

     (7 )     (462 )

Accounts payable and accrued liabilities

     (651 )     578  

Income taxes payable

     (140 )     47  

Deferred taxes

     —         (95 )
    


 


Net cash provided by operating activities

     5,729       3,418  
    


 


Investing activities:

                

Exploration expense

     (149 )     (116 )

Additions to property and equipment

     (483 )     (4,245 )

Other

     (61 )     55  
    


 


Net cash used in investing activities

     (693 )     (4,306 )
    


 


Financing activities:

                

Proceeds from the issuance of common stock

     145       23  

Funds in escrow, net

     (4 )     998  

Debt repayment

     (750 )     (1,000 )
    


 


Net cash used in financing activities

     (609 )     21  
    


 


Net change in cash and cash equivalents

     4,427       (867 )

Cash and cash equivalents at beginning of period

     27,574       22,995  
    


 


Cash and cash equivalents at end of period

   $ 32,001     $ 22,128  
    


 


Supplemental disclosure of cash flow information:

                

Income taxes paid

   $ 10,016     $ 1,389  
    


 


Interest paid

   $ 63     $ 96  
    


 


 

See notes to consolidated financial statements.

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED MARCH 31, 2005

(Unaudited)

 

1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS AND ACCOUNTING POLICIES

 

The consolidated financial statements of VAALCO Energy, Inc. and subsidiaries (collectively, “VAALCO” or the “Company”), included herein are unaudited, but include all adjustments consisting of normal recurring accruals which the Company deems necessary for a fair presentation of its financial position, results of operations and cash flows for the interim period. Such results are not necessarily indicative of results to be expected for the full year. These financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Form 10-KSB for the year ended December 31, 2004, which also contains a summary of the significant accounting policies followed by the Company in the preparation of its consolidated financial statements. These policies were also followed in preparing the quarterly report included herein. The Company follows the successful efforts method of accounting for exploration expense.

 

VAALCO Energy, Inc., a Delaware corporation, is a Houston-based independent energy company principally engaged in the acquisition, exploration, development and production of crude oil and natural gas. VAALCO owns producing properties and conducts exploration activities as operator of an international consortium in Gabon, West Africa. Domestically, the Company has interests in the Texas Gulf Coast area.

 

VAALCO’s subsidiaries holding interests in Gabon are VAALCO Energy (International), Inc., VAALCO Gabon (Etame), Inc. and VAALCO Production (Gabon), Inc. VAALCO Energy (USA), Inc. holds interests in certain properties in the United States.

 

2. EARNINGS PER SHARE

 

The Company accounts for earnings per share in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128 – “Earnings per Share,” which establishes the requirements for presenting earnings per share (“EPS”). SFAS No. 128 requires the presentation of “basic” and “diluted” EPS on the face of the income statement. Basic EPS is calculated using the average number of shares of common stock outstanding during each period. Diluted EPS assumes the conversion of preferred stock to common stock and the exercise of all stock options and warrants having exercise prices less than the average market price of the common stock using the treasury stock method.

 

Diluted Shares consist of the following:

 

Item


  

Three months ended

March 31, 2005


  

Three months ended

March 31, 2004


Basic weighted average common stock issued and outstanding

   36,910,855    21,437,752

Preferred stock convertible to common stock

   15,482,256    27,500,000

Dilutive warrants

   4,012,656    5,585,159

Dilutive options

   1,981,758    2,084,685
    
  

Total diluted shares

   58,387,525    56,607,596

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED MARCH 31, 2005

(Unaudited)

 

3. ASSET RETIREMENT OBLIGATION

 

The Company records the fair value of a liability for an asset retirement obligation (“ARO”) in the period in which it is incurred by capitalizing it as part of the carrying amount of the long-lived asset. The Company records the systematic accretion and depreciation of future abandonment costs of tangible assets such as platforms, wells, service assets, pipelines, and other facilities. The fair value of the liability for an asset’s retirement obligation is recorded in the period in which it is incurred if a reasonable estimate of the fair value can be made and the corresponding cost is capitalized as part of the carrying amount of the related long-lived asset. The liability is accreted to its then present value each period, and the capitalized cost is depreciated over the useful life of the related asset. If the liability is settled for an amount other than the recorded amount, a gain or loss is recognized. During the three months ending March 31, 2005 and 2004, the Company recognized accretion expense of $20,000 and $17,000 respectively, associated with continuing operations to reflect the fair value of the ARO.

 

4. RECENT ACCOUNTING PRONOUNCEMENTS

 

Share based payment - In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R), Share-Based Payment, which establishes accounting standards for all transactions in which an entity exchanges its equity instruments for goods and services. SFAS No. 123(R) focuses primarily on accounting for transactions with employees, and carries forward without change to prior guidance for share-based payments for transactions with non employees.

 

SFAS No. 123(R) eliminates the intrinsic value measurement objective in APB Opinion 25 and generally requires the Company to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the date of the grant. The standard requires grant date fair value to be estimated using either an option-pricing model which is consistent with the terms of the award or a market observed price, if such a price exists. Such cost must be recognized over the period during which an employee is required to provide service in exchange for the award (which is usually the vesting period). The standard also requires the Company to estimate the number of instruments that will ultimately be issued, rather than accounting for forfeitures as they occur.

 

The Company is required to apply SFAS No. 123(R) to all awards granted, modified or settled in our first annual reporting period under U.S. GAAP beginning after June 15, 2005. The Company is also required to use either the “modified prospective method” or the “modified retrospective method.” Under the modified prospective method, the Company must recognize compensation cost for all awards granted after the Company adopts the standard and for the unvested portion of previously granted awards that are outstanding on that date.

 

Under the modified retrospective method, the Company must restate our previously issued financial statements to recognize the amounts the Company previously calculated and reported on a pro forma basis, as if the prior standard had been adopted.

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED MARCH 31, 2005

(Unaudited)

 

Under both methods, the Company is permitted to use either a straight line or an accelerated method to amortize the cost as an expense for awards with graded vesting. The standard permits and encourages early adoption.

 

The Company has commenced the analysis of the impact of SFAS 123(R). Because of the inexact and subjective nature of deriving non-freely traded employee stock option values, the Company has adopted the disclosure-only provisions of SFAS No. 123 and continues to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” Accordingly, no compensation cost has been recognized for the Company’s stock-based plans. Had compensation cost for the Company’s stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the optional method prescribed by SFAS No. 123, the Company’s net income and net income per share would have been adjusted to the pro forma amounts indicated below (in thousands, except per share data):

 

     Three months
ended March 31,


     2005

   2004

Net income as reported

   $ 7,262    $ 3,253

Deduct: Total stock based employee Compensation expense

     1,675      172
    

  

Pro forma net income

   $ 5,587    $ 3,081
    

  

Basic earnings per share

             

As reported

   $ 0.20    $ 0.15

Pro forma

   $ 0.15    $ 0.14

Diluted earnings per share

             

As reported

   $ 0.12    $ 0.06

Pro forma

   $ 0.10    $ 0.05

 

The total stock based employee compensation expense was determined under the fair value based method for all awards, net of related tax effects.

 

The effects of applying SFAS No. 123 in the disclosure may not be indicative of future amounts as additional awards in future years are anticipated.

 

The valuation of the options awarded in 2003 is based upon a Black-Scholes model assuming expected volatility of 38%, risk-free interest rate of 5.5%, expected life of options of 3 to 5 years, depending upon the award and an expected dividend yield of 0%. The valuation of options awarded in 2004 and January 2005 is based on a Black-Scholes model assuming expected volatility of 62%, risk free interest rate of 5.5%, expected life of options of five years and expected dividend yield of 0%.

 

SFAS 151, Inventory Costs - In November 2004, the FASB issued SFAS No. 151, Inventory Costs an amendment of ARB No. 43, Chapter 4, which amends Chapter 4 of ARB No. 43

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED MARCH 31, 2005

(Unaudited)

 

that deals with inventory pricing. The statement clarifies the accounting for abnormal amounts of idle facility expenses, freight, handling costs, and spoilage. Under previous guidance, paragraph 5 of ARB No. 43, chapter 4, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs might be considered to be so abnormal, under certain circumstances, as to require treatment as current period charges. This statement eliminates the criterion of “so abnormal” and requires that those items be recognized as current period charges. This statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005, although earlier application is permitted for fiscal years beginning after the date of issuance of this statement. Retroactive application is not permitted. Management is analyzing the requirements of this new statement and believes that its adoption will not have any significant impact on the Company’s financial position, results of operations or cash flows.

 

SFAS 153, Exchange of Non-Monetary Assets - In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets an amendment of APB No. 29. This statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. The statement specifies that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. This statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date this statement is issued. Retroactive application is not permitted. Management is analyzing the requirements of this new statement and believes that its adoption will not have any significant impact on the Company’s financial position, results of operations or cash flows.

 

FASB Statement No. 19 – On April 4, 2005, the FASB issued FASB Staff Position No. FAS 19-1 (“FSP FAS 19-1”), which addressed a discussion that was ongoing within the oil industry regarding capitalization of costs of drilling exploratory wells. Paragraph 19 of FASB Statement No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies (“FASB No. 19”), requires costs of drilling exploratory wells to be capitalized pending determination of whether the well has found proved reserves. If the well has found proved reserves, the capitalized costs become part of the entity’s wells, equipment, and facilities; if, however, the well has not found proved reserves, the capitalized costs of drilling the well are expensed. Questions arose in practice about the application of this guidance due to changes in oil- and gas-exploration processes and lifecycles. The issue was whether there are circumstances that would permit the continued capitalization of exploratory well costs if reserves cannot be classified as proved within one year following the completion of drilling other than when additional exploration wells are necessary to justify major capital expenditures and those wells are underway or firmly planned for the near future. FSP FAS 19-1 amends FASB No. 19 to allow for the continued capitalization of suspended well costs when the well has found a sufficient quantity of reserves to justify its completion as a producing well and the enterprise is making sufficient progress assessing the reserves and the economic and operating viability of the plan. The issuance of this amendment did not result in an adjustment to the Company suspended well costs.

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED MARCH 31, 2005

(Unaudited)

 

5. GUARANTEES

 

In November 2002, FASB issued Interpretation (“FIN”) No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which elaborates on the disclosure to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. As set forth in the interpretation, the disclosures required are designed to improve the transparency of the financial statement information about the guarantor’s obligations and liquidity risks related to guarantees issued. The fair values of guarantees entered into after December 31, 2002, must be recorded as a liability in the financial statements of the guarantor. Existing guarantees as of December 31, 2002 are grandfathered from the recognition provisions, unless they are later modified. However, such guarantees are still required to be disclosed.

 

The Company charters a floating production, storage and offloading system (“FPSO”) for use in the Etame field, and as operator of the Etame field, guaranteed the charter payments through September 2010. The charter of the FPSO continues beyond September 2010 for a period of two more years, unless one year’s prior notice is given to the owner of the FPSO. The Company obtained guarantees from its partners for each of their shares of the charter payment. The Company’s share of the charter payment is 28.1%.

 

The estimated obligations for the full charter payment and the Company’s share of the charter payments are as follows (in thousands of dollars):

 

Year


   Full Charter Payment

   Company Share

2005

   $ 12,730    $ 3,574

2006

   $ 16,501    $ 4,633

2007

   $ 16,106    $ 4,522

2008

   $ 15,332    $ 4,304

2009

   $ 15,092    $ 4,237

2010

   $ 14,894    $ 4,181

 

The Company recorded a liability of $0.6 million as the guarantee’s fair value at inception.

 

6. DISCONTINUED OPERATIONS

 

On April 30, 2004, the Company closed the sale of all of its assets associated with Service Contract 6 and Service Contract 14 in the Philippines. Terms of the sale included the assumption by the partners of the Company’s entire share of any abandonment, environmental or other liabilities associated with the Service Contracts. The Company has reclassified earnings to break out the results of discontinued operations for prior periods in its financial statements. The Company realized a loss on the sale of the assets of $125,000 after paying transaction costs of $1,253,000.

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED MARCH 31, 2005

(Unaudited)

 

     Three months ended

 
     March 31,

 

Income/(loss) from discontinued operations


   2004

   2003

 

Revenues from oil sales

   $ —      $ —    

Operating costs and expenses:

               

Production expenses

     —        39  

Exploration expenses

     —        —    

Depreciation, depletion and amortization

     —        1  

General and administrative expenses

     5      163  
    

  


Total operating costs and expenses

     5      203  

Other revenues (expenses):

               

Interest income

     —        4  

Interest expense

     —        —    

Other income (expenses) – net

     13      (10 )
    

  


Income/(loss) from discontinued operations before income taxes

     13      (209 )

Income tax expense (credit)

     —        (3 )
    

  


Income/(loss) from discontinued operations

   $ 8    $ (206 )
    

  


 

7. EQUITY TRANSACTIONS

 

On March 17, 2005, the holder of the remaining 18,334,250 shares of preferred stock converted the preferred stock to common stock at the rate of 2,750 shares of common stock per share of preferred stock. In connection with the transaction, the holder exercised warrants to purchase 5,250,000 shares of common stock under a cashless exercise procedure and was issued 4,635,244 shares of common stock. The 614,756 shares which were used to pay the purchase price under the cashless exercise were placed in the treasury. The stock acquired by the conversion of preferred stock and exercise of the warrants was subsequently sold in block sales over the American Stock Exchange.

 

On February 7, 2005, the holder of warrants to purchase 250,000 shares of common stock exercised the warrants under a cashless exercise procedure and was issued 222,707 shares of common stock. The 27,293 which were used to pay the purchase price under the cashless exercise shares were placed in the treasury.

 

Upon completion of the conversion of preferred stock and exercises of warrants the Company has no preferred stock or warrants outstanding.

 

During the quarter ended March 31, 2005, employees and contractors exercised options to receive 199,133 shares of common stock resulting in net proceeds to the Company of $145,000. During the quarter ended March 31, 2004, employees and contractors exercised options to receive 75,000 shares of common stock resulting in net proceeds to the Company of $22,500.

 

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This report includes “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”). All statements other than statements of historical fact included in this report (and the exhibits hereto), including without limitation, statements regarding the Company’s financial position and estimated quantities and net present values of reserves, and statements proceed by, followed by or that otherwise include the word “believe,” “expects,” “anticipates,” “intends,” “projects,” “target,” “goal,” “objective,” “should,” or similar expressions or variations of such expressions are forward looking statements. The Company can give no assurances that the assumptions upon which such statements are based will prove to have been correct. Important factors that could cause actual results to differ materially from the Company’s expectations (“Cautionary Statements”) include volatility of oil and gas prices, future production costs, future production quantities, operating hazards, weather, and statements set forth in the “Risk Factors” section included in the Company’s Forms 10-KSB, which are herein incorporated by reference. All subsequent written and oral forward looking statements attributable to the Company or persons acting on its behalf are expressly qualified by the Cautionary Statements.

 

INTRODUCTION

 

The Company operates the Etame field on behalf of a consortium of five companies offshore of the Republic of Gabon. The Phase 1 development of the field occurred in 2002 and consisted of completing three wells producing into a 1.1 million barrel FPSO. The Phase 2 development commenced in 2004 and consists two wells planned, one of which has already been drilled and completed (the Etame-5H well). The second well of the Phase 2 development (the Etame-6H well) is expected to be drilled during the middle of 2005. The Company also plans to drill an exploration well south of the recently discovered Avouma accumulation. The well is expected to reach total depth during the second quarter of 2005.

 

During the three months ended March 31, 2005, the Etame field produced 1.7 million barrels (0.5 million net to the Company). The Etame field currently produces at approximately 19,000 BOPD (6100 BOPD net to the Company).

 

The Company’s results of operations are affected by currency exchange rates. While oil sales are denominated in U.S. dollars, portions of operating costs in Gabon are denominated in local currency. An increase in the exchange rate of the local currency to the dollar will have the effect of increasing operating costs, while a decrease in the exchange rate will reduce operating costs. The Gabon local currency is tied to the Euro, which appreciated substantially against the dollar in 2003 and 2004. In the past the Company has not entered into any currency hedges to fix or reduce volatility of changes in the exchange rate between the dollar and the Euro, and currently has no plans to do so in the future.

 

The Company sells it Gabon production to Shell Western Supply and Trading, Limited at spot market prices.

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

CAPITAL RESOURCES AND LIQUIDITY

 

Cash Flows

 

Net cash provided by operating activities for the three months ended March 31, 2005 was $5.7 million, as compared to $3.3 million provided by operations for the three months ended March 31, 2004. Net funds provided by operations in 2005 included net income of $7.3 million, non-cash depreciation, depletion and amortization of $1.6 million, minority interest add back of $0.9 million and cash used for working capital of $4.1 million. In 2004, net cash provided by operating activities included net income of $3.2 million, non-cash depreciation, depletion and amortization of $0.8 million, add back of minority interest of $0.4 million and cash used for working capital of $1.2 million.

 

Net cash used in investing activities for the three months ended March 31, 2005 was $0.7 million net of $0.5 million of accounts payable, as compared to net cash used in investing activities of $4.3 million for the three months ended March 31, 2004. In the three months ended March 31, 2005, the Company invested funds to upgrade the gas lift compressor on the FPSO and to purchase casing for the Etame-6H development well. In the three months ended March 31, 2004, the Company added to its investment in Gabon by participating in the Ebouri well, which resulted in an oil discovery.

 

In the three months ended March 31, 2005, net cash used in financing activities was $0.6 million consisting of $0.8 million of debt reduction, offset by $0.1 million of proceeds from the issuance of common stock. Net cash used in financing activities in the three months ended March 31, 2004 was $21 thousand consisting of proceeds from the issuance of common stock.

 

Capital Expenditures

 

During the three months ended March 31, 2005, the Company incurred $0.7 million on activities to upgrade the gas lift compressor on the FPSO and for the Etame-6H well. During the remainder of 2005, the Company anticipates participating in two wells and commencing the development of the Avouma discovery. Total capital expenditures for the remainder of 2005 are anticipated to be $14.3 million.

 

Historically, the Company’s primary sources of capital have been cash flows from operations, private sales of equity, borrowings and purchase money debt. At March 31, 2005, the Company had cash of $32.0 million. The Company believes that this cash combined with cash flow from operations will be sufficient to fund the Company’s remaining 2005 capital expenditure budget, required debt repayments of $1.5 million and additional investments in working capital resulting from potential growth. As operator of the Etame field, the Company enters into project related activities on behalf of its working interest partners. The Company generally obtains advances from it partners prior to significant funding commitments.

 

The Company has a credit facility with the International Finance Corporation (“IFC”), a subsidiary of the World Bank. A total of $3.0 million remains outstanding on the facility.

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

On September 8, 2002, the Company commenced production from the Etame field offshore Gabon. Through March 31, 2005, total field production sold was 14.6 million barrels (3.5 million barrels net to the Company).

 

Substantially all of the Company’s crude oil and natural gas is sold at the well head at posted or index prices under short-term contracts. In Gabon, the Company markets its crude oil under and agreement with Shell Western Trading and Supply, Limited. While the loss of Shell as a buyer might have a material adverse effect on the Company in the near term, management believes that the Company would be able to obtain other customers for its crude oil.

 

Domestically, the Company produces from wells in Brazos County, Frio County and Dimmit County, Texas. Domestic production is sold via separate contracts for oil and gas. The Company has access to several alternative buyers for oil and gas sales domestically.

 

Oil and Gas Exploration Costs

 

The Company uses the “successful efforts” method of accounting for its oil and gas exploration and development costs. All expenditures related to exploration, with the exception of costs of drilling exploratory wells are charged to expense as incurred. The costs of exploratory wells are capitalized on the balance sheet pending determination of whether commercially producible oil and gas reserves have been discovered. If the determination is made that a well did not encounter potentially economic oil and gas quantities, the well costs are charged to expense.

 

At March 31, 2005, the Company had $6.6 million being carried on the balance sheet as work in progress associated with exploratory wells for the Company’s share of the costs of the Ebouri No. 1 well and the Avouma No. 1 well and the South Avouma well to be drilling in the second quarter of 2005. The Ebouri and Avouma wells resulted in discoveries of oil and gas.

 

For offshore exploratory discoveries, it is not unusual to have exploratory well costs remain suspended while additional appraisal and engineering work on the potential oil and gas field is performed and regulatory and government approvals are sought. In Gabon, the government must approve the commerciality of the reserves, assign a development area and approve a formal development plan prior to a field being developed. In February 2005, the Company received approval to declare the reserves commercial from the Gabon government and in April 2005 the government approved the assignment of a development area. The Company subsequently filed a development plan and is awaiting government approval. For the Ebouri discovery the Company acquired new seismic over the discovery in January 2005 and intends to file for a development area and submit a development plan after the seismic is processed later in 2005.

 

Contractual Obligations

 

The Company has completed the commitments to the Gabon government under the third exploration period of the Etame contract. The Company entered into the two year fourth exploration period, beginning in October 2004, which requires a gross expenditure for exploration activities of $5.0 million ($1.5 million net to the Company).

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

In addition to its lending relationships and obligations, the Company has contractual obligations under operating leases. The table below summarizes these obligations and commitments at March 31, 2005 (in thousands):

 

Payment Period


   2005

   2006

   2007

   Thereafter

Long Term Debt

   $ 1,500    $ 1,250    $ 250    $ —  

Operating Leases(1)

     14,861      18,465      16,297      45,330

1. The Company is guarantor of a lease for an FPSO utilized in Gabon (see “Footnote 5 Guarantees”). Approximately 72% of the payment is co-guaranteed by the Company’s partners in Gabon.

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

RESULTS OF OPERATIONS

 

Three months ended March 31, 2005 compared to three months ended March 31, 2004

 

Revenues

 

Total revenues were $23.1 million for the three months ended March 31, 2005 compared to $8.2 million for the comparable period in 2004. The Company sold approximately 519,000 net barrels of oil equivalent at an average price of $44.58 in three months ended March 31, 2005. In the three months ended March 31, 2004, the Company sold approximately 265,000 barrels of oil equivalent at an average price of $30.83 per barrel. The higher oil sales volumes in the three months ended March 31, 2005 are due to higher production rates from the Etame field resulting from the addition of the Etame-5H well in August 2004, and due to timing differences associated with liftings from the Etame field.

 

Operating Costs and Expenses

 

Total production expenses for the three months ended March 31, 2005 were $3.1 million compared to $1.9 million in the three months ended March 31, 2004. The Company matches production expenses with crude oil sales. Any production expenses associated with unsold crude oil inventory are capitalized. Thus, the higher oil sales in the three months ended March 31, 2005 resulted in higher production expenses, although production expense in the three months ended March 31, 2005 were lower on a per barrel basis than for the comparable period in 2004..

 

Exploration expense was $0.1 million for the three months ended March 31, 2005 compared to $0.1 million in the comparable period in 2004. Exploration expense in both periods was associated with seismic interpretation activity on the Etame block.

 

Depreciation, depletion and amortization expenses were $1.6 million in the three months ended March 31, 2005 compared to $0.8 million in the three months ended March 31, 2004. The deprecation, depletion and amortization expenses during the three months ended March 31, 2005 reflect the effects of the increase in amortizable costs due to the addition of the Etame 5H well, as well as the higher volume of crude oil sold. General and administrative expenses for the three months ended March 31, 2005 and 2004 were $0.5 million and $0 for each period, respectively. In the three months ended March 31, 2004, the Company benefited from overhead reimbursement associated with production and operations on the Etame block.

 

Other Income (Expense)

 

Interest income received on amounts on deposit was $0.2 million in the three months ended March 31, 2005 compared to $48 thousand in the three months ended March 31, 2004. Interest expense and financing charges for the IFC loan was $0.1 million for both the three months ended March 31, 2005 and the three months ended March 31, 2004.

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Income Taxes

 

Income taxes amounted to $9.9 million and $1.3 million for the three months ended March 31, 2005 and 2004, respectively. In both periods, the income tax was paid in Gabon. The higher income tax paid in 2005 was due in part to higher volumes of production and higher oil prices. In addition, the Company paid a higher tax rate as a result of the cost account on the Etame field being fully recovered. The cost account deduction from income taxes was not fully available in the three months ended March 31, 2005 as compared to the three months ended March 31, 2004 when the full deduction was available.

 

Discontinued Operations

 

Income from discontinued operations in the Philippines in the three months ended March 31, 2004 was $8 thousand compared to a $0.2 million loss in the three months ended March 31, 2004. In the three months ended March 31, 2004, the loss was due to severance costs associated with the sale of the Philippines assets.

 

Minority Interest

 

The Company incurred $0.9 million in minority interest charges in the three months ended March 31, 2005. These minority interest charges were associated with VAALCO Energy (International), Inc., a subsidiary that is 90.01% owned by the Company. In the three months ended March 31, 2004, minority interest charges of $0.4 million were incurred.

 

Net Income

 

Net income for the three months ended March 31, 2005 was $7.3 million, compared to net income of $3.3 million for the same period in 2004. In the three months ended March 31, 2004, the Company experienced lower crude oil sales volumes and lower oil prices.

 

ITEM   3. QUANTATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Company’s results of operations are dependent upon the difference between prices received for its oil and gas production and the costs to find and produce such oil and gas. Oil and gas prices have been and are expected in the future to be volatile and subject to fluctuations based on a number of factors beyond the control of the Company. The Company does not presently engage in any hedging activities and has no plans to do so in the near future.

 

ITEM 4. CONTROLS AND PROCEDURES

 

The Company’s management, including the Company’s principal executive officer and principal financial officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that

 

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VAALCO ENERGY, INC. AND SUBSIDIARIES

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

evaluation, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report on Form 10-Q. There were no changes in the Company’s internal controls over financial reporting that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect the Company’s internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 6. EXHIBITS

 

(a) Exhibits

 

3. Articles of Incorporation and Bylaws

 

  3.1 Restated Certificate of Incorporation (incorporated by reference to exhibit 4.1 to the Company’s Registration Statement on Form S-3 filed with the Commission on July 15, 1998, Reg. No. 333-59095).

 

  3.2 Certificate of Amendment to Restated Certificate of Incorporation (incorporated by reference to exhibit 4.2 to the Company’s Registration Statement on Form S-3 filed with the Commission on July 15, 1998, Reg. No. 333-59095).

 

  3.3 Amended and Restated Bylaws dated March 24, 2005

 

31. Rule 13a-14(a)/15d-14(a) Certifications

 

  31.1 Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002

 

  31.2 Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002

 

Section 1350 Certificates

 

  32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002.

 

  32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002.

 

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SIGNATURES

 

In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

VAALCO ENERGY, INC.
(Registrant)
By  

/s/W. RUSSELL SCHEIRMAN


    W. Russell Scheirman, President,
    Chief Financial Officer and Director
   

(on behalf of the Registrant and as the

principal financial officer)

 

Dated: April 29, 2005

 

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EXHIBIT INDEX

 

Exhibits

 

3. Articles of Incorporation and Bylaws

 

  3.1 Restated Certificate of Incorporation (incorporated by reference to exhibit 4.1 to the Company’s Registration Statement on Form S-3 filed with the Commission on July 15, 1998, Reg. No. 333-59095).

 

  3.2 Certificate of Amendment to Restated Certificate of Incorporation (incorporated by reference to exhibit 4.2 to the Company’s Registration Statement on Form S-3 filed with the Commission on July 15, 1998, Reg. No. 333-59095).

 

  3.3 Amended and Restated Bylaws dated March 24, 2005

 

Additional exhibits

 

  31.1 Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002

 

  31.2 Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002

 

  32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002.

 

  32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act Of 2002.

 

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