UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-KSB
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
|_| 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
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VAALCO Energy, Inc.
(Name of small business issuer in its charter)
Delaware 76-0274813
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4600 Post Oak Place
Suite 309
Houston, Texas 77027
(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (713) 623-0801
Securities registered under Section 12(b) of the Exchange Act:
Title of each class Name of each exchange
on which registered
None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $.10 par value
(Title of class)
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 _ .
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB X .
The registrant's revenues for the fiscal year ended December 31, 1998
were $594,692.
The aggregate market value of the voting and non-voting common equity
of the registrant held by non-affiliates, as of March 18, 1999 was $5,150,697
based upon the closing price as of such date.
As of March 18, 1999, there were outstanding 20,749,968 shares of
Common Stock, $.10 par value per share, of the registrant.
Documents incorporated by reference: Definitive proxy statement of
VAALCO Energy, Inc. relating to the Annual Meeting of Stockholders to be filed
within 120 days after the end of the fiscal year covered by this Form, which is
incorporated into Part III of this 10-KSB.
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VAALCO ENERGY, INC.
TABLE OF CONTENTS
<TABLE>
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PART I
<S> <C> <C>
Item 1. Business...............................................................................3
Item 2. Properties............................................................................14
Item 3. Legal Proceedings.....................................................................19
Item 4. Submission of Matters to a Vote of Security Holders...................................19
PART II
Item 5. Market for Common Equity and Related
Stockholder Matters...................................................................20
Item 6. Management's Discussion and Analysis or Plan
of Operations.........................................................................21
Item 7. Financial Statements and Supplementary Data...........................................26
Item 8. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................................................51
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act.....................................52
Item 10. Executive Compensation................................................................52
Item 11. Security Ownership of Certain Beneficial Owners and Management........................52
Item 12. Certain Relationships and Related Transactions........................................52
Item 13. Exhibits and Reports on Form 8-K......................................................52
</TABLE>
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PART I
Item 1. Business
BACKGROUND
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. As used herein, the
terms "Company" and "VAALCO" mean VAALCO Energy, Inc. and its subsidiaries,
unless the context otherwise requires. VAALCO owns producing properties and
conducts exploration activities as operator of consortium internationally in the
Philippines and Gabon. Through participation in a partnership with Hunt Oil
Company, VAALCO has additional international exploration interests in Argentina,
Peru, Ethiopia, Ghana, Niger and Canada. Domestically, the Company has interests
in the Texas Gulf Coast area.
In April 1998, the Company acquired from The 1818 Fund II, L.P., (the
"1818 Fund"), a fund managed by Brown Brothers Harriman & Co., all of the
outstanding capital stock of 1818 Oil Corp (the "Hunt Transaction"). The assets
of 1818 Oil Corp. at closing consisted of a 7.5% limited partnership interest in
Hunt Overseas Exploration Company, L.P. ("Hunt") with book value of $2.8 million
and $12.6 million in cash. The $12.6 million of cash which 1818 Oil Corp. had at
the time of the acquisition has been pledged as cash collateral to secure a
letter of credit payable to Hunt for cash calls associated with the partnership.
If Hunt does not call such capital contributions as provided in the partnership
agreement of Hunt, the cash collateral will be released to the Company.
Hunt has entered into production sharing contracts and other
arrangements which entitle it to explore for oil and gas, both onshore and
offshore, on 34 million acres in countries including Argentina, Peru, Ethiopia,
Ghana, Niger and Canada. The general partner of Hunt is Hunt Overseas Operating
Company, a subsidiary of Hunt Oil Company. Hunt explores for high risk, large
reserve accumulations, generally targeting deposits which pre-drilling seismic
and other data indicate to have potential in excess of 100 MMBOE.
Under the partnership agreement of Hunt, the Company will have an
obligation to contribute an estimated $5.1 million to fund its share of the
exploration costs of Hunt, $0.7 million of which was funded subsequent to the
acquisition. In addition, if Hunt discovers oil or gas deposits, the Company
will be required to contribute an additional $7.5 million to fund appraisal
costs. VAALCO has $12.3 million in cash in an escrow account to fund its
obligations under the partnership agreement, which includes $0.4 million of
interest earned on the funds since they were placed in escrow.
The 1818 Oil Corp. acquisition has been accounted for as a reverse
acquisition and 1818 Oil Corp. is the acquiring entity for financial accounting
purposes. Therefore, because 1818 Oil Corp. is the acquirer for accounting
purposes, the financial statements for prior years are those of 1818 Oil Corp.,
not VAALCO the legal acquirer. Accordingly, a comparison of 1998 and 1997
results is not meaningful. 1818 Oil Corp.'s equity as of December 31, 1998 and
December 31, 1997 have been retroactively charged for the equivalent number of
shares of VAALCO's common stock received in the transaction. The difference
between the par value of the common stock of
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1818 Oil Corp. and VAALCO has been charged to additional paid-in capital. In
addition, at the time of the merger, 1818 Fund contributed the debt owed to it
by 1818 Oil Corp. as additional paid-in capital to 1818 Oil Corp.
VAALCO's Philippine subsidiaries include Alcorn (Philippines) Inc. and
Alcorn (Production) Philippines Inc. VAALCO's Gabon subsidiaries are VAALCO
Gabon (Equata), Inc., VAALCO Gabon (Etame), Inc., VAALCO Production (Gabon),
Inc. and VAALCO Energy (Gabon), Inc. VAALCO (USA), Inc. holds interests in
certain properties in the United States.
RECENT DEVELOPMENTS
The Company is the operator of a 3,073 square kilometer concession
known as the Etame Block offshore Gabon, West Africa, with a working interest
ownership of 17.9%. In June 1998, the Company announced the discovery of the
Etame field, with the drilling of the Etame No. 1 well. The well was drilled to
a depth of 8,000 feet and resulted in an oil discovery, which tested at a rate
of 3,700 barrels oil per day on a 32/64's inch choke from perforations in the
Gamba Sandstone. The Etame Block contains two former Gulf Oil Company
discoveries, the North and South Tchibala discoveries. All three discoveries
consist of subsalt reservoirs that lie in approximately 250 feet of water depth,
20 miles offshore.
In January 1999, the Company completed the drilling of the Etame 2V
delineation well. The well found oil pay in the Gamba Sandstone, however, the
reservoir was encountered at a lower depth than expected. The well was not
tested. A seismic reprocessing effort has been commenced to better delineate the
Gamba reservoir below the salt before additional wells will be drilled. At least
one additional delineation well is planned for 1999.
During February 1999, Hunt Oil Company drilled a 4,500 foot test on its
Rio Belgrano block in Argentina. The well did not encounter any commercial
hydrocarbons and was abandoned.
In December 1998, an Australian Company completed the acquisition of
3-D seismic over the Company's interests in Service Contract 14 in the
Philippines. The Company and the other members of the Service Contract 14
Consortium assigned 35% of their working interest in the Service Contract to the
Australian Company pursuant to the farm-out agreement.
In September 1998, the Company elected to participate in a two well
exploration program in Lafourche Parish, Louisiana. The prospects are gas
prospects generated from a 3-D seismic survey over the leases. The Company has
taken a 15% working interest in the two prospects, and expects its share of the
cost of the wells to be approximately $0.7 million. In October 1998, drilling of
the first prospect was completed and no commercial gas zones were encountered.
The second well of the program is anticipated to spud in the second quarter of
1999.
The Company participates in a joint venture with Paramount Petroleum,
Inc. to conduct exploration activities primarily in the onshore Gulf Coast area,
including Alabama, Mississippi and Louisiana. In July 1998, the Company elected
to participate at a 15% working interest level in the first prospect developed
by the joint venture. The well was drilled in October 1998 and did not encounter
productive hydrocarbon intervals and has been abandoned. The Company's share
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of the cost of the well was approximately $0.1 million. The Company has agreed
to take a 10% interest in two additional prospects to be drilled during the
second quarter of 1999.
GENERAL
The Company's strategy is to increase reserves and production in a
cost-effective manner through a program that balances lower risk acquisitions
and exploratory drilling on VAALCO's domestic acreage with high potential
international prospects. Internationally, financial exposure and political risk
are mitigated through alliances with experienced industry partners who fund the
majority of required capital.
International
The Company's international strategy is to pursue selected
opportunities that are characterized by reasonable entry costs, favorable
economic terms, high reserve potential relative to capital expenditures and the
availability of existing technical data that may be further developed using
current technology. The Company believes that it has unique management and
technical expertise in identifying international opportunities and establishing
favorable operating relationships with host governments and local partners
familiar with the local practices and infrastructure.
The Company owns producing properties and conducts exploration
activities as operator of consortium internationally in the Philippines and
Gabon. Through participation in a partnership with Hunt Oil Company, VAALCO has
additional international exploration interests in Argentina, Peru, Ethiopia,
Ghana, Niger and Canada.
Domestic
The Company's domestic strategy is to build near-term cash flows
through focused acquisition of domestic properties that have significant
exploration potential, increasing production from existing fields with the
application of the Company's technical and operating expertise and participating
in exploration through farm out and other arrangements. Recognizing that
international operations are subject to greater social, economic and political
volatility, the Company seeks to build a stable domestic production and reserve
base that will permit the Company to continue to participate in more high-risk
international projects with greater reserve potential.
The joint venture agreement with Paramount Petroleum, Inc., entitles
the Company to acquire, at its option, 25% of any prospect generated by the
joint venture, on a non-promoted basis taking into account the Company's
interest in the joint venture. The joint venture agreement also provides for the
sharing of any revenues attributable to prospects generated by the joint venture
and sold to others. The Company has committed to expend $3.0 million to fund
overhead, leases, seismic and other amounts in connection with the joint
venture, $2.7 million of which has been funded as of the date of this filing.
The Company has posted a letter of credit to secure such commitment.
The Company owns an interest in 8,000 acres onshore Texas and has
interests in producing fields in the Gulf of Mexico.
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CUSTOMERS
Substantially all of the Company's crude oil and natural gas is sold at
the well head at posted or indexed prices under short-term contracts, as is
customary in the industry. For the year ended December 31, 1998, one purchaser
of the Company's crude oil accounted for essentially all of the Company's total
crude oil sales. The Company markets its crude oil share in the Philippines
under an agreement with SeaOil Corporation, a local Philippines refiner
("SeaOil"). While the loss of this buyer might have a material effect on the
Company in the near term, management believes that the Company would be able to
obtain other customers for its crude oil.
EMPLOYEES
As of December 31, 1998, the Company had 24 full-time employees, 17 of
which were located in the Philippines. The Company is not subject to any
collective bargaining agreements and believes its relations with its employees
are satisfactory.
COMPETITION
The oil and gas industry is highly competitive. Competition is
particularly intense with respect to acquisitions of desirable oil and gas
reserves. There is also competition for the acquisition of oil and gas leases
suitable for exploration and the hiring of experienced personnel. Competition
also exists with other industries in supplying the energy needs of consumers. In
addition, the producing, processing and marketing of oil and gas is affected by
a number of factors beyond the control of the Company, the effects of which
cannot be accurately predicted.
The Company's competition for acquisitions, exploration, development
and production include the major oil and gas companies in addition to numerous
independent oil companies, individual proprietors, drilling and acquisition
programs and others. Many of these competitors possess financial and personnel
resources substantially in excess of those available to the Company, giving
those competitors an enhanced ability to pay for desirable leases and to
evaluate, bid for and purchase properties or prospects. The ability of the
Company to generate reserves in the future will depend on its ability to select
and acquire suitable producing properties and prospects for future drilling and
exploration.
RISK FACTORS
Volatility of Oil and Gas Prices and Markets
The Company's revenues, cash flow, profitability and future rate of
growth are substantially dependent upon prevailing prices for oil and gas. The
Company's ability to borrow funds and to obtain additional capital on attractive
terms is also substantially dependent on oil and gas prices. The Company's
production in the Philippines is from mature offshore fields with high
production costs. The Company's margin on sales from these fields (the price
received for oil less the production costs for the oil) is lower than the margin
on oil production from many other areas. As a result, the profitability of the
Company's production in the Philippines is affected more by changes in prices
than production located in other areas. Historically, oil and gas prices and
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markets have been volatile and are likely to continue to be volatile in the
future. Prices for oil and gas are subject to wide fluctuations in response to
relatively minor changes in supply of and demand for oil and gas, market
uncertainty and a variety of additional factors that are beyond the control of
the Company. These factors include international political conditions, the
domestic and foreign supply of oil and gas, the level of consumer demand,
weather conditions, domestic and foreign governmental regulations, the price and
availability of alternative fuels and overall economic conditions. In addition,
various factors, including the availability and capacity of gas gathering
systems and pipelines, the effect of federal, state and foreign regulation of
production and transportation, general economic conditions, changes in supply
due to drilling by other producers and changes in demand may adversely affect
the Company's ability to market its oil and gas production. Any significant
decline in the price of oil or gas would adversely affect the Company's
revenues, operating income, cash flows and borrowing capacity and may require a
reduction in the carrying value of the Company's oil and gas properties and its
planned level of capital expenditures. The downturn in certain of the economies
in Asia has resulted in substantially lower crude oil prices in the area, with
the Company averaging approximately $6.50 per barrel for its crude oil during
1998.
Replacement of Reserves
The Company's future success depends upon its ability to find, develop
or acquire additional oil and gas reserves that are economically recoverable.
Except to the extent that the Company conducts successful exploration or
development activities or acquires properties containing proved reserves, the
estimated net proved reserves of the Company will generally decline as reserves
are produced. There can be no assurance that the Company's planned development
and exploration projects and acquisition activities will result in significant
additional reserves or that the Company will have continuing success drilling
productive wells at economic finding costs. The drilling of oil and gas wells
involves a high degree of risk, especially the risk of dry holes or of wells
that are not sufficiently productive to provide an economic return on the
capital expended to drill the wells. In addition, the Company's drilling
operations may be curtailed, delayed or canceled as a result of numerous
factors, including title problems, weather conditions, political instability,
economic/currency imbalances, compliance with governmental requirements or
delays in the delivery of equipment and availability of drilling rigs. Certain
of the Company's oil and gas properties are operated by third parties or may be
subject to operating committees controlled by national oil companies and, as a
result, the Company has limited control over the nature and timing of
exploration and development of such properties or the manner in which operations
are conducted on such properties.
Substantial Capital Requirements
The Company makes, and will continue to make, substantial capital
expenditures for the acquisition, exploitation, development, exploration and
production of oil and gas reserves. Historically, the Company has financed these
expenditures primarily with cash flow from operations, asset sales, private
sales of equity, bank borrowings and purchase money debt. The Company believes
that it will have sufficient capital to finance planned capital expenditures
through 1999.
The Company has $12.3 million of funds in escrow to be utilized to fund
its share of activities within Hunt. The partnership agreement of Hunt obligates
the Company to contribute,
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when requested by Hunt, up to $5.1 million to fund Hunt's exploration program,
$0.7 million of which has been funded subsequent to the acquisition. In
addition, if Hunt discovers oil, the Company may be required to contribute an
additional $7.5 million to fund the appraisal of the discovery. If Hunt does not
call such capital contributions as provided in the partnership agreement of
Hunt, the remaining cash in escrow will be released to the Company.
The Company has committed to invest $3.0 million in the Paramount joint
venture, $2.7 million of which has already been funded as of the date of this
filing. There can be no assurance that the Company will realize a return on this
investment or that the Company's investment in the Paramount joint venture will
be successful.
Drilling Risks
Drilling activities are subject to many risks, including the risk that
no commercially productive reservoirs will be encountered. There can be no
assurance that new wells drilled by the Company will be productive or that the
Company will recover all or any portion of its investment. Drilling for oil and
natural gas may involve unprofitable efforts, not only from dry wells, but also
from wells that are productive but do not produce sufficient net revenues to
return a profit after drilling, operating and other costs. The cost of drilling,
completing and operating wells is often uncertain and cost overruns are common.
The Company's drilling operations may be curtailed, delayed or canceled as a
result of numerous factors, many of which are beyond the Company's control,
including title problems, weather conditions, compliance with governmental
requirements and shortages or delays in the delivery of equipment and services.
Operating Hazards and Uninsured Risks
The oil and gas business involves a variety of operating risks,
including fire, explosions, blow-outs, pipe failure, casing collapse, abnormally
pressured formations and environmental hazards such as oil spills, gas leaks,
ruptures and discharges of toxic gases, the occurrence of any of which could
result in substantial losses to the Company due to injury and loss of life,
severe damage to and destruction of property, natural resources and equipment,
pollution and other environmental damage, clean-up responsibilities, regulatory
investigation and penalties and suspension of operations. The Company's
production facilities are also subject to hazards inherent in marine operations,
such as capsizing, sinking, grounding, collision and damage from severe weather
conditions. The relatively deep offshore drilling conducted by the Company
overseas involves increased drilling risks of high pressures and mechanical
difficulties, including stuck pipe, collapsed casing and separated cable. The
impact that any of these risks may have upon the Company is increased due to the
low number of producing properties owned by the Company. The Company and
operators of properties in which it has an interest maintain insurance against
some, but not all, potential risks; however, there can be no assurance that such
insurance will be adequate to cover any losses or exposure for liability. The
occurrence of a significant unfavorable event not fully covered by insurance
could have a material adverse effect on the Company's financial condition and
results of operations. Furthermore, the Company cannot predict whether insurance
will continue to be available at a reasonable cost or at all.
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Uncertainties in Estimating Reserves and Future Net Cash Flows
There are numerous uncertainties inherent in estimating quantities of
proved oil and gas reserves, including many factors beyond the control of the
Company. Reserve engineering is a subjective process of estimating the
underground accumulations of oil and gas that cannot be measured in an exact
manner. The estimates in this document are based on various assumptions required
by the Commission, including unescalated prices and costs and capital
expenditures, and, therefore, are inherently imprecise indications of future net
revenues. Actual future production, revenues, taxes, operating expenses,
development expenditures and quantities of recoverable oil and gas reserves may
vary substantially from those assumed in the estimates. Any significant variance
in these assumptions could materially affect the estimated quantity and value of
reserves set forth in this document. In addition, the Company's reserves may be
subject to downward or upward revision based upon production history, results of
future development, availability of funds to acquire additional reserves,
prevailing oil and gas prices and other factors. Moreover, the calculation of
the estimated present value of the future net revenue using a 10% discount rate
as required by the Commission is not necessarily the most appropriate discount
factor based on interest rates in effect from time to time and risks associated
with the Company's reserves or the oil and gas industry in general.
It is also possible that reserve engineers may make different estimates
of reserves and future net revenues based on the same available data. In
calculating reserves on a BOE basis, gas was converted to oil at the ratio of
six Mcf of gas to one Bbl of oil. While this conversion ratio approximates the
energy equivalent of oil and gas on a Btu basis, it may not represent the
relative prices received by the Company on the sale of its oil and gas
production.
The estimated future net revenues attributable to the Company's net
proved reserves are prepared in accordance with Commission guidelines, and are
not intended to reflect the fair market value of the Company's reserves. In
accordance with the rules of the Commission, the Company's reserve estimates are
prepared using period end prices received for oil and gas. Future reductions in
prices below those prevailing at year-end 1998 would result in the estimated
quantities and present values of the Company's reserves being reduced.
A substantial portion of the Company's proved reserves are or will be
subject to service contracts, production sharing contracts and other
arrangements. The quantity of oil and gas the Company will ultimately receive
under these arrangements will differ based on numerous factors, including the
price of oil and gas, production rates, production costs, cost recovery
provisions and local tax and royalty regimes. Changes in many of these factors
do not affect estimates of U.S. reserves in the same way they affect estimates
of proved reserves in foreign jurisdictions, or will have a different effect on
reserves in foreign countries than in the United States. As a result, proved
reserves in foreign jurisdictions may not be comparable to proved reserve
estimates in the United States.
Foreign Operations
The Company's international assets and operations are subject to
various political, economic and other uncertainties, including, among other
things, the risks of war, expropriation, nationalization, renegotiation or
nullification of existing contracts, taxation policies, foreign exchange
restrictions, changing political conditions, international monetary
fluctuations, currency
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controls and foreign governmental regulations that favor or require the awarding
of drilling contracts to local contractors or require foreign contractors to
employ citizens of, or purchase supplies from, a particular jurisdiction. In
addition, if a dispute arises with foreign operations, the Company may be
subject to the exclusive jurisdiction of foreign courts or may not be successful
in subjecting foreign persons, especially foreign oil ministries and national
oil companies, to the jurisdiction of the United States.
The Company's private ownership of oil and gas reserves under oil and
gas leases in the United States differs distinctly from its ownership of foreign
oil and gas properties. In the foreign countries in which the Company does
business, the state generally retains ownership of the minerals and consequently
retains control of (and in many cases, participates in) the exploration and
production of hydrocarbon reserves. Accordingly, operations outside the United
States may be materially affected by host governments through royalty payments,
export taxes and regulations, surcharges, value added taxes, production bonuses
and other charges.
Certain of the Company's producing properties are located offshore
Palawan Island in the Philippines, and, consequently, a portion of the Company's
assets is subject to regulation by the government of the Philippines. Although
there has been unrest and uncertainty in the Philippines, to date, the country's
Office of Energy Affairs has been largely unaffected by political changes. The
Company has operated in the Philippines since 1985 and believes that it has good
relations with the current Philippine government. However, there can be no
assurance that present or future governmental regulation in the Philippines will
not materially adversely affect the operations or cash flows of the Company.
All of the Company's current Philippine producing properties are
located in fields covered under Service Contract No. 14. To obtain favorable tax
treatment, Philippine nationals must own at least 15% of Service Contract No.
14. Residents of the Philippines currently own in excess of 15% of Blocks A, B,
C and D of Service Contract 14, including 53% of Block C. The Company's ability
to export oil produced in the Philippines is restricted by the terms of Service
Contract No. 14. The Company currently sells its oil production within the
Philippines and therefore may be exposed to foreign currency risk.
Control by 1818 Fund
In connection with the Hunt Transaction, the Company issued to the 1818
Fund Common Stock and Preferred Stock which votes as a class with the Common
Stock on an as converted basis, representing approximately 65% of the
outstanding voting power of the Company on an as converted basis (excluding
options and warrants). In addition, the terms of the Preferred Stock acquired by
the 1818 Fund provide that while the Preferred Stock is outstanding, the holders
of Preferred Stock voting together as a class are entitled to elect three
directors of the Company. Accordingly, the 1818 Fund is able to control all
matters submitted to a vote of the stockholders of the Company, including the
election of directors.
In connection with the Hunt Transaction, the Company made certain
changes to its bylaws which require that at least a majority of the directors
constituting the entire board of directors, which majority must include at least
one of the directors elected by the holders of Preferred Stock, approve each of
the following transactions effected by either the Company or, as applicable, any
subsidiary of the Company, any issuance of or agreement to issue any equity
securities, including
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securities convertible into or exchangeable for such equity securities (other
than issuances pursuant to an employee benefit plan); the declaration of any
dividend; the incurrence, assumption of or refinancing of indebtedness; the
adoption of any employee stock option or similar plan; entering into employment
or consulting agreements with annual compensation exceeding $100,000; any merger
or consolidation; the sale, conveyance, exchange or transfer of the voting stock
or all or substantially all of the assets; the sale or other disposition to
another person, or purchase, lease or other acquisition from another person, of
any material assets, rights or properties; certain expenditures in excess of
$300,000; the formation of any entity that is not wholly-owned by the Company;
material changes in accounting methods or policies; any amendment, modification
or restatement of the certificate of incorporation or bylaws; the settlement of
any claim or other action against the Company or subsidiary in an amount in
excess of $50,000; approval or amendment of the annual operating budget; any
other action which is not in the ordinary course of business; and the agreement
to take any of the foregoing actions. Accordingly, none of the foregoing actions
can be taken by the Company without the approval of at least one director
designated by the holders of the Preferred Stock.
Investment in Hunt
The Company is a limited partner in Hunt. The general partner without
the consent or input of the limited partners makes all decisions concerning the
operations of Hunt. Accordingly, the Company is not able to influence decisions
with respect to operations of Hunt, including decisions regarding the purchase
of concessions and other interests, exploration and development operations
(including the location, testing, completing or plugging and abandoning of
wells, as well as the gathering of seismic and other geophysical data), farm out
and other participation agreements, the acquisition or sale of real and personal
property, insurance coverage, bank and other financings and other matters
significant to the operations of Hunt.
The exploration activity of Hunt is ongoing. To date, Hunt's
exploration activities have not resulted in the discovery of any commercial oil
or gas reserves. No assurance can be given that Hunt's activities will result in
commercial production or that the Company will realize a return on its
investment in Hunt. Hunt's operations are subject to risks applicable to the oil
and gas industry in general as well as to risks inherent in foreign operations,
and are subject to many of the risks disclosed herein under "Risk Factors"
including, without limitation, "--Foreign Operations," "--Volatility of Oil and
Gas Prices and Markets," "--Replacement of Reserves," "--Drilling Risks,"
"--Operating Hazards and Uninsured Risks," "--Uncertainties in Estimating
Reserves and Future Net Cash Flows," "--Environmental and Other Regulations" and
"--Acquisition Risks."
Environmental and Other Regulations
The laws and regulations of the United States, Philippines and Gabon
regulate the Company's business. In addition, VAALCO owns a 7.5% interest in the
Hunt limited partnership, which does business in and is subject to the laws and
regulations of other foreign countries. These laws and governmental regulations,
which cover matters including drilling operations, taxation and environmental
protection, may be changed from time to time in response to economic or
political conditions. See "--Foreign Operations."
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The Company's domestic operations are subject to numerous laws and
regulations governing the discharge of materials into the environment or
otherwise relating to environmental protection. The Company's domestic
operations could result in liability for personal injuries, property damage, oil
spills, discharge of hazardous materials, remediation and clean-up costs and
other environmental damages. In addition, the Company could be liable for
environmental damages caused by previous property owners. As a result,
substantial liabilities to third parties or governmental entities may be
incurred; the payment of which could have a material adverse effect on the
Company's financial condition, results of operations and liquidity. The Company
maintains insurance coverage for its operations, including limited coverage for
sudden environmental damages, but does not believe that insurance coverage for
environmental damages that occur over time is available at a reasonable cost.
Moreover, the Company does not believe that insurance coverage for the full
potential liability that could be caused by sudden environmental damages is
available at a reasonable cost. Accordingly, the Company may be subject to
liability or may lose substantial portions of its properties in the event of
certain environmental damages. The Company could incur substantial costs to
comply with environmental laws and regulations.
A substantial portion of the Company's producing properties are located
offshore. The costs to abandon offshore wells may be substantial. For financial
accounting purposes the Company accrues a per BOE charge over the life of a
field to cover such abandonment costs. No assurances can be given that such
reserves will be sufficient to cover such costs in the future as they are
incurred.
The Oil Pollution Act of 1990 imposes a variety of regulations on
"responsible parties" related to the prevention of oil spills. The
implementation of new, or the modification of existing, environmental laws or
regulations, including regulations promulgated pursuant to the Oil Pollution Act
of 1990, could have a material adverse impact on the Company.
The recent trend toward stricter standards in environmental legislation
and regulation in the U.S. is likely to continue. For instance, legislation has
been introduced in Congress that would reclassify certain exploration and
production wastes as "hazardous wastes" which would make the reclassified wastes
subject to much more stringent handling, disposal and clean-up requirements. If
such legislation were enacted, it could have a significant impact on the
operating costs of the Company, as well as the oil and gas industry in general.
Initiatives to further regulate the disposal of oil and gas wastes are also
pending in certain states, and these various initiatives could have a similar
impact on the Company.
In addition, while the Company believes that it is currently in
compliance with environmental laws and regulations applicable to the Company's
operations in the Philippines, Gabon and the U.S., no assurances can be given
that the Company will be able to continue to comply with such environmental laws
and regulations without incurring substantial costs.
Acquisition Risks
The Company intends to acquire oil and gas properties. Although the
Company performs a review of the acquired properties that it believes is
consistent with industry practices, such reviews are inherently incomplete. It
generally is not feasible to review in depth every individual property involved
in each acquisition. Ordinarily, the Company will focus its due diligence
12
<PAGE>
efforts on the higher valued properties and will sample the remainder. However,
even an in-depth review of all properties and records may not necessarily reveal
existing or potential problems nor will it permit a buyer to become sufficiently
familiar with the properties to assess fully their deficiencies and
capabilities. Inspections may not be performed on every well, and structural or
environmental problems, such as ground water contamination, are not necessarily
observable even when an inspection is undertaken. The Company may be required to
assume preclosing liabilities, including environmental liabilities, and may
acquire interests in properties on an "as is" basis. There can be no assurance
that the Company's acquisitions will be successful.
Reliance on Key Personnel
The Company is highly dependent upon its executive officers and key
employees, particularly Messrs. Gerry, Walston and Scheirman. Moreover, the
Company's investment in the Paramount joint venture is highly dependent upon
Robert Schneeflock. The unexpected loss of the services of any of these
individuals could have a detrimental effect on the Company. The Company does not
maintain key man life insurance on any of its employees, but maintains a $4.0
million life insurance policy on Mr. Schneeflock.
Forward-Looking Information and Risk Factors
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, 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") are
disclosed in the section "Risk Factors," elsewhere herein and in other periodic
reports filed under the Exchange Act, 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.
13
<PAGE>
Item 2. Properties
Philippines
The Company has an interest in two service contracts in the
Philippines. Service Contract No. 14 covers 158,000 offshore acres and Service
Contract No. 6 covers 131,000 offshore acres. The Company produces the Nido and
Matinloc fields with a total gross production for 1998 of approximately 287,000
barrels or 797 BOPD.
Nido Field
This field is covered by Service Contract No. 14 and has four producing
wells. These wells have been producing since 1979, and through the year ended
December 31, 1998 had produced an aggregate of approximately 17.1 MMBbls of oil.
The field is produced using the cyclic method under which the field is shut in
for a period of time (generally 60 days) and then opened up to produce
(generally four to five days). Under this cyclical method, the four wells in the
field produced at an equivalent rate of 244 BOPD during 1998. The Company has an
approximate 22.2% working interest and an approximate 17.2% net revenue interest
in the field, subject to proportionate reduction upon SOCDET's successful
completion of its obligations under the farm out discussed below.
Matinloc Field
This field is located within the contract area covered by Service
Contract No. 14 and has three producing wells. The field had produced an
aggregate production of approximately 10.3 MMBbls from 1982 through 1991.
Production was suspended from the field in 1991 until it was reactivated in
1995. At December 31, 1998 the field had produced an aggregate of 10.8 MMBbls.
During 1998, the field produced approximately 198 MBbls or 553 BOPD. The Company
has an approximate 38.2% working interest and an approximate 28.1% net revenue
interest in the field, subject to proportionate reduction upon SOCDET's
successful completion of its obligations under the farm out discussed below.
During 1997 and 1998 an Australian oil company, (SOCDET), acquired
132,000 line kilometers of 3-D seismic data over Service Contracts No. 14 and
No. 6 in exchange for a farm out of interests in the Service Contracts. Upon
completion of the seismic shoot and presentation of an interpretation thereof,
SOCDET earned a 35% interest in Service Contract 14 effective December 29, 1998.
In connection with the assignment, SOCDET was assigned an interest in the
production platforms, and the liability to abandon them in the future. This
resulted in a reversal of abandonment liability net the Company of $1.1 million.
In addition, SOCDET has the option to drill two wells, one on each block, to
earn an additional 25% interest in Service Contract 14 and 60% in Service
Contract 6 and acquire operatorship thereto. SOCDET has until October 1999 to
elect its drilling option, and until April 2000 to spud the wells in order to
earn the additional interests. The Company does not anticipate funding any
significant capital expenditures in 1999 for the Philippines operations.
14
<PAGE>
Galoc Field
This field is located within the contract area covered by Service
Contract No. 14 and is currently not producing. Four wells have been drilled in
this field, of which one well in 1,150 feet of water has undergone a long-term
testing program. The Galoc reservoir is made up of a sandstone turbidite fan
sequence that was deposited on top of the Lower Miocene limestone in a
deep-water environment. The Galoc field is one of the areas being studied
extensively for the potential to drill an additional well in the field under the
farm-out agreement with SOCDET.
An extended production test at the Galoc 1 well in 1988 produced
approximately 400,000 Bbls of crude oil at rates up to 5,200 BOPD. As a result
of this test, a second phase testing program was conducted in early 1989. The
Galoc 1 vertical well was reentered and deviated into a high-angle lateral well
to a horizontal length of 2,000 feet in the reservoir. This well proved the
lateral extension of the Galoc oil accumulation but failed to produce multiples
of the rates achieved in vertical production. However, combined flow rates of
7,399 BOPD were achieved from the 2,000-foot horizontal section. Despite the
test rates achieved it was determined not to develop this field at that time.
Subsequent analysis and research has determined that the Galoc
turbidites have poor vertical permeability as displayed during the various
drillstem tests. Consequently, development plans under consideration are all
based upon production from vertical wells that will maximize the horizontal
permeability. Costs in connection with the Galoc field are recoverable under the
cost recovery procedures of Service Contract No. 14.
Gabon
Gabon is a former French colony and a former member of OPEC. Production
from the country is approximately 300 MBbls/day of oil with Shell Gabon and Elf
Gabon SA being the largest producers. The country has a population of
approximately two million, making it relatively under-populated compared to its
neighbors. For this reason, the standard of living is quite high relative to
many West African nations, and the country is politically stable. The French
Foreign Legion maintains a presence in the country due to the large quantities
of minerals that France still imports from Gabon, notably uranium.
VAALCO has an interest in one offshore block in Gabon, the Etame Block.
Interest in the block vests in a production-sharing contract entered into by the
Company's subsidiary VAALCO (Gabon) Equata, Inc., providing for two three-year
terms, which commenced in July 1995. The Company elected to extend the contract
into the second three-year term during 1998. As a result of the participation
agreement discussed below, VAALCO currently owns a 17.9% interest in the
production-sharing contract covering the Etame Block.
Etame Block
The Etame Block is a 3,073 square kilometer block acquired in July
1995, containing two former Gulf Oil Company discoveries, the North and South
Tchibala discoveries. These discoveries consist of subsalt reservoirs that lie
in approximately 250 feet of water depth, 20 miles offshore. The Company and its
partners undertook an obligation to the Government of Gabon to obtain and
process seismic data and to drill one commitment well on the Etame block over
the
15
<PAGE>
three-year primary term of the license. In April 1997, a participation agreement
was entered into with Western Atlas Afrique, Ltd. ("Western Atlas"), a
subsidiary of Baker Hughes, to conduct a 320 square kilometer seismic survey at
Western Atlas' sole cost and to pay a disproportionate 80% of the cost, up to
$4.7 million, of the first commitment well. In return for these payments,
Western Atlas earned a 65% interest in the production-sharing contract. In June
1997, Western Atlas completed the above-mentioned acquisition of seismic data
over the property. This data was processed, and the Company drilled the
commitment well, the Etame No. 1 well, in June 1998 resulting in a 3,700 BOPD
Gamba sandstone discovery on the block. Completion of the Etame No. 1 well
satisfied all of the Company's obligations to the Government of Gabon under the
primary three-year term of the contract.
During 1998, the consortium of companies owning the Etame Block
production sharing contract agreed to renew the production sharing contract for
three additional years, thereby taking on a commitment to drill two additional
exploration wells and to perform a 3-D seismic reprocessing. A delineation well,
the Etame 2V well, was drilled in January 1999 and encountered additional oil
pay in the Gamba sandstone, however the well encountered the Gamba sandstone
lower than expected. The Company is currently reprocessing the 3-D seismic data
prior to drilling additional delineation wells. The Company anticipates drilling
at least one additional delineation well in 1999. The Etame 2V counted as the
first of the two commitment wells under the three-year contract term extension.
Domestic Properties
Brazos County Prospects
The Company has working interests in approximately 6,800 net acres in
Brazos County, Texas, where the Company intends to participate in the drilling
of extended-reach horizontal wells in the underlying Buda and Georgetown
formations. The Company has sufficient acreage for approximately 15 exploratory
drilling prospects in both the Buda and Georgetown formations, however, drilling
plans have been placed on hold in reaction to the low crude oil price
environment presently being experienced by the industry.
Goliad County, Texas
VAALCO owns an interest in approximately 1,200 acres in two blocks, one
located immediately east of the Goliad townsite in Goliad County, Texas, and the
other located immediately west of the townsite. The acreage consists of
approximately 70 leases and is located within an area of the Wilcox trend that
has recently seen a considerable amount of leasing, 3-D seismic and drilling
activity.
In January 1998, a farm out agreement was entered into with an industry
partner over 1,000 acres of its Goliad acreage whereby it will recover its lease
costs and assign a 75% working interest to its partner. The Company owns certain
overriding royalties and a 25% working interest in the acreage.
16
<PAGE>
Other Domestic Properties
The Company also owns certain non-operated interests in the Vermilion
and Ship Shoal areas of the Gulf of Mexico, which accounted for no significant
production during the year ended December 31, 1998. No capital expenditures are
anticipated in 1999 for these properties.
Aggregate Production
Additional production data (net to the Company) for all of the
Company's operations for the years 1998 and 1997 are as follows: (See "Item 1 -
BACKGROUND" regarding the merger with 1818 Oil Corp.)
<TABLE>
<CAPTION>
Company Owned Production
Year Ended December 31,
1998 1997
--------------------------------- --------------------------------
BOE(1) Bbl Mcf BOE(1) Bbl Mcf
<S> <C> <C> <C> <C> <C> <C>
Average Daily Production
(Oil in BOPD, gas in MCFD) 332 332 -- -- -- --
Average Sales Price ($/unit) $6.51 $6.51 -- -- -- --
Average Production Cost ($/unit) $5.10 $5.10 -- -- -- --
</TABLE>
(1) BOE is barrels of oil equivalent with 6 Mcf of gas equal to 1 Bbl of oil.
RESERVE INFORMATION
A reserve report as of December 31, 1998 has been opined on by
Netherland Sewell & Associates, independent petroleum engineers. There have been
no estimates of total proved net oil or gas reserves filed with or included in
reports to any federal authority or agency other than the Commission since the
beginning of the last fiscal year. All of the reserves are located in the
Philippines. No reserve estimates have been prepared to date on the Etame
discovery in Gabon, pending further delineation drilling. (See "Item 1 -
BACKGROUND" regarding the merger with 1818 Oil Corp.)
<TABLE>
<CAPTION>
<S> <C> <C>
As of December 31,
--------------------------------------
1998 1997
--------------- --------------
Crude Oil
Proved Developed Reserves (MBbls) 691 --
Proved Undeveloped Reserves (MBbls) -- --
--------------- --------------
Total Proved Reserves (MBbls) 691 --
=============== ==============
Standardized measure of discounted
future net cash flows at 10% (in thousands) $ 226 $ --
=============== ==============
</TABLE>
17
<PAGE>
The standardized measure of discounted cash flows does not include the
costs of abandoning the Company's non-producing properties.
There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and timing of
development expenditures, including many factors beyond the control of the
Company. Reserve engineering is a subjective process of estimating underground
accumulations of crude oil and natural gas that cannot be measured in an exact
manner, and the accuracy of any reserve estimate is a function of the quality of
available data and of engineering and geological interpretation and judgment.
The quantities of oil and natural gas that are ultimately recovered, production
and operating costs, the amount and timing of future development expenditures
and future oil and natural gas sales prices may all differ from those assumed in
these estimates. The standardized measure of discounted future net cash flow
should not be construed as the current market value of the estimated oil and
natural gas reserves attributable to the Company's properties. The information
set forth in the foregoing tables includes revisions for certain reserve
estimates attributable to proved properties included in the preceding year's
estimates. Such revisions are the result of additional information from
subsequent completions and production history from the properties involved or
the result of a decrease (or increase) in the projected economic life of such
properties resulting from changes in product prices. Moreover, crude oil amounts
shown are recoverable under the service contracts and the reserves in place
remain the property of the Philippine government.
In accordance with the guidelines of the Commission, the Company's
estimates of future net cash flow from the Company's properties and the present
value thereof are made using oil and natural gas contract prices in effect as of
year end and are held constant throughout the life of the properties except
where such guidelines permit alternate treatment, including the use of fixed and
determinable contractual price escalations. The contract price as of December
31, 1998 was $6.00 per Bbl. of oil. See "Financial Statements and Supplementary
Data" for certain additional information concerning the proved reserves of the
Company.
Drilling History
The Company drilled or participated in the drilling of six wells for
the period ended December 31, 1998. The Company had one well in progress at
December 31, 1998. Both productive wells drilled were suspended at December 31,
1998. During 1997, the Company participated in two gross dry international wells
(0.15 net), all with Hunt.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
1998 Wells Drilled United States International
Gross Net Gross Net
Exploration Wells...........
Productive 1.0 0.35 1.0 0.18
Dry 3.0 0.30 1.0 0.10
--- ---- --- ----
Total 4.0 0.65 2.0 0.28
Development Wells........... -- -- -- --
--- ---- --- ----
Total Wells................. 4.0 0.65 2.0 0.28
=== ==== === ====
</TABLE>
18
<PAGE>
Acreage and Productive Wells
Below is the total acreage under lease and the total number of
productive oil and gas wells of the Company as of December 31, 1998:
<TABLE>
<CAPTION>
United States International
--------------------------------------------------------------
Gross Net(1) Gross Net(1)
--------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C>
Developed acreage.......................... 15.6 1.2 14.7 4.6
Undeveloped acreage(2) .................... 8.0 7.3 34,319.8 2,728.1
Productive gas wells....................... 2 0.4 -- --
Productive oil wells....................... 5 0.3 7 2.0
<FN>
(1) Net acreage and net productive wells are based upon the Company's working
interest in the properties.
(2) Includes acreage attributable to the investment in Hunt.
</FN>
</TABLE>
Office Space
The Company leases its offices in Houston, Texas (approximately 8,000
square feet) and in Manila, The Republic of the Philippines (approximately 2,000
square feet), which management believes are suitable and adequate for the
Company's operations.
Item 3. Legal Proceedings
The Company is currently not a party to any material litigation.
Item 4. Submission of Matters to a Vote of Security Holders
None.
19
<PAGE>
PART II
Item 5. Market for Common Equity and Related Stockholder Matters
General
The Company's Common Stock trades on the OTC Bulletin Board. The
following table sets forth the range of high and low sales prices of the Common
Stock for the periods indicated. The prices represent adjusted prices between
dealers, do not include retail markups, markdowns or commissions and do not
necessarily represent actual transactions. As of December 31, 1998 there were
approximately 106 holders of record of the Company's Common Stock.
<TABLE>
<CAPTION>
Period High Low
1997:
<S> <C> <C>
First Quarter.............................................. $ 0.72 $ 0.33
Second Quarter............................................. 1.06 0.63
Third Quarter.............................................. 3.56 1.00
Fourth Quarter............................................. 2.78 1.50
1998:
First Quarter.............................................. $ 2.69 $ 1.88
Second Quarter............................................. 3.56 2.50
Third Quarter.............................................. 3.03 1.38
Fourth Quarter............................................. 1.38 0.63
1999:
First Quarter (through March 18, 1999)..................... $ 1.09 $ 0.25
</TABLE>
On March 18, 1999, the last reported sale price of the Common Stock on
the OTC Bulletin Board was $0.406 per share.
Dividends
The Company has not paid cash dividends and does not anticipate paying
cash dividends on the Common Stock in the foreseeable future.
20
<PAGE>
Item 6. Management's Discussion and Analysis or Plan of Operations
INTRODUCTION
In April 1998, the Company acquired from The 1818 Fund, a fund managed
by Brown Brothers Harriman & Co., all of the outstanding capital stock of 1818
Oil Corp. The 1818 Oil Corp. acquisition has been accounted for as a reverse
acquisition and 1818 Oil Corp. is the acquiring entity for financial accounting
purposes. Therefore, because 1818 Oil Corp. is the acquirer for accounting
purposes, the financial statements for prior years are those of 1818 Oil Corp.,
not VAALCO the legal acquirer. Accordingly, a comparison of 1998 and 1997
results is not meaningful. 1818 Oil Corp.'s equity as of December 31, 1998 and
December 31, 1997 have been retroactively charged for the equivalent number of
shares of VAALCO's common stock received in the transaction. The difference
between the par value of the common stock of 1818 Oil Corp. and VAALCO has been
charged to additional paid-in capital. In addition, at the time of the merger,
1818 Fund contributed the debt owed to it by 1818 Oil Corp. as additional
paid-in capital to 1818 Oil Corp.
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's production in the Philippines
is from mature offshore fields with high production costs. The Company's margin
on sales from these fields (the price received for oil less the production costs
for the oil) is lower than the margin on oil production from many other areas.
As a result, the profitability of the Company's production in the Philippines is
affected more by changes in oil prices than production located in other areas.
The Company's results of operations are also affected by currency
exchange rates. The Company and Seaoil Corporation, the purchaser of the
Company's Philippines production, have agreed that 20% of the price of oil paid
by Seaoil to the Company will be paid in Philippine pesos at the prevailing
rate, up to 40 pesos to the dollar. A decrease in the exchange rate of pesos to
the dollar will have the effect of reducing the price received for oil (in U.S.
dollars). This reduction will be partially offset because certain operating
costs paid by the Company and Seaoil are paid in Philippine pesos.
A substantial portion of the Company's oil production is located
offshore of the Philippines. The Company produces into barges, which transport
the oil to market. Due to weather and other factors, the Company's production is
generally highest during the first and fourth quarters of the year.
The Company uses the successful efforts method to account for its
investment in oil and gas properties whereby costs of productive wells,
developmental dry holes and productive leases are capitalized and amortized
using the units-of-production method based on estimated net proved reserves. The
costs of development wells are capitalized but charged to expense if and when
the well is determined to be unsuccessful. Geological and geophysical costs and
the costs of carrying and retaining undeveloped properties are expensed as
incurred.
21
<PAGE>
CAPITAL RESOURCES AND LIQUIDITY
Historically, the Company's primary source of capital resources has
been from cash flows from operations, private sales of equity, borrowings and
purchase money debt. In 1997 and 1998, cash was derived predominantly from the
sale of marketable securities, and the private placement of Common Stock,
Preferred Stock and debt. The Company's primary uses of capital have been to
fund its exploration operations.
The Company produces oil from the Matinloc and Nido fields in the South
China Sea, the Philippines. During the year ended December 31, 1998, total
production from the fields was approximately 287,000 gross barrels of oil.
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, as is customary in
the industry. The Company markets its share of crude oil under an agreement with
Seaoil, a local Philippines refiner. While the loss of this buyer might have a
material effect on the Company in the near term, management believes that the
Company would be able to obtain other customers for its crude oil.
On April 21, 1998 VAALCO consummated the acquisition of 1818 Oil Corp.
for 10,000 shares of Convertible Preferred Stock, Series A. The assets of 1818
Oil Corp. consisted at closing of a 7.5% limited partnership interest in Hunt
with book value of $2.8 million and $12.6 million in cash. As a result of the
voting control 1818 Oil Corp.'s shareholder obtained in the transaction, the
1818 Oil Corp. acquisition has been accounted for as a reverse acquisition and
1818 Oil Corp. is the acquiring entity for financial accounting purposes. The
financial statements presented for the prior year periods are those of 1818 Oil
Corp., not VAALCO the legal acquirer. The results of operations of VAALCO are
included in the accompanying financial statements for the periods subsequent to
the date of the acquisition. Accordingly, a comparison of 1998 and 1997 results
is not meaningful. The legal name of the registrant continues to be VAALCO
Energy, Inc.
Hunt has entered into production sharing contracts and other
arrangements which entitle it to explore for oil and gas, both onshore and
offshore, on approximately 34 million acres in countries including Argentina,
Canada, Ethiopia, Ghana, Niger and Peru. The partnership agreement of Hunt
obligates the Company to contribute, when requested by Hunt, up to $5.1 million
to fund Hunt's exploration program of which $0.7 million has been funded since
the acquisition. In addition, if Hunt discovers oil, the Company may be required
to contribute an additional $7.5 million to fund the appraisal of the discovery.
The $12.6 million of cash which 1818 Oil Corp. had at the time of the
acquisition has been pledged as cash collateral to secure a letter of credit
payable to Hunt for cash calls associated with the partnership. If Hunt does not
call such capital contributions as provided in the partnership agreement of
Hunt, the cash collateral will be released to the Company.
During 1998, the Company issued 5.2 million shares of Common Stock in a
private placement for proceeds of $9.0 million net of $0.8 million in fees and
expenses. These amounts will be used to fund the Company's capital expenditure
program, including investments in the Paramount joint venture and possible
future acquisitions, and for general corporate purposes.
The Company has committed to invest $3.0 million in the Paramount joint
venture, $2.7 million of which has already been funded as of the date of this
filing. There can be no assurance
22
<PAGE>
that the Company will realize a return on this investment or that the Company's
investment in the Paramount joint venture will be successful.
The Company continues to seek financing to fund the development of
existing properties and to acquire additional assets. The Company will rely on
the issuance of equity and debt securities, assets sales and cash flow from
operations to provide the required capital for funding future operations. While
there can be no assurance the Company will be successful in raising new
financing, management believes the prospects the Company has in hand will enable
it to attract sufficient capital to fund required oil and gas activities.
During 1999, the Company anticipates that it will make capital
expenditures on oil and gas properties of approximately $4.0 million, including
Hunt partnership expenditures, and a contribution of $0.3 million to the
Paramount joint venture. The Company has postponed drilling plans for
exploration activities in Brazos County, Texas due to low oil prices. The
anticipated capital expenditures exclude potential acquisitions. The Company
believes the total net proceeds of $22.6 million received from the 1998 private
placement and cash acquired in 1818 Oil Corp. will be sufficient to fund the
Company's capital budget through 1999.
YEAR 2000
The Company, like other businesses, is facing the Year 2000 issue. Many
computer systems and equipment with embedded chips or processors use only two
digits to represent the calendar year. This could result in computational or
operational errors as dates are compared across the century boundary causing
possible disruptions in business operations. The Year 2000 issue can arise at
any point in the Company's operations.
State of Readiness
The Company began addressing the Year 2000 issue in 1997, with an
initial assessment of Year 2000 readiness efforts for it's foreign and domestic
business units. Based on the initial assessment, the following items were
acknowledged as areas for attention to ensure Year 2000 compliance:
1. Assessment of all systems for Year 2000 compliance.
2. Development of a project schedule for remediation or replacement of
non-compliant systems.
3. Development of a project schedule for testing the compliant systems.
4. Development of a list of significant vendors/suppliers for surveying
their Year 2000 readiness efforts.
The Year 2000 issue is being addressed within the Company by its
domestic and foreign business units, and progress is reported periodically to
management. The Company has committed necessary resources to conduct risk
assessment and to take corrective actions
Third Party Relationships
The Company's business units are in the process of surveying the Year
2000 readiness efforts of significant external parties, including suppliers and
customers. Major vendors were
23
<PAGE>
contracted to determine status of their Year 2000 compliance plan. To the best
of the Company's knowledge these suppliers, customers and other entities have
addressed their Year 2000 issues as they pertain to the Company's operations.
Contingency Planning
The Company is developing contingency plans intended to mitigate
possible disruption in business operations that may result from the Year 2000
issue. Contingency plans may include stockpiling necessary materials and
inventories, securing alternate sources of supply, adjusting facility shutdown
and start-up schedules, development of manual procedures to execute transactions
and complete processes and other appropriate measures. Once developed,
contingency plans will be continually refined, as additional information becomes
available
Independent Verification and Validation
For the Philippine operations, an outside programmer was hired to
review the systems and make the appropriate changes for Year 2000 compliance in
their accounting systems. This is currently in process and it is expected the
upgrade will be completed on or before June 30, 1999 at a total cost of
approximately $20 thousand net to the Company. As of December 31, 1998, the
Company had incurred approximately $15 thousand of this expense. For VAALCO's
domestic and Gabon operations, upgrades of the current systems were completed by
an independent source in the third quarter of 1998 at no expense to the Company.
The Company relies on third party suppliers for raw materials, water,
utilities, transportation and other key services. Interruption of supplier
operations due to Year 2000 issues could affect the Company's operations. While
each business unit will evaluate the status of its major suppliers' Year 2000
readiness efforts and develop contingency plans to manage the risk, it can not
eliminate the potential for disruption due to third party failures. The Company
is also dependent upon its customers for sales and cash flow. Year 2000
interruptions in the operations of its major customers could result in reduced
sales, increased inventory or receivable levels and cash flow reductions. The
Company is in the process of surveying its major customers' Year 2000 readiness
efforts to assess risk and develop plans to minimize the impact on its
operations. The Company believes that it is taking all reasonable steps to
ensure Year 2000 readiness. Its ability to meet the projected goals, including
the costs of addressing the Year 2000 issue and the dates upon which compliance
will be attained, depends on the availability and cost of personnel trained in
this area, the timing and success of Year 2000 remediation and testing efforts,
the Year 2000 readiness of its key suppliers and customers and the successful
development and implementation of contingency plans. Although these and other
unanticipated Year 2000 issues could have an adverse effect on the results of
operations or financial condition of the Company, it is not possible to
anticipate the extent of impact or the worst case scenario at this time, since
the contingency plans are still under development.
ALL STATEMENTS REGARDING YEAR 2000 MATTERS CONTAINED IN THIS ANNUAL REPORT ON
FORM 10-KSB ARE "YEAR 2000 READINESS DISCLOSURES" WITHIN THE MEANING OF THE YEAR
2000 INFORMATION AND READINESS DISCLOSURE ACT.
24
<PAGE>
RESULTS OF OPERATIONS
The 1818 Oil Corp. acquisition has been accounted for as a reverse
acquisition and 1818 Oil Corp. is the acquiring entity for financial accounting
purposes. As such, the financial statements presented for the prior year, are
those of 1818 Oil Corp., not VAALCO the legal acquirer. The results of
operations of VAALCO are included in the accompanying financial statements for
the periods subsequent to the date of the acquisition. Accordingly, a comparison
of 1998 and 1997 results is not meaningful. The legal name of the registrant
continues to be VAALCO Energy, Inc.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Amounts stated hereunder have been rounded to the nearest $100,000,
however, percentage changes have been calculated using the accompanying
consolidated financial statement amounts.
Cash Flows
Net cash used in operating activities for 1998 was $15.3 million, as
compared to net cash provided by operating activities of $0 in 1997. 1998 net
cash used in operating activities included $17.6 million of funds placed in
escrow for the Hunt exploration program, Gabon drilling and the Paramount joint
venture.
Net cash used by investing activities for 1998 was $0.7 million, as
compared to net cash used in investing activities of $5.4 million in 1997.
Investments in Hunt, Paramount and for Gabon were partially offset by assets and
cash acquired in the merger with 1818 Oil Corp.
Net cash provided in financing activities for 1998 was $22.6 million,
as compared to net cash provided by financing activities of $5.4 million in
1997. The 1998 amount consists of proceeds from the issuance of Common Stock and
capital contributed in conjunction with the merger with 1818 Oil Corp.
Revenues
Total oil and gas sales for 1998 were $0.6 million as compared to $0
for 1997. The 1998 revenues include revenues relating to the Philippines. The
Company produced the Nido and Matinloc fields at approximately 797 BOPD.
Operating Costs and Expenses
Production expenses for 1998 were $0.5 million as compared to $0 for
1997.
Exploration costs for 1998 were $0.9 million as compared to $0 for
1997. Exploration costs included costs of the exploration wells drilled in
Texas, Alabama and Louisiana.
Depreciation, depletion and amortization of properties for 1998 and
1997 was $0.
25
<PAGE>
General and administrative expenses for 1998 were $1.5 million as
compared to $0 for 1997.
Operating Loss
Operating loss for 1998 was $2.2 million as compared to a $0 operating
loss for 1997.
Other Income (Expense)
Interest income for 1998 was $0.9 million compared to $0 in 1997. The
1998 amount represents interest earned and accrued on cash balances and funds in
escrow.
Equity in loss on unconsolidated joint ventures expense for 1998 was
$1.1 million compared to $14.6 million in 1997. Expenses associated with the
Paramount exploration effort and Hunt accounted for the losses in 1998. The 1997
losses were associated with Hunt.
Interest expense and financing charges for 1998 were $0.4 million as
compared to $1.7 million in 1997. Interest was accrued on advances to the
Company to fund Hunt expenses. All accrued interest and long-term debt
associated with these advances was extinguished in conjunction with the merger,
with the gain posted to retained earnings.
Other, net was a gain of $1.1 million in 1998 as compared to $0 in
1997. The assignment of the interest in Service Contract 14 to SOCDET resulted
in a reduced abandonment liability of $1.1 million in the Philippines.
Net Loss
Net loss attributable to common stockholders for 1998 was $1.8 million
as compared to net loss of $16.3 million in 1997. The 1998 net loss resulted
from exploration expenses internationally as well as domestically. The 1997 loss
was associated solely with Hunt.
Item 7. Financial Statements and Supplementary Data
26
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of VAALCO Energy, Inc. and
Subsidiaries
We have audited the consolidated balance sheet of VAALCO Energy, Inc.
and its subsidiaries ("VAALCO") as of December 31, 1998, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the year then ended. These financial statements are the responsibility of
VAALCO's management. Our responsibility is to express an opinion on the
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements present fairly,
in all material respects, the financial position of VAALCO at December 31, 1998,
and the results of its operations and its cash flows for the year then ended, in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Houston, Texas
March 24, 1999
27
<PAGE>
Report of Independent Accountants
To the Board of Directors of 1818 Oil Corp.:
We have audited the accompanying balance sheet, of 1818 Oil Corp. (the
"Company") as of December 31, 1997, and the related statement of operations,
changes in stockholder's equity and cash flows for the year then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of 1818 Oil Corp. at
December 31, 1997, and the results of its operations and its cash flows for the
year then ended, in conformity with generally accepted accounting principles.
As explained in Note 2 to the financial statements, an investment
amounting to $1,803,322 (100 percent of total investments) as of December 31,
1997, has been valued at fair value as determined by management. We have
reviewed procedures applied by management in arriving at its estimate of the
value of such investment and have inspected underlying documentation and, in the
circumstances, we believe the procedures are reasonable and the documentation
appropriate. However, because of the inherent uncertainty of valuation,
management's estimates of fair value may differ from the values that would have
been used had a ready market for the investment existed, and the differences
could be material.
As explained in Note 1 to the financial statements 1818 Oil Corp.
entered into a Stock Acquisition Agreement and Plan of Reorganization with
VAALCO Energy, Inc.
PricewaterhouseCoopers LLP
New York, New York
March 24, 1999
28
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands of dollars, except par value amounts)
<TABLE>
<CAPTION>
As of December 31,
----------------------
1998 1997
-------- --------
ASSETS
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 6,671 $ 32
Funds in escrow 5,248 --
Receivables:
Trade 311 --
Other 335 --
Materials and supplies, net of allowance for inventory obsolescence
of $61 326 --
Prepaid expenses and other 25 --
-------- --------
Total current assets 12,916 32
-------- --------
PROPERTY AND EQUIPMENT-SUCCESSFUL EFFORTS METHOD
Wells, platforms and other production facilities 89 --
Undeveloped acreage 1,385 --
Work in progress 1,820 --
Equipment and other 47 --
-------- --------
3,341 --
Accumulated depreciation, depletion and amortization (10) --
-------- --------
Net property and equipment 3,331 --
-------- --------
OTHER ASSETS:
Funds in escrow 12,400 --
Investment in unconsolidated entities 4,949 1,804
Advances-related party 35 --
Deferred tax asset 533 --
-------- --------
TOTAL $ 34,164 $ 1,836
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 2,041 $ 2,872
Accounts with partners 4,567 --
-------- --------
Total current liabilities 6,608 2,872
-------- --------
FUTURE ABANDONMENT COSTS 3,217 --
-------- --------
OTHER LONG TERM LIABILITIES -- 12,295
-------- --------
Total liabilities 9,825 15,167
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 9)
STOCKHOLDERS' EQUITY (DEFICIT):
Preferred stock, $25 par value, 500,000 authorized shares;
10,000 and 0 shares issued and outstanding in 1998 and 1997, respectively 250 --
Common stock, $.10 par value, 100,000,000 authorized shares; 20,755,363 shares
issued of which 5,395 are in the treasury in 1998
and 229 shares issued and outstanding in 1997 2,075 --
Additional paid-in capital 41,215 4,098
Accumulated deficit (19,189) (17,429)
Less treasury stock, at cost (12) --
-------- --------
Total stockholders' equity (deficit) 24,339 (13,331)
-------- --------
TOTAL $ 34,164 $ 1,836
======== ========
</TABLE>
See notes to consolidated financial statements.
29
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED OPERATIONS
(in thousands of dollars, except per share amounts)
Year Ended December 31,
----------------------
1998 1997
-------- --------
REVENUES:
Oil and gas sales $ 595 $ --
-------- --------
Total revenues 595 --
-------- --------
OPERATING COSTS AND EXPENSES:
Production expense 466 --
Exploration expense 887 --
Depreciation, depletion and amortization 10 --
General and administrative expenses 1,451 --
-------- --------
Total operating costs and expenses 2,814 --
-------- --------
OPERATING LOSS (2,219) --
OTHER INCOME (EXPENSE):
Interest income 915 1
Interest expense and financing charges (424) (1,717)
Equity loss in unconsolidated entities (1,120) (14,590)
Other, net 1,082 --
-------- --------
Total other income (expense) 453 (16,306)
-------- --------
LOSS BEFORE TAXES (1,766) (16,306)
Income tax benefit (6) --
-------- --------
NET LOSS (1,760) (16,306)
NET LOSS ATTRIBUTABLE TO
COMMON STOCKHOLDERS $ (1,760) $(16,306)
======== ========
BASIC LOSS PER COMMON SHARE $ (0.09) $ (1.38)
======== ========
DILUTED LOSS PER COMMON SHARE $ (0.09) $ (1.38)
======== ========
BASIC WEIGHTED AVERAGE
COMMON SHARES OUTSTANDING 19,169 11,839
======== ========
DILUTED WEIGHTED AVERAGE
COMMON SHARES OUTSTANDING 20,738 12,891
======== ========
See notes to consolidated financial statements.
30
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY (DEFICIT)
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, except share data)
<TABLE>
<CAPTION>
Total
Additional Stockholders'
Preferred Stock Common Stock Paid-in Accumulated Treasury Equity
------------------- ---------------------
Shares Amount Shares Amount Capital Deficit Stock (Deficit)
--------- --------- ----------- --------- ----------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1997 --- $ --- 163 $ --- $ 2,760 $ (1,123) $ --- $ 1,637
Issuance of Common Stock --- --- 66 --- 1,338 --- --- 1,338
Net Loss --- --- --- --- --- (16,306) --- (16,306)
------ ----- ---------- ------- -------- ---------- ------ -------
Balance at December 31, 1997 --- --- 229 --- 4,098 (17,429) --- (13,331)
Issuance of Preferred Stock 10,000 250 --- --- 12,370 --- --- 12,620
Issuance of Common Stock --- --- 5,183,441 8,440 --- --- 8,958
Acquisition of Treasury --- --- 5,395 --- --- --- (12) (12)
Stock
Net Loss --- --- --- --- --- (1,760) --- (1,760)
Merger with 1818 Oil Corp. --- --- 15,566,298 1,557 16,307 --- --- 17,864
------ ----- ---------- ------- -------- ---------- ------ -------
Balance at December 31, 1998 10,000 $ 250 20,755,363 $ 2,075 $ 41,215 $ (19,189) $ (12) $24,339
====== ===== ========== ======= ======== ========== ====== =======
</TABLE>
See notes to consolidated financial statements.
31
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
(in thousands of dollars)
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net loss $ (1,760) $(16,306)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation, depletion and amortization 10 --
Equity loss in unconsolidated entities 1,120 14,590
Provision for deferred income taxes 6 --
Abandonment reserve (1,060) --
Exploration expense 887 --
Interest expense 424 1,717
Change in assets and liabilities that provided (used) cash:
Funds in escrow (17,648) --
Trade receivables (311) --
Other receivables (335) --
Materials and supplies (326) --
Prepaid expenses and other (25) --
Accounts payable and accrued liabilities (831) --
Accounts with partners 4,567 --
-------- --------
Net cash provided by (used in) operating activities (15,282) 1
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Exploration expense (887) --
Cash acquired in merger 2,154 --
Investment in partnership (1,758) (5,350)
Additions to property and equipment (1,413) --
Investment in joint venture (2,155) --
Assets net of cash acquired in merger 3,180 --
Other - net 184 --
-------- --------
Net cash used in investing activities (695) (5,350)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Capital contributions 13,658 --
Proceeds from borrowings -- 4,012
Proceeds from the issuance of common stock 8,958 1,338
-------- --------
Net cash provided by financing activities 22,616 5,350
-------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS 6,639 1
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 32 31
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 6,671 $ 32
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
Non-cash items:
Contribution of debt to additional paid-in capital $ 16,370 $ --
</TABLE>
See notes to consolidated financial statements.
32
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
1. ORGANIZATION
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.
As used herein, the terms "Company" and "VAALCO" mean VAALCO Energy,
Inc. and its subsidiaries, unless the context otherwise requires.
VAALCO owns producing properties and conducts exploration activities as
operator of consortium internationally in the Philippines and Gabon.
Through participation in a partnership with Hunt Oil Company, VAALCO
has additional international exploration interests in Argentina, Peru,
Ethiopia, Ghana, Niger and Canada. Domestically, the Company has
interests in the Texas Gulf Coast area.
In April 1998, the Company acquired from The 1818 Fund II, L.P., (the
1818 Fund), a fund managed by Brown Brothers Harriman & Co., all of the
outstanding capital stock of 1818 Oil Corp. The assets of 1818 Oil
Corp. at closing consisted of a 7.5% limited partnership interest in
Hunt Overseas Exploration Company, L.P. ("Hunt") with book value of
$2.8 million and $12.6 million in cash. The $12.6 million of cash which
1818 Oil Corp. had at the time of the acquisition has been pledged as
cash collateral to secure a letter of credit payable to Hunt for cash
calls associated with the partnership. If Hunt does not call such
capital contributions as provided in the partnership agreement of Hunt,
the cash collateral will be released to the Company.
Hunt has entered into production sharing contracts and other
arrangements which entitle it to explore for oil and gas, both onshore
and offshore, on approxiamtely 34 million acres in countries including
Argentina, Peru, Ethiopia, Ghana, Niger and Canada. The general partner
of Hunt is Hunt Overseas Operating Company, a subsidiary of Hunt Oil
Company. Hunt explores for high risk, large reserve accumulations,
generally targeting deposits which pre-drilling seismic and other data
indicate to have potential in excess of 100 MMBOE.
Under the partnership agreement of Hunt, the Company will have an
obligation to contribute an estimated $5.1 million to fund its share of
the exploration costs of Hunt, $0.7 million of which was funded
subsequent to the acquisition. In addition, if Hunt discovers oil or
gas deposits, the Company will be required to contribute an additional
$7.5 million to fund appraisal costs. VAALCO has $12.3 million in cash
in an escrow account to fund its obligations under the partnership
agreement.
The 1818 Oil Corp. acquisition has been accounted for as a reverse
acquisition and 1818 Oil Corp. is the acquiring entity for financial
accounting purposes. Therefore, because 1818 Oil Corp. is the acquirer
for accounting purposes, the financial statements for prior years are
those of 1818 Oil Corp., not VAALCO the legal acquirer. Accordingly, a
comparison of 1998 and 1997 results is not meaningful. 1818 Oil Corp.'s
equity as of December 31, 1998 and December 31, 1997 have been
retroactively charged for the equivalent number of shares of VAALCO's
common stock received in the transaction. The difference between the
par value of the common stock of 1818 Oil Corp. and VAALCO has been
charged to additional paid-in capital. In addition, at the time of the
33
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
merger, 1818 Fund contributed the debt owed to it by 1818 Oil Corp. as
additional paid-in capital to 1818 Oil Corp.
The following summarizes pro forma financial information assuming the
acquisition of 1818 Oil Corp. had occurred on January 1, 1997.
<TABLE>
<CAPTION>
(Thousands of Dollars)
Year Ended Year Ended
December 31, 1998 December 31, 1997
----------------- -----------------
<S> <C> <C>
Total revenues $ 750 $ 6,437
Loss before income taxes (1,528) (12,128)
Net loss attributable to common stockholders (1,508) (12,310)
Basic net loss per share (0.07) (0.73)
</TABLE>
1818 Oil Corp. ("1818 Oil") is a corporation which was organized and
commenced operations on September 13, 1995 under the General
Corporation Law of the State of Delaware. Prior to the merger, 1818 Oil
was a wholly owned subsidiary of the 1818 Fund, a limited partnership
organized on August 20, 1993 under the Delaware Revised Uniform Limited
Partnership Act. The 1818 Fund owned beneficial and legal title to all
outstanding equity and voting securities of 1818 Oil. The general
partner of the 1818 Fund is Brown Brothers Harriman & Co. ("BBH&Co."),
a New York limited partnership. BBH&Co. had the exclusive power to
manage, operate and control the businesses of the 1818 Fund and 1818
Oil and has sole discretion in making investment decisions.
On September 13, 1995, 1818 Oil entered into a subscription agreement
to purchase Class B limited partnership interest in Hunt Overseas
Exploration Company, L.P. (the "Hunt Partnership"), a Delaware limited
partnership, in the amount of $30,000,000. The nature of Hunt's
business is the exploration of international oil and gas prospects.
Countries in which exploration activities are conducted by Hunt include
Argentina, Canada, Ethiopia, Niger, Ghana, and Peru. As of December 31,
1997, 1818 Oil's contributed capital to Hunt was $16,393,405.
Within the gross commitment level of $30,000,000 to Hunt, first level
commitments comprise 75% ($22,500,000) and second level commitments
comprise 25% ($7,500,000). First level commitments are associated with
exploration efforts while second level commitments may only be called
by Hunt after a discovery well has been drilled upon any of the
properties of Hunt, and may only be used by Hunt in connection with
appraisal activities to evaluate whether such properties are worthy of
being developed commercially.
34
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
As of December 31, 1998 and 1997, remaining first and second level
commitments were as follows:
<TABLE>
<CAPTION>
1998 1997
------------------- ---------------
<S> <C> <C>
Gross Commitment $ 30,000 $30,000
=================== ===============
First level commitment $ 22,500 22,500
Less: First level capital contributions 18,151 16,393
------------------- ---------------
Remaining first level capital commitment $ 4,349 $6,107
=================== ===============
Second level commitment $ 7,500 $7,500
Less: Second level capital contributions -- --
=================== ===============
Remaining second level capital commitment $ 7,500 $7,500
=================== ===============
</TABLE>
VAALCO's subsidiaries include Alcorn (Philippines) Inc. and Alcorn
(Production) Philippines Inc., VAALCO Gabon (Equata), Inc., VAALCO
Gabon (Etame), Inc., VAALCO Production (Gabon), Inc., VAALCO Energy
(Gabon), Inc., VAALCO (USA), Inc. and 1818 Oil Corp.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation - The accompanying consolidated financial
statements include the accounts of the Company and its wholly owned
subsidiaries, as well as the subsidiaries' share in the assets,
liabilities, income and expenses of joint operations. All significant
transactions within the consolidated group have been eliminated in
consolidation.
Cash and Cash Equivalents - For purposes of the consolidated statement
of cash flows, the Company and its subsidiaries consider all highly
liquid debt instruments purchased with an original maturity of three
months or less to be cash equivalents. For the years ended December 31,
1998 and 1997, no payments were made for income taxes or for interest.
Funds in Escrow - Current amounts represent an escrow for the drilling
of the Etame 2V well in Gabon. Other funds in escrow represent amounts
for Hunt ($12,311) and funds for abandonment costs relating to certain
Gulf of Mexico properties ($89).
Inventory Valuation - Materials and supplies are valued at the lower of
cost, determined by the weighted-average method, or market.
Income Taxes - The Company records taxes on income in accordance with
Statement of Financial Accounting Standards "SFAS" No. 109, "Accounting
for Income Taxes". Under SFAS No. 109, deferred income taxes reflect
the net tax effects of (a) temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes, and (b) operating loss and
tax credit carryforwards.
35
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
The Company calculates current and deferred income taxes on separate
company basis. Deferred income taxes are recognized for future tax
consequences of differences between the tax basis of assets and
liabilities and their financial reporting amounts at year-end.
As of December 31, 1997, the Company had a net operating loss
carryforward available to offset future taxable income. A valuation
allowance has been provided for the entire amount of the net deferred
tax asset resulting from these carryforwards.
As of December 31, 1998, the Company had a net operating loss
carryforward available to offset future taxable income of $7,029. A
valuation allowance of $6,394 has been provided for against this
amount.
Property and Equipment - The subsidiaries follow the successful efforts
method of accounting for exploration and development costs. Under this
method, exploration costs, other than the cost of exploratory wells,
are charged to expense as incurred. Exploratory well costs are
initially capitalized until a determination as to whether proved
reserves have been discovered. If an exploratory well is deemed to not
have found proved reserves, the associated costs are expensed at that
time. All development costs, including developmental dry hole costs,
are capitalized. Provisions for impairment of undeveloped oil and gas
leases are based on periodic evaluations and other factors. The Company
recognizes gains for the sale of developed properties based upon an
allocation of property costs between the interest sold and the interest
retained based on the fair value of those interests.
The Company has adopted statement of Financial Accounting Standards
("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of." SFAS No. 121 requires
that long-lived assets and certain identifiable intangibles to be held
and used be reported at the lower of carrying amounts or fair values.
Assets to be disposed of and assets not expected to provide any future
service potential to the Company are recorded at the lower of carrying
amount or fair value less cost to sell. In 1998, SFAS No. 121 did not
have a material effect on the Company's financial position or results
of operations.
Depletion of wells, platforms and other production facilities are
provided on a field basis under the unit-of-production method based
upon estimates of proved developed reserves. Provision for estimated
abandonment costs, including platform dismantlement and site
restoration, is included in depreciation, depletion and amortization
expense on a unit-of-production basis. Provision for depreciation of
other property is made primarily on a straight line basis over the
estimated useful life of the property. The annual rates of depreciation
are as follows:
Office and miscellaneous equipment.............. 3 - 5 years
Leasehold improvements...........................8 - 12 years
36
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
In connection with the annual estimate of the Company's oil and gas
reserves for the fiscal year ended December 31, 1998, the Company's
independent petroleum engineers estimated proved oil reserves at
December 31, 1998 to be 0.7 million barrels, all of which are
classified as proved developed, net to the Company. The Company had no
gas reserves at December 31, 1998. The proved developed reserves relate
to the Company's Philippine operations.
Investments - The Company invests funds in escrow and excess cash in
certificates of deposit and commercial paper issued by banks with
maturities typically not exceeding 90 days.
At December 31, 1998, the Company accounted for its investments in
unconsolidated entities under the equity method.
At December 31, 1997, the investment in unconsolidated entities was
valued at fair value using methods determined in good faith by
management after consideration of all relevant information, including,
current financial information and restrictions on dispositions. The
values assigned to the investments do not necessarily represent the
amount which might ultimately be realized upon the sale or other
disposition, since such amounts depend on future circumstances and
cannot reasonably be determined until actual liquidation occurs.
However, because of the inherent uncertainty of such valuations, those
estimated values may differ significantly from the values that would
have been used had a ready market for the investments existed, and the
difference could be material.
In 1997 management determined to write off exploration costs
attributable to a concession at the time of a dry hole and capitalize
costs on a concession if the concession continues to be the subject of
active exploration by Hunt.
Foreign Exchange Transactions - For financial reporting purposes, the
subsidiaries use the United States dollar as their functional currency.
Monetary assets and liabilities denominated in foreign currency are
translated to U.S. dollars at the rate of exchange in effect at the
balance sheet date, and items of income and expense are translated at
average monthly rates. Nonmonetary assets and liabilities are
translated at the exchange rate in effect at the time such assets were
acquired and such liabilities were incurred. Gains and losses on
foreign currency transactions are included in income currently and were
insignificant during each of 1998 and 1997.
Accounts With Partners - Accounts with partners represent cash calls
due or excess cash calls paid by the partners for exploration,
development and production expenditures made by the following
subsidiaries of the Company: APPI-14, APPI-6, and VAALCO Gabon (Etame),
Inc.
Revenue Recognition - The Company recognizes revenues from crude oil
and natural gas sales upon delivery to the buyer.
37
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
Fair Value of Financial Instruments - The Company's financial
instruments consist primarily of cash, trade accounts and note
receivables, trade payables and debt instruments. The book values of
cash, trade receivables, and trade payables are representative of their
respective fair values due to the short-term maturity of these
instruments. The book value of the Company's debt and note receivable
instruments are considered to approximate the fair value, as the
interest rates are adjusted based on rates currently in effect.
Risks and Uncertainties - The Company's interests are located overseas
in certain offshore areas of the Philippines and Gabon.
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, as
is customary in the industry. For the year ended December 31, 1998 one
purchaser of the Company's crude oil accounted for essentially all of
the Company's total crude oil sales. The Company markets its crude oil
share under an agreement with SeaOil, a local Philippines refiner.
While the loss of this buyer might have a material effect on the
Company in the near term, management believes that the Company would be
able to obtain other customers for its crude oil.
All of Hunt's operations are conducted outside the United States. The
partnership attempts to conduct its affairs so as to protect against
risks that may be inherent in doing business in international
locations.
Estimates of oil and gas values as made in the financial statements
require extensive judgments and are generally less precise than other
estimates made in connection with financial disclosures. Assigning
monetary values to such estimates does not reduce the subjectivity and
changing nature of such estimates of value. The information set forth
herein is therefore subjective and, since judgments are involved, may
not be comparable to estimates of value made by other companies. The
Company considers its estimates to be reasonable; however, due to
inherent uncertainties and the limited nature of data, estimates are
imprecise and subject to change over time as additional information
become available.
Use of Estimates in Financial Statement Preparation - The preparation
of financial statements in conformity with generally accepted
accounting principles requires estimates and assumptions that affect
the reported amounts of assets and liabilities as well as certain
disclosures. The Company's financial statements include amounts that
are based on management's best estimates and judgments. Actual results
could differ from those estimates.
Reclassifications - Certain amounts from 1997 have been reclassified to
conform to the 1998 presentation.
38
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
3. INVESTMENT IN UNCONSOIDATED ENTITIES
At December 31, 1998, VAALCO had the following investments:
<TABLE>
<CAPTION>
December 31,
1998
--------------------
<S> <C>
Investment in Hunt $ 3,094
Investment in VAALCO Exploration LLC 1,855
--------------------
$ 4,949
====================
</TABLE>
Investment in Hunt represents a $30 million limited partnership
interest in Hunt Overseas Exploration Company L.P., a $350 million
partnership, giving the Company a 7.5% interest in the assets of the
partnership. Cash investments were made to Hunt during 1998 totaling
approximately $1.8 million. VAALCO recognized a write-down of $0.5
million during 1998 reflecting its share of certain dry hole costs and
exploration expenses incurred by the Partnership. Investment is
recorded under the equity method. At December 31, 1997 the investment
had a cost of $16.4 million with an estimated value of $1.8 million. At
December 31, 1998, the investment had a cost of $18.1 million.
Investment in Joint Venture represents a 50/50 membership interest
shared by VAALCO Energy, Inc. and Robert Schneeflock of Paramount
Petroleum in VAALCO Exploration LLC. VAALCO Exploration was formed to
conduct exploration activities primarily in the onshore Gulf Coast
area, including Alabama, Mississippi and Louisiana. VAALCO and
Schneeflock have contributed capital interests of 93.75% and 6.25%,
respectively. Net Profit is allocated first based on contributed
capital interests up to the aggregate amount of Net Loss allocated and
thereafter based on membership interest of 50/50. Net Loss is allocated
first based on membership interest up to the aggregate amount of Net
Profit allocated and thereafter based on contributed capital interest.
VAALCO has committed to expend $3.0 million to fund overhead, leases,
seismic and other amounts in connection with the business. The Company
records the investment under the equity method as VAALCO's membership
interest is 50% and neither party has a majority voting interest.
Investment value at December 31, 1998 was $1.9 million.
39
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
The following summarizes the aggregated financial information for all
investments owned by VAALCO, which were accounted for under the equity
method as of December 31, 1998:
<TABLE>
<CAPTION>
<S> <C>
December 31, 1998
(in thousands)
-------------
Balance Sheet:
Current assets $ 9,976
Oil and gas property 37,877
Other assets 165
Owner's equity 47,436
Statement of Earnings:
Income $ 443
=============
Gross profit $ (29,231)
=============
Net loss $ (29,951)
=============
VAALCO's share of net loss $ (1,120)
=============
</TABLE>
4. ACCRUED LIABILITIES
<TABLE>
<CAPTION>
December 31,
-------------------------------------
1998 1997
-------------- ---------------
<S> <C> <C>
Interest $ -- $ 2,872
Other 136 --
-------------- --------------
$ 136 $ 2,872
============== ==============
</TABLE>
5. DEBT OBLIGATIONS AND FINANCING ARRANGEMENTS
<TABLE>
<CAPTION>
December 31,
-----------------------------------
1998 1997
------------- ------------
<S> <C> <C>
Note payable - Shareholder $ -- $ 12,295
Less current portion -- --
-------------- ------------
Long-term portion $ -- $ 12,295
============= ============
</TABLE>
Pursuant to the subscription at the time of organization of 1818 Oil
Corp., capital contributions from the 1818 Fund to the Company were
apportioned between long-term debt and paid-in capital. The percentages
set forth in the agreement were 75% long-term debt and 25% capital
contribution. Interest accrued on the long-term debt at a rate of 14%
per annum. There were no payments of interest to the 1818 Fund. There
were no contractual repayment terms in place. The debt was extinguished
in conjunction with the merger of 1818 Oil Corp. with VAALCO in April
1998.
40
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
6. STOCKHOLDERS' EQUITY (DEFICIT)
The following discussion of shares under option incorporates options
granted by the predecessor VAALCO. These obligations were assumed by
the Company pursuant to the merger.
In 1993, an officer and director of the Company was granted options to
purchase 75,000 shares of Common Stock of the Company, and was also
granted 75,000 stock appreciation rights ("SARs"), all at an exercise
price of $10.25 per share. One-third of such options and SAR's vested
at the end of each of the three years of the contract term, and are
exercisable for five years from the date of vesting. As of December 31,
1998, the options and SAR's were completely vested, and none of the
options and SAR's had been exercised. In 1996 additional options were
granted to this officer and director for 1,000,000 shares of the Common
Stock of the Company at exercise prices of $0.375 per share for 400,000
shares, $0.50 for 300,000 shares and $1.00 for 300,000 shares. The
options vest over a term of three years and may be exercised for five
years from the vesting date. As of December 31, 1998, the options were
completely vested. None of the options had been exercised as of
December 31, 1998.
In 1996, a former officer of the Company was granted warrants to
purchase shares of the Company's Common Stock. The warrants have a
remaining term expiring August 31, 2003 and consist of the right to
purchase 250,000 shares of Common Stock at an exercise price of $0.50
per share; 250,000 shares of Common Stock at an exercise price of $2.50
per share; 250,000 shares of Common Stock at an exercise price of $5.00
per share; and 250,000 shares of Common Stock at an exercise price of
$7.50 per share. None of the warrants had been exercised as of December
31, 1998.
In 1997, another officer of the Company was granted options to purchase
1,000,000 shares at $0.625 per share, vesting 500,000 shares at August
1, 1997 and 500,000 shares at August 1, 1998. None of the options had
been exercised as of December 31, 1998.
An investment banking firm was granted 345,325 warrants to purchase the
Company's Common Stock on July 31, 1997 in connection with the private
placement of Common Stock. The warrants have a term of five years from
the date of issuance and consist of the right to purchase shares at
$1.00 per share. The same investment banking firm was granted 100,000
warrants to purchase the Company's Common Stock on April 1, 1998 in
connection with the private placement of Common Stock. The warrants
have a term of five years from the date of issuance and consist of the
right to purchase shares at $2.00 per share. None of the warrants had
been exercised as of December 31, 1998.
41
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
Information with respect to the Company's stock options are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Vested Weighted
Options/ Shares Average
Warrants Under Exercise
Exercisable Option Price
---------------- ------------- -------------
Balance, December 31, 1996 1,675,000 2,475,000 $ 2.73
Granted/Vested 1,165,325 1,345,325 0.72
Exercised -- -- --
Forfeited 400,000 400,000 3.75
--------------- ------------- -------------
Balance, December 31, 1997 2,440,325 3,420,325 1.82
Granted/Vested 1,080,000 100,000 2.00
Exercised -- -- --
Forfeited -- -- --
--------------- ------------- -------------
Balance, December 31, 1998 3,520,325 3,520,325 $ 1.82
=============== ============= =============
</TABLE>
The following table summarizes information about stock options
outstanding as of December 31, 1998:
<TABLE>
<CAPTION>
Weighted-
Average Weighted- Weighted-
Range of Exercise Number Remaining Average Number Average
Prices Outstanding Contractual Exercise Exercisable Exercise
At 12/31/98 Life Price At 12/31/98 Price
----------------------- ---------------- ---------------- ----------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C> <C>
$ 0.375 to 1.00 2,595,325 3.84 years $ 0.65 2,595,325 $ 0.65
1.01 to 2.50 350,000 4.55 years 2.36 350,000 2.36
2.51 to 5.00 250,000 4.67 years 5.00 250,000 5.00
5.01 to 10.25 325,000 3.85 years 8.13 325,000 8.13
======================= ================ ================ ================= ================ ================
$ 0.375 to 10.25 3,520,325 3.97 years $ 1.82 3,520,325 $ 1.82
======================= ================ ================ ================= ================ ================
</TABLE>
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (SFAS No. 123) encourages, but does not
require companies to record compensation cost for stock-based employee
compensation plans at fair value as determined by generally recognized
option pricing models such as the Black-Scholes model or the binomial
model. Because of the inexact and subjective nature of deriving
non-freely traded employee stock option values using these methods, 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."
The provision of SFAS No. 123 had no material effect for 1998.
The Company follows Statement of Financial Accounting Standards No. 128
- "Earnings per Share," ("SFAS No. 128"), which establishes the
requirements for presenting earnings
42
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
per share ("EPS"). SFAS No. 128 requires the presentations of "basic"
and "diluted" EPS on the face of the income statement.
The following schedule is presented as a reconciliation of the
numerators and denominators of basic and diluted earnings per share
computations.
<TABLE>
<CAPTION>
<S> <C> <C> <C>
For the Year Ended December 31, 1998
-----------------------------------------------------------------
Per-Share Net Loss Shares
Amount (Numerator) (Denominator)
-------------------- ------------------ -------------------
Basic EPS
Net loss attributable to common
Shareholders $ (0.09) $ (1,760) 19,169
Effect of Diluted Securities
Common stock options -- -- 1,569
-------------------- ------------------ -------------------
Diluted EPS
Net loss attributable to common
shareholders $ (0.09) $ (1,760) 20,738
==================== ================== ===================
For the Year Ended December 31, 1997
-----------------------------------------------------------------
Per-Share Net Loss Shares
Amount (Numerator) (Denominator)
-------------------- ------------------ -------------------
Basic EPS
Net loss attributable to common
shareholders $ (1.38) $ (16,306) 11,839
Effect of Diluted Securities
Common stock options -- -- 1,052
-------------------- ------------------ -------------------
Diluted EPS
Net loss attributable to common
shareholders $ (1.38) $ (16,306) 12,891
==================== ================== ===================
</TABLE>
Options excluded from the above calculation, as they are anti-dilutive,
are 825,000 for 1998 and 1997.
43
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
7. INCOME TAXES
The Company and its domestic subsidiaries file a consolidated United
States income tax return. Certain subsidiaries' operations are also
subject to Philippine income taxes.
Provision (benefit) for income taxes consists of the following:
Year Ended December 31,
1998 1997
------------ ------------
U.S. federal:
Current $ -- $ --
Deferred -- --
Philippine:
Current (6) --
Deferred -- --
------------ ------------
Total $ (6) $ --
============ ============
The primary differences between the financial statement and tax bases
of assets and liabilities at December 31, 1998 and 1997 are as follows:
Year Ended December 31,
-----------------------
1998 1997
------ ------
Deferred Tax Liabilities:
Unrealized foreign exchange gain $ 102 $ --
------ ------
Deferred Tax Assets:
Reserves not currently deductible 756 --
Operating loss carryforwards 5,518 382
Alternative minimum tax credit carryover 635 --
Other assets 120 --
------ ------
7,029 382
Valuation allowance 6,394 382
------ ------
635 --
------ ------
Net deferred tax asset $ 533 $ --
====== ======
Pretax income (loss) is comprised of the following:
Year Ended December 31,
---------------------------
1998 1997
-------- --------
United States $ (2,276) $(16,306)
Foreign (Philippine) 510 --
-------- --------
$ (1,766) $(16,306)
======== ========
44
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
A reconciliation between the provision (benefit) for income taxes
recognized in the Company's Statements of Operations computed by
applying the statutory federal income tax rate and income taxes to
pre-tax losses follows:
Year ended December 31,
--------------------
1998 1997
---- ----
Statutory income tax rate (35%) (35%)
Effective income tax rate 34% 35%
---- ----
(1%) --%
==== ====
At December 31, 1998, the Company and its subsidiaries had no foreign
tax credit ("FTC") carryforwards for United States tax purposes.
At December 31, 1998, the Company and its subsidiaries had net
operating loss ("NOL") carryforwards of approximately $15.8 million for
United States income tax purposes. A full valuation allowance has been
provided against this NOL. Due to previous ownership changes, future
utilization of the net operating loss carryforwards will be limited by
Internal Revenue Code section 382.
At December 31, 1997, the Company was subject to federal taxes only,
with no allocations made to state and local taxes.
8. RELATED-PARTY TRANSACTIONS
A subsidiary of the Company has a note receivable from an officer,
director and stockholder of the Company, which bears interest at 9% per
annum and is due in monthly installments through December 1, 2002. The
balance of the note was $35 at December 31, 1998.
The 1818 Fund entered into a guaranty and covenant agreement with Hunt
under which the 1818 Fund is contingently liable to Hunt in the amount
of undrawn cash commitments of 1818 Oil of $11,849 and $13,607 as of
December 31, 1998 and 1997, respectively.
As compensation for its services, the 1818 Fund paid BBH&Co. quarterly
management fees, in arrears, in an amount equal to one percent per
annum of the average weekly amount of invested funds for each fiscal
quarter. It was the policy of the 1818 Fund to bear 1818 Oil's
allocable share of these costs on behalf of 1818 Oil.
9. COMMITMENTS AND CONTINGENCIES
The Company owns a 17.9% interest in a block offshore Gabon, the Etame
Block. The block contains the recent Etame discovery as well as
previous discoveries that the Company is currently evaluating to
determine their commercial viability. The Company and its partners
undertook an obligation to the Government of Gabon to obtain and
process seismic data and to drill one commitment well on the Etame
Block over the three-year
45
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
(in thousands of dollars, unless otherwise indicated)
term of the license. In April 1997, a participation agreement was
entered into with Western Atlas Afrique, Ltd. ("Western Atlas"), a
subsidiary of Western Atlas International, Inc., to conduct a 320
square kilometer seismic survey at Western Atlas' sole cost and to pay
a disproportionate 80% of the cost, up to $4.7 million, of the first
commitment well. In return for these payments, Western Atlas earned a
65% interest in the production-sharing contract. In June 1997, Western
Atlas completed the above-mentioned acquisition of seismic data over
the property. This data was processed, and the Company drilled the
commitment well, the Etame No. 1 well, in June 1998 resulting in a
3,700 BOPD Gamba sandstone discovery on the block. Completion of the
Etame No. 1 well satisfied all of the Company's obligations to the
Government of Gabon under the primary three-year term of the contract.
During 1998, the consortium of companies owning the Etame Block
production sharing contract agreed to renew the production sharing
contract for three additional years, thereby taking on a commitment to
drill two additional exploration wells and to perform a 3-D seismic
reprocessing. A delineation well, the Etame 2V well, was drilled in
January 1999 and encountered additional oil pay in the Gamba sandstone,
however the well encountered the Gamba sandstone lower than expected.
The Company is currently reprocessing the 3-D seismic data prior to
drilling additional delineation wells. The Company anticipates drilling
at least one additional delineation well in 1999. The Etame 2V counted
as the first of the two commitment wells under the three-year contract
term extension.
The Company participates in a joint venture with Paramount Petroleum,
Inc. ("Paramount"), a corporation owned by Robert Schneeflock, to
engage in the exploration of oil and gas properties in the United
States, primarily in the onshore Gulf Coast area, including Alabama,
Mississippi and Louisiana. The Company has committed to expend $3.0
million to fund overhead, leases, seismic and other amounts in
connection with the joint venture, $2.7 million of which has been
funded as of the date of this filing. The Company has posted a letter
of credit to secure such commitment.
46
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES
(Unaudited)
(in thousands of dollars, unless otherwise indicated)
The following information is being provided as supplemental information
in accordance with certain provisions of SFAS No. 69, "Disclosures about Oil and
Gas Producing Activities". The Company's reserves are located offshore of the
Republic of the Philippines. The following tables set forth costs incurred,
capitalized costs, and results of operations relating to oil and natural gas
producing activities for each of the periods. (See "Footnote 1 - ORGANIZATION")
Costs Incurred in Oil and Gas Property
Acquisition, Exploration and Development
Activities
<TABLE>
<CAPTION>
United States International
----------------------------------- ---------------------------------
1998 1997 1998 1997
----------------- ---------------- ---------------- ---------------
Costs incurred during the year:
<S> <C> <C> <C> <C>
Exploration(1) $ 1,215 $ -- $ 1,515 $ --
Acquisition - unproved 180 -- -- --
----------------- ---------------- ---------------- ---------------
Total $ 1,395 $ -- $ 1,515 $ --
================= ================ ================ ===============
Company's share of equity
method investee's costs
incurred(1) $ 1,613 $ -- $ 1,373 $ 14,871
================= ================ ================ ===============
</TABLE>
(1) Includes costs which are capitalized or expensed.
Of the $1,215 U.S. exploration costs incurred, $632 was expensed for dry hole
costs. International exploration costs include capitalized costs of $1,259 for
Etame, and $255 was expensed for the Gabon Equata Block as the lease term
expired. The Company's share of investee's costs was for the Paramount joint
venture in the U.S. and Hunt internationally.
Capitalized Costs Relating to Oil and Gas Producing Activities:
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997
-------------- ---------------
<S> <C> <C>
Capitalized costs -
Unproved properties not being amortized $ 3,205 $ --
Properties being amortized 89 --
-------------- ---------------
Total capitalized costs 3,294
Less accumulated depreciation, --
depletion, and amortization (10) --
============== ===============
Net capitalized costs $ 3,284 $ --
============== ===============
Company's share of equity method
investee's net capitalized costs $ 4,453 $ 3,275
============== ===============
</TABLE>
47
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES
(Unaudited)
(in thousands of dollars, unless otherwise indicated)
The capitalized costs pertain to the Company's producing activities in the
Philippines, the Etame discovery and U.S. activities. As a result of the merger
with 1818 Oil Corp., $39.5 million carried by VAALCO in previously fully
depleted costs carried in capitalized costs were closed out against the
associated accumulated depreciation, depletion and amortization.
Results of Operations for Oil and Gas Producing Activities:
<TABLE>
<CAPTION>
-----------------------------------------------------------------------
United States International
----------------------------------- ---------------------------------
1998 1997 1998 1997
----------------- ---------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Crude oil sales $ 26 $ -- $ 569 $ --
Production expense (18) -- (448) --
Exploration expense (632) -- (255) --
Depreciation, depletion and
amortization -- -- -- --
----------------- ---------------- ---------------- ---------------
Loss before taxes (624) -- (134) --
Income tax benefit -- -- 6 --
----------------- ---------------- ---------------- ---------------
Results from oil and gas
producing activities $ (624) $ -- $ (128) $ --
================= ================ ================ ===============
Company's share of equity method
investee's results of operations $ -- $ -- $ (851) $ (14,590)
================= ================ ================ ===============
</TABLE>
Proved Reserves
The following tables set forth the net proved reserves of VAALCO
Energy, Inc. as of December 31, 1998 and 1997, and the changes therein during
the periods then ended.
Oil (MBbls)
-------------------
PROVED RESERVES:
BALANCE AT DECEMBER 31, 1996 --
Production --
Discoveries, extensions and other additions --
Sales of reserves in place --
Revisions --
-------------------
BALANCE AT DECEMBER 31, 1997 --
Production (91)
Discoveries, extensions and other additions --
Acquired in merger 1,154
Sales of reserves in place (372)
Revisions --
-------------------
BALANCE AT DECEMBER 31, 1998 691
===================
In April 1998, the Company merged with 1818 Oil Corp. The 1818 Oil
Corp. acquisition has been accounted for as a reverse acquisition and 1818 Oil
Corp. is the acquiring entity for
48
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES
(Unaudited)
(in thousands of dollars, unless otherwise indicated)
financial accounting purposes. As such, the reserves prior to 1998 reflect the
reserves of 1818 Oil Corp.
PROVED DEVELOPED RESERVES Oil (MBbls)
--------------------
Balance at December 31, 1997 --
Balance at December 31, 1998 691
All of the Company's Proved Developed Reserves are located offshore the
Republic of the Philippines.
Standardized Measure of Discounted Future Net Cash
Flows Relating to Proved Oil Reserves
The information that follows has been developed pursuant to procedures
prescribed by SFAS No. 69 and utilizes reserve and production data estimated by
independent petroleum consultants. The information may be useful for certain
comparison purposes, but should not be solely relied upon in evaluating VAALCO
Energy, Inc. or its performance.
The future cash flows are based on sales prices and costs in existence
at the dates of the projections, excluding the interests of the Philippine
government and the other consortium members. Future production costs do not
include overhead charges allowed under joint operating agreements or
headquarters general and administrative overhead expenses. Future development
costs include amounts accrued attributable to future abandonment when the wells
become uneconomic to produce. The standardized measure of discounted cash flows
for 1998 do not include the costs of abandoning the Company's non-producing
properties.
Philippines
------------------------
December 31,
------------------------
1998 1997
----------- -----------
Future cash inflows $ 4,146 $ --
Future production costs (2,801) --
Future development costs (1,517) --
Future income tax expense -- --
----------- -----------
Future net cash flows (172) --
Discount to present value
at 10% annual rate 398 --
----------- -----------
Standardized measure of
discounted future net cash
flows $ 226 $ --
=========== ===========
Future development costs at December 31, 1998 includes $1,517 for future
abandonment costs which have been accrued by the Company. Due to the
availability of net operating loss carryforwards, there is no future income tax
expense attributable to the Company's reserves.
49
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES
(Unaudited)
(in thousands of dollars, unless otherwise indicated)
Changes in Standardized Measure of Discounted Future Net Cash Flows:
The following table sets forth the changes in standardized measure of
discounted future net cash flows as follows:
<TABLE>
<CAPTION>
December 31,
-------------------------------
1998 1997
---------- ----------
<S> <C> <C>
BALANCE AT BEGINNING OF PERIOD $ -- $ --
Sales of oil and gas, net of production costs (129) --
Net changes in prices and production costs -- --
Revisions of previous quantity estimates -- --
Purchase (Sale) of reserves in place, net of
taxes 355 --
Changes in estimated future development
costs -- --
Development costs incurred during the period -- --
Accretion of discount -- --
Net change in income taxes -- --
Change in production rates (timing) and other -- --
---------- ----------
BALANCE AT END OF PERIOD $ 226 $ --
========== ==========
</TABLE>
There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and timing of
development expenditures, including many factors beyond the control of the
Company. Reserve engineering is a subjective process of estimating underground
accumulations of crude oil and natural gas that cannot be measured in an exact
manner, and the accuracy of any reserve estimate is a function of the quality of
available data and of engineering and geological interpretation and judgment.
The quantities of oil and natural gas that are ultimately recovered, production
and operating costs, the amount and timing of future development expenditures
and future oil and natural gas sales prices may all differ from those assumed in
these estimates. The standardized measure of discounted future net cash flow
should not be construed as the current market value of the estimated oil and
natural gas reserves attributable to the Company's properties. The information
set forth in the foregoing tables includes revisions for certain reserve
estimates attributable to proved properties included in the preceding year's
estimates. Such revisions are the result of additional information from
subsequent completions and production history from the properties involved or
the result of a decrease (or increase) in the projected economic life of such
properties resulting from changes in product prices. Moreover, crude oil amounts
shown are recoverable under the service contracts and the reserves in place
remain the property of the Philippine government.
In accordance with the guidelines of the U.S. Securities and Exchange
Commission, the Company's estimates of future net cash flow from the Company's
properties and the present value thereof are made using oil and natural gas
contract prices in effect as of year end and are held constant throughout the
life of the properties except where such guidelines permit alternate treatment,
including the use of fixed and determinable contractual price escalations. The
contract price as of December 31, 1998 was $6.00 per Bbl for oil of crude oil in
the Philippines.
50
<PAGE>
VAALCO ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES
(Unaudited)
(in thousands of dollars, unless otherwise indicated)
Under the laws of the Republic of the Philippines, the Philippine
government is the owner of all oil and gas mineral rights. However, pursuant to
The Oil Exploration and Development Act of 1972, the Philippine government,
acting through its Office of Energy Affairs (formerly, the Petroleum Board), may
enter into service contracts under which contractors will be granted exclusive
rights to perform exploration, drilling, production and other "petroleum
operations" in a contract area. Further, such Act vested the Ministry of Energy
with regulatory powers over business activities relating to the exploration,
exploitation, development and extraction of energy resources.
Pursuant to the service contracts, the Philippine government receives
an allocation of the production from the contract area instead of a royalty.
Under the service contracts, the Philippine government does not take actual
delivery of its allocated production. Instead, the Company has been authorized
to sell the Philippine government's share of production and remit the proceeds
to the Philippine government. Under this production sharing scheme, the
consortium is permitted a Filipino Participation Incentive Allowance ("FPIA")
and a deduction to recover certain costs expended on the development of the
contract area of up to 60% of gross revenues from the contract area. The FPIA, a
deduction equivalent to 7.5% of project gross revenue, is allowed when Filipino
ownership participation in the consortium equals or exceeds 15%, which is the
case for Service Contract No. 14. The consortium also receives a production
allowance of approximately 50% of the balance of the oil after deducting FPIA
and cost recovery oil. The remaining oil is shared 40% by the consortium and 60%
by the Philippine government. Under this scheme, the consortium currently
receives approximately 90.3% of the oil produced and the Philippine government
receives approximately 9.7%. Because the cost recovery account contains over
$200 million, the Company anticipates receiving the maximum 60% of cost oil
during the life of the Nido and Matinloc reserves.
Item 8. Changes In and Disagreements with Accountants
on Accounting and Financial Disclosure
None.
51
<PAGE>
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act
Information required by this item will be included in the Company's
proxy statement for its 1999 annual meeting, which will be filed with the
Commission within 120 days of December 31, 1998, and which is incorporated
herein by reference.
Item 10. Executive Compensation
Information required by this item will be included in the Company's
proxy statement for its 1999 annual meeting, which will be filed with the
Commission within 120 days of December 31, 1998, and which is incorporated
herein by reference.
Item 11. Security Ownership of Certain Beneficial Owners and Management
Information required by this item will be included in the Company's
proxy statement for its 1999 annual meeting, which will be filed with the
Commission within 120 days of December 31, 1998, and which is incorporated
herein by reference.
Item 12. Certain Relationships and Related Transactions
Information required by this item will be included in the Company's
proxy statement for its 1999 annual meeting, which will be filed with the
Commission within 120 days of December 31, 1998, and which is incorporated
herein by reference.
Item 13. Exhibits and Reports on Form 8-K
2. Plan of acquisition, reorganization , arrangement, liquidation or
succession
2.1 (a) Stock Acquisition Agreement and Plan of Reorganization dated
February 17, 1998 by and among the Company and the 1818 Fund
II, L.P.
2.2 (c) First Amendment to Stock Acquisition Agreement
and Plan of Reorganization, dated April 21, 1998
3. Articles of Incorporation and Bylaws
3.1(b) Restated Certificate of Incorporation
3.2(b) Certificate of Amendment to Restated Certificate of
Incorporation
3.3(b) Bylaws
52
<PAGE>
3.4(b) Amendment to Bylaws
3.5(c) Designation of Convertible Preferred Stock, Series A
10. Material Contracts
10.1(d) Service Contract No. 6, dated September 1, 1973, among the
Petroleum Board of the Republic of the Philippines and
Mosbacher Philippines Corporation, et al, as amended
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