ITEM 2.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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This discussion and analysis should be read with reference to a similar discussion in the 2018 Form 10-K, as well as the financial statements included in this Form 10-Q.
Forward-Looking Statements
This discussion and analysis includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements give the Company’s current expectations of future events. They include statements regarding the drilling of oil and gas wells, the production that may be obtained from oil and gas wells, cash flow and anticipated liquidity and expected future expenses.
Although management believes the expectations in these and other forward-looking statements are reasonable, we can give no assurance they will prove to have been correct. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Factors that would cause actual results to differ materially from expected results are described under “Forward-Looking Statements” on page 8 of the 2018 Form 10-K.
We caution you not to place undue reliance on these forward-looking statements, which speak only as of the date of this Form 10-Q, and we undertake no obligation to update this information because of new information, future developments, or otherwise. You are urged to carefully review and consider the disclosures made in this and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect our business.
Financial Conditions and Results of Operations
Liquidity and Capital Resources
Please refer to the Balance Sheets and the Condensed Statements of Cash Flows in this Form 10-Q to supplement the following discussion. In the first nine months of 2019, the Company continued to fund its business activity through the use of internal sources of cash. The Company had net cash provided by operations of $2,174,640 and cash provided by the maturities of available-for-sale debt securities of $22,176,226. Additional cash of $34,173 was provided by property dispositions and equity method investments for total cash provided of $24,385,039. The Company utilized cash for the purchase of available-for-sale debt securities of $25,677,995; property additions of $1,505,293; other investments activity of $3,733; and financing activities of $1,177,247 for total cash applied of $28,364,268. Cash and cash equivalents decreased $3,979,229 (62%) to $2,449,270.
Discussion of Significant Changes in Working Capital. In addition to the changes in cash and cash equivalents discussed above, there were other changes in working capital line items from December 31, 2018. A discussion of these items follows.
Available-for-sale debt securities increased $3,501,769 (22%) to $19,751,183 as of September 30, 2019 from $16,249,414 at December 31, 2018. The increase was due to purchasing additional available-for-sale debt securities because of rising short-term interest rates.
Refundable income taxes increased $3,994 (24%) to $20,381 as of September 30, 2019 from $16,387 at December 31, 2018. This decrease was due to lower revenues and lease bonuses for the nine months ended September 30, 2019.
Accounts payable decreased $105,243 (33%) to $213,144 as of September 30, 2019 from $318,387 at December 31, 2018. This decrease was primarily due to a decrease in intangible drilling costs at September 30, 2019 versus December 31, 2018.
Discussion of Significant Changes in the Condensed Statements of Cash Flows. As noted in the first paragraph above, net cash provided by operating activities was $2,174,640 in the nine months ended September 30, 2019, a decrease of $1,287,235 (37%) from the comparable period in 2018. The decrease was primarily due to decreased operating revenues and other income for the nine months ended September 30, 2019 compared to 2018. For more information see “Operating Revenues” and “Operating Costs and Expenses” below.
Cash applied to the purchase of property, plant and equipment in the nine months ended September 30, 2019 was $1,505,293, a decrease of $239,045 (14%) from cash applied in the comparable period in 2018 of $1,744,338. In both 2019 and 2018, cash applied to property, plant and equipment additions was mostly related to oil and gas exploration and development activity. See the subheading “Exploration Costs” in the “Results of Operations” section below for additional information.
Cash paid for other investments in the nine months ended September 30, 2019 was $3,733, a decrease of $49,353 from cash paid in the comparable period in 2018 of $53,086. In 2019, the Company increased its investment in Ocean by an additional $3,733.
Conclusion. The volatile oil and natural gas commodity prices continue to present many problems and hardships in the oil and gas exploration and production industry. However, during the first nine months of 2019, the Company has continued to generate positive operating cash flows at levels adequate to cover our operating and financing cash needs. Current cash reserves were used for some investment opportunities during this same period. Management is unable to quantify the effect that a continuation of the current volatile commodity prices will have on the Company. Operating results could be negatively impacted by the non-cash long-lived asset impairment write-downs required by the changes in commodity prices. However, management believes that with our current cash reserves the Company will not suffer any material adverse effects to its financial condition for the foreseeable future. Management is unaware of any additional material trends, demands, commitments, events or uncertainties that would impact liquidity and capital resources to the extent that the discussion presented in the 2018 Form 10-K would not be representative of the Company’s current position.
Material Changes in Results of Operations Nine Months Ended September 30, 2019, Compared with Nine Months Ended September 30, 2018
Net income decreased $1,679,114 (66%) to $875,419 in the nine months ended September 30, 2019 from $2,554,533 in the comparable period in 2018. Net income per share, basic and diluted, decreased $10.64 to $5.58 in the nine months ended September 30, 2019 from $16.22 in the comparable period in 2018.
A discussion of revenue from oil and gas sales and other significant line items in the statements of operations follows.
Operating Revenues. Revenues from oil and gas sales decreased $1,292,307 (22%) to $4,712,970 in the nine months ended September 30, 2019 from $6,005,277 in the comparable period in 2018. The $1,292,307 decrease is due to a decrease in crude oil sales of $856,708, natural gas sales of $374,443, and miscellaneous oil and gas product sales of $61,156.
The $856,708 (21%) decrease in oil sales to $3,239,602 in the nine months ended September 30, 2019 from $4,096,310 in the comparable period in 2018 was the net result of a decrease in the average price per barrel (Bbl) and a decrease in the volume sold. The average price per Bbl decreased $9.21 to $53.52 per Bbl in the nine months ended September 30, 2019, resulting in a negative price variance of $557,423 compared to 2018. The volume of oil sold decreased 4,771 Bbls to 60,528 Bbls in the nine months ended September 30, 2019, resulting in a negative volume variance of $299,285 compared to 2018. The net decrease in oil volumes sold was mostly due to a decline of 12,000 Bbls during the period from older wells in Oklahoma and Texas, partially offset by new production of about 7,200 Bbls.
The $374,443 (22%) decrease in gas sales to $1,336,748 in the nine months ended September 30, 2019 from $1,711,191 in the comparable period in 2018 was the net result of a decrease in the average price per thousand cubic feet (MCF) and a decrease in the volume sold. The average price per MCF decreased $0.35 to $2.37 per MCF in the nine months ended September 30, 2019, resulting in a negative price variance of $196,163 compared to 2018. The volume of gas sold decreased 65,544 MCF to 564,238 MCF in the nine months ended September 30, 2019, resulting in a negative volume variance of $178,280 compared to 2018. The net decrease in gas volumes sold was mostly due to production declines from older wells, partially offset by production of 34,000 MCF from several new working and royalty interest wells.
Sales from the Robertson County, Texas royalty interest properties provided approximately 32% of the Company’s gas sales volumes for the nine months ended September 30, 2019 and 33% of the gas sales volumes for the comparable period in 2018. See discussion on page 11 of the 2018 Form 10-K, under the subheading “Operating Revenues,” for more information about these properties. Sales from Arkansas working interest properties provided approximately 12% of the Company’s gas sales volumes for both periods.
For both oil and gas sales, the price change was mostly the result of a change in the spot market prices upon which most of the Company’s oil and gas sales are based. These spot market prices have had significant fluctuations in the past and these fluctuations are expected to continue.
Sales of miscellaneous oil and gas products were $136,620 in the nine months ended September 30, 2019 as compared to $197,776 in the comparable period in 2018.
The Company received lease bonuses of $89,101 in the nine months ended September 30, 2019 for leases on its owned minerals compared to $523,445 in the comparable period in 2018. In the nine months ended September 30, 2019, almost all of lease bonuses were for leases on owned minerals in Oklahoma compared to 91% in Texas in 2018.
Operating Costs and Expenses. Operating costs and expenses decreased $252,105 (6%) to $4,186,465 in the nine months ended September 30, 2019 from $4,438,570 in the comparable period of 2018. Material line item changes are discussed and analyzed in the following paragraphs.
Exploration costs decreased $119,839 (66%) to $60,549 in the nine months ended September 30, 2019 from $180,388 in the comparable period in 2018. The decrease is due to a decrease in dry hole costs and geological and geophysical expenses, offset by an increase in other exploration costs. Geological and geophysical expenses and dry hole costs totaled $51,608 in the nine months ended September 30, 2019 as compared to $206,606 in 2018. Other expenses increased $35,159.
The following is a summary as of October 25, 2019, updating both exploration and development activity from December 31, 2018, for the period ended September 30, 2019.
The Company participated with a 9.5% working interest in the completion of a development well that was drilled in 2018 on a Woods County, Oklahoma prospect. The well is a commercial oil and gas producer. Capitalized costs for the period were $37,762.
The Company is participating with its 14% interest in the acquisition of additional leasehold on a Creek County, Oklahoma 3-D seismic prospect. Two exploratory wells will be drilled on the prospect starting in October 2019. Leasehold costs for the period were $9,299.
The Company owns a 35% interest in 16,472.55 net acres of leasehold on a Crockett and Val Verde Counties, Texas prospect. The Company and its partners entered into an agreement with a third party to drill two strat tests on the prospect, earning the option to drill three additional wells, purchase a 50% interest in the acreage and conduct a thermal recovery pilot test. The strat tests have been drilled, but the third party has decided not to proceed with additional drilling. Negotiations are underway with another group to finish the pattern and conduct the pilot test.
The Company is participating with a 13% interest in a 3-D seismic prospect covering approximately 35,000 acres in San Patricio County, Texas. A 3-D seismic survey of the prospect area has been completed and fourteen prospects have been identified. Two exploratory wells have been drilled on two of the prospects. One well was completed as a commercial oil and gas producer. The other has been completed as a commercial gas and condensate producer and is awaiting pipeline completion. Leasing is complete on two additional prospects and exploratory wells will be drilled on these as soon as surface use agreements are negotiated. Lease acquisition is in progress on five additional prospects. Leasehold costs for the period were $79,196. Additional capitalized costs were $308,612.
The Company has been participating with a 50% interest in an attempt to develop oil prospects in the Permian Basin. Lease acquisition is in progress on four prospects, one in Crane County, Texas, two in Crockett County, Texas and one in Nolan County, Texas. The Company intends to sell a portion of its interest prior to any drilling. Geological costs for the period were $41,770 and leasehold costs were $81,987.
The Company participated with its 16% working interest in the drilling of an exploratory well on a Barber County, Kansas prospect. The well has been completed as a commercial oil producer. Capitalized costs for the period were $67,173.
In October 2018, the Company entered into an agreement to acquire mineral rights in Tyler, Doddridge and Ritchie Counties, West Virginia. The Company is funding the acquisition of the mineral rights, which are then sold to a third party for a profit, with the Company retaining an interest in the minerals. Several small tracts have been acquired and sold, and a larger tract is under contract. Costs for the period, net of sales proceeds, were $298,031.
The Company participated with its 10.5% working interest in the completion of an exploratory well on an Oldham County, Texas prospect as a marginal oil producer. The well was drilled in 2018. Capitalized costs for the period were $166,927, including $17,897 of additional leasehold costs, and an impairment expense of $300,000 was taken against the well.
The Company participated with 17.1% and 17.5% working interests in successful recompletions of two wells on a McClain County, Oklahoma prospect. Capital costs for the period were $15,596.
In June 2019, the Company purchased a 10.5% interest in 100 net acres of leasehold, five producing wells and two salt water disposal wells on a Murray County, Oklahoma prospect for $231,000. The Company participated in the drilling of a development well on the prospect that has been completed as a commercial oil producer. Additional capitalized costs for the period were $104,907.
In October 2019, the Company purchased an 8.4% interest in 998.33 net acres of leasehold on a Custer County, Oklahoma prospect for $18,935. An exploratory horizontal well is currently in progress.
Depreciation, Depletion, Amortization and Valuation Provision (DD&A). DD&A decreased $143,570 (11%) to $1,132,718 in the nine months ended September 30, 2019 from $1,276,288 in the comparable period in 2018. Depreciation, Depletion and Amortization amounts decreased $189,000, offset by an increase in impairment loss of approximately $45,000. See Note 10 – LONG-LIVED ASSETS IMPAIRMENT LOSS on page 31 of the 2018 Form 10-K for a description of the impairment loss calculation.
Other Income, Net. This line item decreased $484,939 (62%) to $292,296 in the nine months ended September 30, 2019 from $777,235 in the comparable period in 2018. See Note 2 to the accompanying financial statements for an analysis of the components of this item.
Equity securities gains were $37,111 in the nine months ended September 30, 2019 compared to losses of $(4,598) in the comparable period in 2018. In the nine months ended September 30, 2019, the Company had unrealized losses of $17,968 from adjusting securities, held at September 30, to estimated fair market value and net realized trading gains of $55,079. In the nine months ended September 30, 2018, the Company had unrealized losses of $80,001 and net realized trading gains of $75,403.
Gain on the sale of assets decreased $591,809 (98%) to $9,422 in the nine months ended September 30, 2019 from a $601,231 gain mostly from a large, multiple property transaction in the comparable period in 2018.
Interest income increased $183,505 (80%) to $412,946 in the nine months ended September 30, 2019 from $229,441 in the comparable period in 2018. The increase was due to increased interest rates on available-for-sale debt securities and other interest-bearing accounts.
Other income decreased $16,874 (68%) to $8,008 in the nine months ended September 30, 2019 from $24,882 in the comparable period in 2018 mostly due to a decrease in other investment income to $2,000 in 2019 from $16,500 in 2018.
Income Tax Provision. Income taxes decreased $278,896 to $34,761 in the nine months ended September 30, 2019 from $313,657 in the comparable period in 2018. The income tax decrease was the result of a $1,958,010 decrease in the pre-tax income to $910,180 in the nine months ended September 30, 2019 from a $2,868,190 pre-tax income in the comparable period in 2018. Of the 2019 income tax provision, the estimated current tax provision was $66,285 and the estimated deferred tax benefit was $(31,524). Of the 2018 income tax provision, the estimated current tax provision was $163,107 and the estimated deferred tax provision was $150,550. See Note 4 to the accompanying financial statements for additional information on income taxes.
Material Changes in Results of Operations Three Months Ended September 30, 2019, Compared with Three Months Ended September 30, 2018
Net income/(loss) decreased $1,080,791 (120%) to a loss of $(179,538) in the three months ended September 30, 2019 from income of $901,253 in the comparable period in 2018. The significant changes in the statements of operations are discussed below.
Operating Revenues. Revenues from oil and gas sales decreased $594,046 (32%) to $1,274,761 in the three months ended September 30, 2019 from $1,868,807 in the comparable period in 2018 due to decreases in oil, gas and other product sales of $303,869, $261,700 and $28,477, respectively.
The decrease in oil sales was the net result of a decrease in the average price received of $13.75 per Bbl to $52.69, for a negative price variance of $240,685, and a decrease in the volume of oil sold of 951 Bbls to 17,500 Bbls, for a negative volume variance of $63,184. See the “Results of Operations” section above for the nine months ended September 30, 2019 for additional discussion of the oil sales variances.
The decrease in gas sales was the result of a decrease in the average price of $1.01 per MCF to $1.82, for a negative price variance of $175,269, and a decrease in the volume of gas sold of 30,541 MCF to 174,661 MCF, for a negative volume variance of $86,431. See the “Results of Operations” section above for the nine months ended September 30, 2019 for additional discussion of gas sales variances.
Other operating revenues decreased $296,422 (99%) to $2,031 for the three months ended September 30, 2019 due to a decrease in lease bonuses from the comparable period in 2018.
Operating Costs and Expenses. Operating costs and expenses increased $292,923 (23%) to $1,550,222 in the three months ended September 30, 2019 from $1,257,299 in the comparable period in 2018. The increase was the net result of an increase in depreciation, depletion, amortization and valuation provisions (DD&A) of $264,921; an increase in general administrative and other expense (G&A) of $71,891; a decrease in production costs of $14,370; and a decrease in exploration costs charged to expense of $29,519. The significant changes in these line items are discussed below.
Exploration costs decreased $29,519 (65%) to $15,684 in the three months ended September 30, 2019 from $45,203 in the comparable period in 2018. Most of the decrease is due to a $21,906 decrease in geological and geophysical costs for the three months ended September 30, 2019 compared to 2018.
DD&A increased $264,921 (84%) to $581,716 in the three months ended September 30, 2019 from $316,795 in the comparable period in 2018. Impairment losses for the three months ended September 30, 2019 were $300,000, versus none in the comparable period in 2018. See Note 10 – LONG-LIVED ASSETS IMPAIRMENT LOSS on page 31 of the 2018 Form 10-K for a description of the impairment loss calculation.
Other Income, Net. See Note 2 to the accompanying financial statements for an analysis of the components of other income, net. In the three months ended September 30, 2019, this line item decreased $40,564 (58%) to $29,229 from $69,793 in the comparable period in 2018.
Equity securities decreased $31,249 in the three months ended September 30, 2019 to losses of $(50,791) compared to losses of $(19,542) in the comparable period in 2018. The decrease was due to an increase in realized gains of $7,210 and an increase in unrealized losses of $38,459.
Interest income increased $15,124 (14%) to $123,832 in the three months ended September 30, 2019 from $108,708 in the comparable period in 2018. The increase was due to increased interest rates on available-for-sale debt securities and other interest-bearing accounts.
Income Tax Provision/(Benefit). Income taxes decreased $143,164 (182%) to a benefit of $(64,663) in the three months ended September 30, 2019 from a provision of $78,501 in the comparable period in 2018. The decrease was due to the decrease in income before income taxes of $1,223,955 to a loss of $(244,201) in the three months ended September 30, 2019 from income of $979,754 in the comparable period in 2018. Of the 2019 income tax benefit, the estimated current tax benefit was $(12,409) and the estimated deferred tax benefit was $(52,254). Of the 2018 income tax provision, the estimated current tax provision was $70,669 and the estimated deferred tax provision was $7,832. See discussions above in “Results of Operations” section and Note 4 to the accompanying financial statements for additional explanation of the changes in the provision for income taxes.
Off-Balance Sheet Arrangements
The Company’s off-balance sheet arrangements relate to Broadway Sixty-Eight, LLC, an Oklahoma limited liability company, and Grand Woods Development, LLC, an Oklahoma limited liability company. The Company does not have actual or effective control of these entities. Management of these entities could at any time make decisions in their own best interest, which could materially affect the Company’s net income or the value of the Company’s investment. See Note 3 to the accompanying financial statements for more information about these entities.