Item 2. - Management's Discussion and Analysis of Financial Condition
and
Results of Operations
WARNING CONCERNING FORWARD LOOKING STATEMENTS
The following discussion should be read in conjunction with the financial
statements and notes thereto appearing elsewhere in this report.
This Report on Form 10-Q may contain forward-looking statements within
the meaning of the federal securities laws, principally, but not only, under the caption “Management’s Discussion and
Analysis of Financial Condition and Results of Operations.” We caution investors that any forward-looking statements in this
report, or which management may make orally or in writing from time to time, are based on management’s beliefs and on assumptions
made by, and information currently available to, management. When used, the words “anticipate,” “believe,”
“expect,” “intend,” “may,” “might,” “plan,” “estimate,”
“project,” “should,” “will,” “result” and similar expressions which do not relate
solely to historical matters are intended to identify forward-looking statements. These statements are subject to risks, uncertainties,
and assumptions and are not guarantees of future performance, which may be affected by known and unknown risks, trends, uncertainties,
and factors, that are beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, or projected. We caution you
that while forward-looking statements reflect our good faith beliefs when we make them, they are not guarantees of future performance
and are impacted by actual events when they occur after we make such statements. We expressly disclaim any responsibility to update
our forward-looking statements, whether as a result of new information, future events or otherwise. Accordingly, investors should
use caution in relying on past forward-looking statements, which are based on results and trends at the time they are made, to
anticipate future results or trends.
`
Some of the risks and uncertainties that may cause our actual results,
performance or achievements to differ materially from those expressed or implied by forward-looking statements include, among others,
the factors listed and described at Item 1A “Risk Factors” in the Company’s Annual Report on Form 10-K, which
investors should review. There have been no changes from the risk factors previously described in the Company’s Form 10-K
for the fiscal year ended December 31, 2015 (the “Form 10-K”).
Uncertainties regarding the global economic and financial environment
could lead to an extended national or global economic recession. A slowdown in economic activity caused by a recession would likely
reduce national and worldwide demand for oil and natural gas and result in lower commodity prices for
long periods of time.
Costs of exploration, development and production have not yet adjusted to current economic conditions, or in proportion to the
significant reduction in product prices. Prolonged,
substantial decreases in oil and natural gas prices would likely
have a material adverse effect on the Company’s business, financial condition, and results of operations, and could further
limit the Company's access to liquidity and credit, and could hinder its ability to satisfy its capital requirements.
In the past several years, capital and credit
markets have experienced volatility and disruption. Given the levels of market volatility and disruption, the availability of funds
from those markets may diminish substantially. Further, arising from concerns about the stability of financial markets generally
and the solvency of borrowers specifically, the cost of accessing the credit markets has increased as many lenders have raised
interest rates, enacted tighter lending standards, or altogether ceased to provide funding to borrowers.
Due to these potential capital and credit market conditions, the
Company cannot be certain that funding will be available in amounts or on terms acceptable to the Company. The Company is evaluating
whether current cash balances and cash flow from operations alone would be sufficient to provide working capital to fully fund
the Company's operations. Accordingly, the Company is evaluating alternatives, such as joint ventures with third parties
,
or
sales of interest in one or more of its properties. Such transactions, if undertaken, could result in a reduction in the Company's
operating interests or require the Company to relinquish the right to operate the property. There can be no assurance that any
such transactions can be completed or that such transactions will satisfy the Company's operating capital requirements. If the
Company is not successful in obtaining sufficient funding or completing an alternative transaction on a timely basis on terms acceptable
to the Company, the Company would be required to curtail its expenditures or restructure its operations, and the Company would
be unable to continue its exploration, drilling, and recompletion program, any of which would have a material adverse effect on
its business, financial condition, and results of operations.
The Obama administration has set forth budget proposals which if
passed, would significantly curtail our ability to attract investors and raise capital. Proposed changes in the Federal income
tax laws which would eliminate or reduce the percentage depletion deduction and the deduction for intangible drilling and development
costs for small independent producers, will significantly reduce the investment capital available to those in the industry as well
as our Company. Lengthening the time to expense seismic costs will also have an adverse effect on our ability to explore and find
new reserves.
Other sections of this report may also include suggested factors
that could adversely affect our business and financial performance. Moreover, we operate in a very competitive and rapidly changing
environment. New risks may emerge from time to time and it is not possible for management to predict all such matters; nor can
we assess the impact of all such matters on our business or the extent to which any factor, or combination of factors, may cause
actual results to differ materially from those contained in any forward-looking statements. Given these uncertainties, investors
should not place undue reliance on forward-looking statements as a prediction of actual results. Investors should also refer to
our quarterly reports on Form 10-Q for future periods and current reports on Form 8-K as we file them with the SEC, and to other
materials we may furnish to the public from time to time through Forms 8-K or otherwise.
Results of Operations
Six months ended June 30, 2016 compared to six months ended
June 30, 2015
Oil and gas revenues for the first six months of 2016 were $1,549,000,
as compared to $2,434,000 for the same period in 2015, a decrease of approximately $885,000 or 36.4%.
Natural gas revenue for the first six months of 2016 was $526,000
compared to $886,000 for the same period in 2015, a decrease of approximately $360,000, or 40.6%. Natural gas sales volumes for
the first six months of 2016 were approximately 297,000 mcf compared to approximately 345,000 mcf during the first six months of
2015, a decrease of approximately 48,000 mcf or 13.9%. In general, this decrease was due primarily to a decrease in natural gas
prices discussed below, and to a natural decline in production. In addition, several wells that went down were shut in rather than
repaired as a result of lower natural gas prices which contributed to an overall decline in gas production between the periods.
Average natural gas prices received were $1.57 per mcf in the first
six months of 2016 as compared to $2.51 per mcf in the same time period in 2015, a decrease of approximately $0.94 per mcf or 37.5%.
Oil sales for the first six months of 2016 were approximately $1,023,000
compared to approximately $1,548,000 for the first six months of 2015, a decrease of approximately $525,000 or 33.9%. Oil sales
volumes for the first six months of 2016 were approximately 25,600, compared to approximately 30,900 bbls during the same period
in 2015, a decrease of approximately 5,300 bbls, or 17.2%. This decrease was due primarily to a decrease in oil prices discussed
below, and to a decline on oil production between the two periods related to several non-operated horizontal wells in East Texas
in which the Company owns working and royalty interests.
Average oil prices received were $31.43 per bbl in the first half
of 2016 compared to $49.92 per bbl in the first half of 2015, a decrease of approximately $18.49 per bbl or 37.0%.
The primary reason for the decrease in natural gas and oil revenues
during the first half of 2016 as compared to the first half of 2015 is the decline in prices at which we sell our oil and natural
gas products. The prices for our products have decreased significantly in conjunction with the overall decline in oil and gas prices
worldwide starting in the fourth quarter of 2014. The Company has experienced a similar decline in the selling prices of its products.
Average quarterly natural gas prices per mcf for the Company for the year ended December 31, 2014 were $4.64, $4.71, $4.45, and
$4.06, respectively. Average quarterly crude oil prices per bbl for the Company for the year ended December 31, 2014 were $113.76,
$100.55, $98.05, and $83.03 respectively. Average quarterly natural gas prices per mcf for the Company for the year ended December
31, 2015 were $2.67, $2.46, $2.31, and $2.45, respectively. Average quarterly crude oil prices per bbl for the Company for the
year ended December 31, 2015 were $46.33, $54.48, $45.68, and $41.03 respectively. Average quarterly natural gas prices per mcf
for the Company for the first half of 2016 were $1.34, and $1.77, respectively. Average quarterly crude oil prices per bbl for
the Company for the first half of 2016 were $46.33, and $38.02 respectively.
The decreases in the Company’s product prices have a direct
effect on its cash flow and profits.
Revenues from lease operations were $196,000 in the first six months
of 2016 compared to $244,000 in the first six months of 2015, a decrease of approximately $48,000 or 19.67%. This decrease is due
primarily to an approximate $14,000 decrease in field supervision charges due to a reduction in the number of operated wells that
were disposed of or that were shut in. In addition to the reduced number of operated wells, a reduction in the COPAS overhead rate
adjustment led to a decrease of approximately $33,000 in operator overhead charged to the leases.
Revenues from gas gathering, compression and equipment rental for
the first six months of 2016 were $69,000 compared to $70,000 for the same period in 2015, a decrease of $1,000 or 1.4%.
Real estate revenue was approximately $156,000 during the first six
months of 2016 compared to $114,000 for the first six months of 2015, an increase of approximately $42,000, or 36.8%. This increase
is due to the addition of a new tenant at the Company’s corporate office building effective December 1, 2015.
Interest income was $38,000 during the first six months of 2016 as
compared to $52,000 during the same period in 2015, a decrease of approximately $14,000 or 26.9%. Interest income is derived from
investments in both short-term and long-term certificates of deposit as well as money market accounts at banks. Interest income
is lower due to generally lower interest rates and cash balances during the periods.
Other revenues for the first six months of 2016 were $241,000 as
compared to $38,000 for the same time period in 2015, an increase of $203,000. This is due primarily due to the recognition of
fees earned under drilling ventures.
Lease
operating expenses in the first six months of 2016 were $571,000 as compared to $1,110,000 in the first six months of 2015, a net
decrease of $539,000, or 48.6%. Approximately $150,000 of the decrease is due to a reduction in operating expenses billed by third-party
operators on non-operated properties. There was an approximate
$98,000
decrease in expenses due to several wells that were either divested or plugged during 2015. A decrease in workovers of approximately
$280,000 was due to reduced activity as the result of lower oil and natural gas price economics. The remaining represents net increases
and decreases on various properties due to general price fluctuations and levels of operation activity.
Production taxes, gathering and marketing expenses in the first six
months of 2016 were approximately $226,000 as compared to $288,000 for the first six months of 2015, a decrease of approximately
$62,000, or 21.5%. These decreases related directly to the decline in oil and gas production and revenues as described in the above
paragraphs.
Pipeline and rental expenses for the first six months of 2016 were
$26,000 compared to $19,000 for the same time period in 2015, an increase of $7,000, or 36.8%. This change is primarily due to
an increase in repairs and maintenance expenses.
Real estate expenses in the first six months of 2016 were approximately
$71,000 compared to $81,000 during the same period in 2015, a decrease of approximately $10,000 or 12.4%. This decrease is due
primarily to lower utilities, maintenance and repair expenses.
Depreciation, depletion, and amortization expenses for first six
months of 2016 were $649,000 as compared to $837,000 for the same period in 2015, a decrease of $188,000, or 22.5%. $615,000 of
the amount for the first six months of 2016 was for amortization of the full cost pool of capitalized costs compared to $803,000
for the same period of 2015, a decrease of $188,000 or 23.4%. The Company re-evaluated its proved oil and natural gas reserve quantities
as of December 31, 2015. This re-evaluated reserve base was adjusted for the first six months as of June 30, 2016 by estimating
variances in average prices of oil and natural gas that occurred during the period, adding estimated quantities of oil and natural
gas reserves acquired during the period, and deducting oil and natural gas reserves that were produced or sold during the period.
A depletion rate of 3.350% for the first quarter of 2016 and a depletion rate of 4.481% for the second quarter of 2016 was calculated
and applied to the Company’s full cost pool of capitalized oil and natural gas properties compared to rates of 2.929% and
2.795% for the first two quarters of 2015 respectively. Although the depletion rate for the first six months of 2016 is greater
than the depletion rate for the same period in 2015, the decrease of $188,000 in expense noted above is due to the depletion rate
of 7.831% being applied to a smaller undepleted full cost pool after the full cost pool was reduced by an impairment charge of
$5,116,000 at December 31, 2015.
Asset Retirement Obligation (“ARO”) expense for the first
six months of 2016 was approximately $17,000 as compared to approximately $21,000 for the same time period in 2015, a decrease
of approximately $4,000 or 19.1%. This decrease is due to a recalculation of the estimated present value to plug producing properties
compared to the estimate made in the previous year. This recalculation was made after the Company re-evaluated its proved oil and
natural gas reserves at the end of 2015.
General and administrative expenses for the first six months of 2016
were approximately $1,325,000 as compared to approximately $1,649,000 for the same time period of 2015, a decrease of approximately
$324,000 or 19.7%. This decrease is due to a reduction in the number of personnel employed by the Company during 2015 and during
the first half of 2016, along with related reductions in salary, payroll taxes, benefits and other direct employee expenses.
Three months ended June 30, 2016 compared to three months ended
June 30, 2015
Oil and natural gas revenues for the three months ended June 30,
2016 were $906,000, compared to $1,205,000 for the same time period in 2015, a decrease of 299,000, or 24.8%.
Natural gas revenues for the second quarter of 2016 were $280,000
compared to $426,000 for the same period in 2015, a decrease of $146,000 or 34.3%. Natural gas volumes sold for the second quarter
of 2016 were approximately 155,000 mcf compared to approximately 173,000 mcf during the same period of 2015, a decrease of approximately
18,000 mcf, or 10.4%.
Average natural gas prices received were approximately $1.77 per
mcf in the second quarter of 2016 as compared to approximately $2.46 per mcf during the same period in 2015, a decrease of approximately
$0.69 or 28.1%.
Oil sales for the second quarter of 2016 were approximately $626,000
compared to approximately $779,000 for the same period of 2015, a decrease of approximately $153,000 or 19.6%. Oil volumes sold
for the second quarter of 2016 were approximately 15,300 bbls compared to approximately 14,300 bbls during the same period of 2015,
an increase of 1,000 bbl or 7.0%.
Average oil prices received were approximately $38.02 per bbl in
the second quarter of 2016 compared to $54.48 per bbl during the same period of 2015, a decrease of approximately $16.46 per bbl,
or 30.2%.
Revenues from lease operations for the second quarter of 2016 were
approximately $106,000 compared to approximately $141,000 for the second quarter of 2015, a decrease of approximately $35,000 or
24.8%. This decrease is due primarily to an approximate $13,000 decrease in field supervision charges and an approximate decrease
of $22,000 in operator overhead charged to the leases due to a reduction in the number of operated wells that were disposed of
or that were shut in. In addition to the reduced number of operated wells, a reduction in the COPAS overhead rate adjustment led
to a decrease of approximately $22,000 in operator overhead charged to the leases.
Revenues from gas gathering, compression and equipment rental for
the second quarter of 2016 were approximately $39,000, compared to approximately $39,000 remaining substantially the same.
Real estate revenue was approximately $78,000 during the second quarter
of 2016 compared to $54,000 for the same time period of 2015, an increase of approximately $24,000 or 44.4%. This increase is due
to the addition of a new tenant at the Company’s corporate office building effective December 1, 2015.
Interest income for the second quarter of 2016 was approximately
$20,000 as compared with approximately $36,000 for the same period in 2015, a decrease of approximately $16,000 or 44.4%. Interest
income is derived from investments in both short-term and long-term certificated of deposit. Interest income is lower due to generally
lower interest rates and cash balances during the periods.
Other revenues for second quarter of 2016 were approximately $207,000
as compared with approximately $21,000 for the same period in 2015. This increase is primarily due to the recognition of fees earned
under drilling ventures during the second quarter of 2016.
Lease
operating expenses in the second quarter of 2016 were $324,000 as compared to $670,000 in the second quarter of 2015, a net decrease
of approximately $346,000, or 51.6%. Approximately $66,000 of the decrease is due to a reduction in operating expenses billed
by third-party operators on non-operated properties. There was an approximate
$81,000
decrease in expenses due to several wells that were either divested or plugged during 2015. A decrease in workovers of approximately
$186,000 was due to reduced activity as the result of lower oil and natural gas price economics. The remaining represents net increases
and decreases on various properties due to general price fluctuations and levels of operation activity
.
Production taxes, gathering, transportation and marketing expenses
for the second quarter of 2016 were approximately $126,000 as compared to $151,000 during the second quarter of 2015, a net decrease
of
approximately $25,000 or 16.6%. These decreases related directly to the decline in oil and gas production and revenues as described
in the above paragraphs.
Pipeline and rental expenses for the second quarter of 2016 were
$16,000 compared to $11,000 for the same time period in 2015, an increase of $5,000 or 45.5%. This change is primarily due to the
timing of repairs and maintenance expense.
Real estate expenses during the second quarter 2016 were approximately
$32,000 compared to approximately $35,000 for the same period in 2015, a decrease of approximately $3,000 or 8.6%.
Depreciation, depletion, and amortization expenses for the second
quarter of 2016 were $396,000 as compared to $427,000 for the same period in 2015, a decrease of $31,000, or 7.26%. $379,000 of
the amount for the second quarter of 2016 was for amortization of the full cost pool of capitalized costs compared to $406,000
for the second quarter of 2015, a decrease of $27,000 or 6.7%. The Company re-evaluated its proved oil and natural gas reserve
quantities as of December 31, 2015. This re-evaluated reserve base was adjusted for the first six months as of June 30, 2016 by
estimating variances in average prices of oil and natural gas that occurred during the period, adding estimated quantities of oil
and natural gas reserves acquired during the period, and deducting oil and natural gas reserves that were produced or sold during
the period. A depletion rate of 3.350% for the first quarter of 2016 and a depletion rate of 4.481% for the second quarter of 2016
was calculated and applied to the Company’s full cost pool of capitalized oil and natural gas properties compared to rates
of 2.929% and 2.795% for the first two quarters of 2015 respectively. Although the depletion rate for the second quarter of 2016
is greater than the depletion rate for the same period in 2015, the decrease of $31,000 in expense noted above is due to the depletion
rate of 4.481% being applied to a smaller undepleted full cost pool after the full cost pool was reduced by an impairment charge
of $5,116,000 at December 31, 2015.
Asset Retirement Obligation (“ARO”) expense for the second
quarter of 2016 was approximately $8,000 as compared to approximately $11,000 for the same time period in 2015, a decrease of approximately
$3,000 or 27.3%. This decrease is due to a recalculation of the estimated present value to plug producing properties compared to
the estimate made in the previous year. This recalculation was made after the Company re-evaluated its proved oil and natural gas
reserves at the end of 2015.
General and administrative expenses for the second quarter of 2016
were $638,000 compared to $805,000 for the same period in 2015, a decrease of approximately $167,000 or 20.8%. The decrease is
primarily due to lower salaries and benefits and contract labor, offset by higher franchise tax expense, in the second quarter
of 2016 compared to the second quarter of 2015. This decrease is primarily due to a reduction in the number of personnel employed
by the Company during 2015 and during the first half of 2016, along with related reductions in salary, payroll taxes, benefits
and other direct employee expenses.
Financial Condition and Liquidity
The Company's operating capital needs, as well as its capital spending
program are generally funded from cash flow generated by operations. Because future cash flow is subject to a number of variables,
such as the level of production and the sales price of oil and natural gas, the Company can provide no assurance that its operations
will provide cash sufficient to maintain current levels of capital spending. Accordingly, the Company may be required to seek additional
financing from third parties in order to fund its exploration and development programs.