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.
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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, 2016 (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.
There could be adverse legislation 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, 2017 compared to six months ended
June 30, 2016
Oil and gas revenues for the first six months of 2017 were $2,088,000,
as compared to $1,549,000 for the same period in 2016, an increase of approximately $539,000 or 34.8%.
Natural gas revenue for the first six months of 2017 was $763,000
compared to $526,000 for the same period in 2016, an increase of approximately $237,000, or 45.06%. Natural gas sales volumes for
the first six months of 2017 were approximately 261,000 mcf compared to approximately 297,000 mcf during the first six months of
2016, a decrease of approximately 36,000 mcf or 12.2%.
Average natural gas prices received were $2.88 per mcf in the first
six months of 2017 as compared to $1.57 per mcf in the same time period in 2016, an increase of approximately $1.31 per mcf or
83.4%.
Oil sales for the first six months of 2017 were approximately $1,325,000
compared to approximately $1,023,000 for the first six months of 2016, an increase of approximately $302,000 or 29.5%. Oil sales
volumes for the first six months of 2017 were approximately 26,300, compared to approximately 25,600 bbls during the same period
in 2016, an increase of approximately 700 bbls, or 2.7%.
Average oil prices received were $46.33 per bbl in the first half
of 2017 compared to $31.43 per bbl in the first half of 2016, an increase of approximately $14.90 per bbl or 47.4%.
Revenues from lease operations were $184,000 in the first six months
of 2017 compared to $196,000 in the first six months of 2016, a decrease of approximately $12,000 or 6.2%. This decrease is due
primarily to a decrease in field supervision charges due to some operated wells that were shut-in.
Revenues from gas gathering, compression and equipment rental for
the first six months of 2017 were $64,000 compared to $69,000 for the same period in 2016, a decrease of $5,000 or 7.3%.
Real estate revenue was approximately $147,000 during the first six
months of 2017 compared to $156,000 for the first six months of 2016, a decrease of approximately $9,000, or 5.8%. This decrease
is due to the loss of a tenant at the Company’s corporate office building effective March, 2017.
Interest income was $71,000 during the first six months of 2017 as
compared to $38,000 during the same period in 2016, an increase of approximately $33,000 or 86.8%. This increase was due to moving
funds during the second half of 2016 to a bank paying higher interest rates. Interest income is derived from investments in both
short-term and long-term certificates of deposit as well as money market accounts at banks.
Other revenues for the first six months of 2017 were $67,000 as compared
to $241,000 for the same time period in 2016, a decrease of $174,000 or 72,2%. The reduction in 2017 is due in part to the timing
of a negotiated settlement in 2016 as well as to the recognition of fees earned under a drilling venture during 2016.
Lease operating expenses in the first six months of 2017 were $681,000
as compared to $571,000 in the first six months of 2016, a net increase of $110,000, or 19.3%. Approximately $20,000 of the increase
is due to operating expenses billed by third-party operators on non-operated properties. There was an approximate $2,000 decrease
in expenses due to several non-operated wells that were either divested or plugged during 2016 and an increase in workovers of
approximately $63,000. An increase of approximately $28,000 is due to operating expenses for new wells drilled or acquired in the
last half of 2016. 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 2017 were approximately $232,000 as compared to $226,000 for the first six months of 2016, an increase of approximately
$6,000, or 2.7%.
Pipeline and rental expenses for the first six months of 2017 were
$12,000 compared to $26,000 for the same time period in 2016, a decrease of $14,000, or 53.9%. This change is primarily due to
repairs and maintenance expenses made in 2016.
Real estate expenses in the first six months of 2017 were approximately
$63,000 compared to $71,000 during the same period in 2016, a decrease of approximately $8,000 or 11.3%. This decrease is due primarily
to lower utilities, maintenance and repair expenses.
Depreciation, depletion, and amortization expenses for first six
months of 2017 were $466,000 as compared to $649,000 for the same period in 2016, a decrease of $183,000, or 28.2%. $437,000 of
the amount for the first six months of 2017 was for amortization of the full cost pool of capitalized costs compared to $615,000
for the same period of 2016, a decrease of $178,000 or 28.9%. The Company re-evaluated its proved oil and natural gas reserve quantities
as of December 31, 2016. This re-evaluated reserve base was adjusted for the first six months as of June 30, 2017 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 3.186% for the first quarter of 2017 and a depletion rate of 4.130% for the second quarter of 2017 was calculated
and applied to the Company’s full cost pool of capitalized oil and natural gas properties compared to rates of 3.350% and
4.481% for the first two quarters of 2016 respectively.
Asset Retirement Obligation (“ARO”) expense for the first
six months of 2017 was approximately $18,000 as compared to approximately $17,000 for the same time period in 2016, an increase
of approximately $1,000 or 5.9%. This increase 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 2016.
General and administrative expenses for the first six months of 2017
were approximately $1,242,000 as compared to approximately $1,325,000 for the same time period of 2016, a decrease of approximately
$83,000 or 6.3%.
Three months ended June 30, 2017 compared to three months ended
June 30, 2016
Oil and natural gas revenues for the three months ended June 30,
2017 were $1,031,000, compared to $906,000 for the same time period in 2016, an increase of $125,000, or 13.8%.
Natural gas revenues for the second quarter of 2017 were $388,000
compared to $280,000 for the same period in 2016, an increase of $108,000 or 38.6%. Natural gas volumes sold for the second quarter
of 2017 were approximately 135,000 mcf compared to approximately 155,000 mcf during the same period of 2016, a decrease of approximately
20,000 mcf, or 12.9%.
Average natural gas prices received were approximately $2.79 per
mcf in the second quarter of 2017 as compared to approximately $1.77 per mcf during the same period in 2016, an increase of approximately
$1.02 or 57.6%.
Oil sales for the second quarter of 2017 were approximately $643,000
compared to approximately $626,000 for the same period of 2016, an increase of approximately $17,000 or 2.7%. Oil volumes sold
for the second quarter of 2017 were approximately 18,100 bbls compared to approximately 15,300 bbls during the same period of 2016,
an increase of approximately 2,800 bbl or 18.3%.
Average oil prices received were approximately $44.42 per bbl in
the second quarter of 2017 compared to $38.02 per bbl during the same period of 2016, an increase of approximately $6.40 per bbl,
or 16.8%.
Revenues from lease operations for the second quarter of 2017 were
approximately $93,000 compared to approximately $106,000 for the second quarter of 2016, a decrease of approximately $13,000 or
12.3%. This decrease is due to a reduction in the number of operated wells that were disposed of or that were shut-in.
Revenues from gas gathering, compression and equipment rental for
the second quarter of 2017 were approximately $38,000, compared to approximately $39,000 for the same period in 2016, a decrease
of approximately $1,000 or 2.6%.
Real estate revenue was approximately $73,000 during the second quarter
of 2017 compared to $78,000 for the same time period of 2016, a decrease of approximately $5,000 or 6.4%. This decrease is due
to the loss of a tenant at the Company’s corporate office building effective March 31, 2017.
Interest income for the second quarter of 2017 was approximately
$43,000 as compared with approximately $20,000 for the same period in 2016, an increase of approximately $23,000 or 115.0%. This
increase was due to moving funds during the second half of 2016 to a bank paying higher interest rates. Interest income is derived
from investments in both short-term and long-term certificates of deposit as well as money market accounts at banks.
Other revenues for second quarter of 2017 were approximately $49,000
as compared with approximately $207,000 for the same period in 2016, a decrease of approximately $158,000 or 76.3%. The reduction
in 2017 is due in part to the timing of a negotiated settlement in 2016 as well as to the recognition of fees earned under a drilling
venture during 2016.
Lease operating expenses in the second
quarter of 2017 were $362,000 as compared to $324,000 in the second quarter of 2016, a net increase of approximately $38,000, or
11.7%. Approximately $12,000 of the increase is due to operating expenses billed by third-party operators on non-operated
properties. There was an approximate $1,000 decrease in expenses due to several wells that were either divested or plugged during
2016. There was an increase in workovers of approximately $44,000 and an increase of approximately $12,000 due to new wells drilled
or acquired during the second half of 2016. Approximately $29,000 represents net 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 2017 were approximately $108,000 as compared to $126,000 during the second quarter of 2016, a net decrease
of approximately $18,000 or 14.3%.
Pipeline and rental expenses for the second quarter of 2017 were
$10,000 compared to $16,000 for the same time period in 2016, a decrease of $6,000 or 37.5%. This change is primarily due to repairs
and maintenance expenses made in 2016.
Real estate expenses during the second quarter 2017 were approximately
$31,000 compared to approximately $32,000 for the same period in 2016, a decrease of approximately $1,000 or 3.1%.
Depreciation, depletion, and amortization expenses for the second
quarter of 2017 were $261,000 as compared to $396,000 for the same period in 2016, a decrease of $135,000, or 34.1%. $247,000 of
the amount for the second quarter of 2017 was for amortization of the full cost pool of capitalized costs compared to $379,000
for the second quarter of 2016, a decrease of $132,000 or 34.8%. The Company re-evaluated its proved oil and natural gas reserve
quantities as of December 31, 2016. This re-evaluated reserve base was adjusted for the first six months as of June 30, 2017 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 3.186% for the first quarter of 2017 and a depletion rate of 4.130% for the second quarter of 2017
was calculated and applied to the Company’s full cost pool of capitalized oil and natural gas properties compared to rates
of 3.350% and 4.481% for the first two quarters of 2016 respectively.
Asset Retirement Obligation (“ARO”) expense for the second
quarter of 2017 was approximately $9,000 as compared to approximately $8,000 for the same time period in 2016, an increase of approximately
$1,000 or 12.5%. This increase 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 2016.
General and administrative expenses for the second quarter of 2017
were $661,000 compared to $638,000 for the same period in 2016, an increase of approximately $23,000 or 3.6%.
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.