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 Company’s Annual Report on Form 10-K for the year ended December 31, 2013
as filed with the Securities and Exchange Commission (hereinafter, the “2013 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 2013 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. 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 quarter of 2014, the
Company continued to fund its business activity through the use of internal sources of cash. The Company had cash provided by operations
of $3,264,333 and a cash distribution of $40,095 from an equity investment for total cash provided of $3,304,428. The Company utilized
cash for property additions of $1,318,627 and financing activities of $72,325 for total cash applied of $1,390,952. Cash and cash
equivalents increased $1,913,676 to $12,678,182.
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, 2013. A discussion of these items follows.
Trading securities decreased $45,511 (8%) from
$586,708 to $541,197. The decrease was the net result of a $62,657 decrease in the trading securities market value offset by $17,146
of net income from these securities.
Refundable income taxes
decreased $402,756 (120%) from a receivable of $336,620 to a payable of $66,136 due to the first quarter 2014 current income
tax provision of $902,762 offset by estimated tax payments of $500,006 for the same period.
Receivables increased $436,467 (18%) to $2,885,515
from $2,449,048. This increase was due mostly to higher oil and gas sales receivables. Sales variances are discussed in the “Results
of Operations” section below.
Accounts payable decreased $119,866 (33%) to
$247,756 from $367,622 due primarily to a decline in the drilling activity in the quarter ended March 31, 2014 compared to
the quarter ended December 31, 2013.
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 $3,264,333
in 2014, an increase of $1,035,152 (46%) from the comparable period in 2013. The increase was primarily the result of increased
oil and gas sales and an increase in lease bonuses. For more information see “Operating Revenues” and “Operating
Costs and Expenses” below.
Cash applied to the purchase of property additions
in 2014 was $1,318,627, a decrease of $857,177 (39%) from cash applied in 2013 of $2,175,804. For both 2014 and 2013, cash applied
to property additions was mostly related to oil and gas exploration and development activity. The decrease in property additions
for 2014 is mostly due to a decline in the exploration and development drilling activity in the first quarter of 2014 versus 2013.
See the subheading “Exploration Costs” in the “Results of Operations” section below for additional information.
Conclusion.
Management is unaware of
any additional material trends, demands, commitments, events or uncertainties, which would impact liquidity and capital resources
to the extent that the discussion presented in the 2013 Form 10-K would not be representative of the Company’s current position.
Material Changes in Results of Operations
Three Months Ended March 31, 2014, Compared with Three Months Ended March 31, 2013
Net income increased $731,693 (59%) to $1,974,703
in 2014 from $1,243,010 in 2013. Net income per share, basic and diluted, increased $4.67 (60%) to $12.40 in 2014 from $7.73 in
2013.
A discussion of revenue from oil and gas sales
and other significant line items in the statements of income follows.
Operating Revenues
. Revenues from oil
and gas sales increased $1,450,894 (38%) to $5,275,210 in 2014 from $3,824,316 in 2013. Of the $1,450,894 change, crude oil sales increased
$751,525; natural gas sales increased $508,743; and miscellaneous oil and gas product sales increased $190,626.
The $751,525 (30%) increase in oil sales
to $3,256,819 in 2014 from $2,505,294 in 2013 was the result of an increase in the average price per barrel (Bbl) and the
volume sold. The volume of oil sold increased 5,813 Bbls to 35,533 Bbls in 2014, resulting in a positive volume variance of
$490,012. The average price per Bbl increased $7.36 to $91.65 per Bbl in 2014, resulting in a positive price variance of
$261,513. The increase in oil volumes sold was mostly due to production of 16,094 Bbls from new wells partially offset by
10,281 Bbls of production declines from older wells.
The $508,743 (41%) increase in gas
sales to $1,753,948 in 2014 from $1,245,205 in 2013 was the net result of an increase in the average price per thousand cubic
feet (MCF) and a decrease in the volume sold. The volume of gas sold decreased 37,249 MCF to 367,705 MCF in 2014 from
404,954 MCF in 2013, for a negative volume variance of $114,354. The decrease in gas volumes sold was mostly due to
production declines from older wells, especially in Arkansas, partially offset by production of 128,054 MCF from new wells.
The average price per MCF increased $1.70 to $4.77 per MCF in 2014 from $3.07 per MCF in 2013, resulting in a positive price
variance of $623,097.
Sales from the Robertson County,
Texas royalty interest properties provided approximately 21% of the Company’s first quarter 2014 gas sales volumes and
about 27% of the first quarter 2013 gas sales volumes. See discussion on page 11 of the 2013 Form 10-K under the
subheading “Operating Revenues” for more information about these properties. Sales from Arkansas working interest
properties provided approximately 18% of the Company’s first quarter 2014 gas sales volumes and about 36% of the first
quarter 2013 gas sales volumes.
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 $264,443 in 2014 compared to $73,817 in 2013.
The Company received lease bonuses of $200,942
in the first quarter of 2014 for leases on its owned minerals. Lease bonuses for the first quarter of 2013 were $22,068.
There were no coal royalties for the first
quarter of 2014 or 2013 for coal mined on North Dakota leases.
Operating Costs and Expenses
. Operating
costs and expenses increased $533,711 (23%) to $2,807,944 in 2014 from $2,274,233 in 2013. Material line item changes are discussed
and analyzed in the following paragraphs.
Production Costs.
Production costs increased
$117,095 (16%) in 2014 to $844,600 from $727,505 in 2013. This increase was due primarily to an increase in lease operating and
handling expense of $67,394 (12%) to $632,467 for 2014 from $565,073 for 2013. This increase was due primarily to new wells which
first produced after March 31, 2013. The remaining $49,701 increase was due to higher production taxes as a result of increased
oil and gas sales revenue.
Exploration Costs.
Total
exploration expense increased $415,668 (172%) to $657,471 in 2014 from $241,803 in 2013. The increase was entirely due to
geological and geophysical expense of $657,945 in 2014 and $237,432 in 2013. This increase was due primarily to the seismic
cost on the Creek County, Oklahoma prospect discussed below.
The following is a summary as of April 30,
2014, updating both exploration and development activity from December 31, 2013, for the period ended March 31, 2014.
The Company is participating
with its 18% working interest in three development wells on a Barber County, Kansas prospect. The wells have been drilled and are
awaiting completion. Three additional development wells will be drilled on the prospect in 2014. Capitalized costs for the period
were $84,856, including $79,257 in prepaid drilling costs.
The Company participated with
16% and 8% working interests in the drilling of two development wells on a Woods County, Oklahoma prospect. Completions are in
progress on both wells. Capitalized costs for the period were $140,800, including $64,500 in prepaid drilling costs.
The Company will participate
with its 10.5% working interest in the drilling of an exploratory well on a Cimarron County, Oklahoma prospect starting in May
2014.
The Company will participate
with a 7.5% working interest in the drilling of two horizontal development wells on a Woods County, Oklahoma prospect starting
in the second quarter of 2014.
The Company is participating
with a 9% working interest in a horizontal development well on a Roger Mills County, Oklahoma prospect. The well is currently drilling.
The Company will participate
with its 10.5% working interest in the drilling of an exploratory well on a Logan County, Oklahoma prospect starting in the second
quarter of 2014.
The Company participated with
a 6.6% working interest in the drilling of an exploratory well on a Garvin County, Oklahoma prospect. The deep objectives were
non-productive and the lower portion of the hole was plugged. The Company will participate with a 12.8% working interest in a completion
attempt of a shallow zone.
The Company will participate
in the drilling of an exploratory well and a salt water disposal well on a Seminole County, Oklahoma prospect starting in the second
quarter of 2014. Prepaid drilling costs for the period were $186,648.
The Company participated with
a 10.7% working interest in the drilling of a development well and with a 10.3% working interest in an attempted re-entry and washdown
on a Woods County, Oklahoma prospect. A completion is in progress on the development well. The re-entry was unsuccessful and the
well was plugged. The Company will participate with a 10.3% interest in an additional development well starting in the second quarter
of 2014. Prepaid drilling costs for the period were $14,685.
In February 2014, the Company
purchased a 10% interest in 250 net acres of leasehold on a McClain County, Oklahoma prospect for $11,875. The Company is participating
in an exploratory well that has been drilled and is awaiting completion.
In March 2014, the Company
purchased a 14% interest in 1,705 net acres of leasehold and 70 square miles of 3-D seismic data on a Creek County, Oklahoma prospect
for $684,376. Seismic interpretation and additional leasehold acquisition are in progress. Eight potential structures have been
identified and exploratory drilling will start in the second half of 2014.
Other Income/(Loss), Net
. This line
item decreased $69,922 (129%) to a loss of $(15,558) in 2014 from income of $54,364 in 2013. See Note 2 to the accompanying financial
statements for the analysis of the various components of this line item.
Trading securities losses in 2014 were $(45,925)
compared to gains of $35,074 in 2013, a decrease of $80,999. In 2014, the Company had realized gains of $16,732 and unrealized
losses of $(62,657) from adjusting the securities to estimated fair market value. In 2013, the Company had realized losses of $(11,155)
and unrealized gains of $46,229.
Provision for Income Taxes
. The provision
for income taxes increased $294,442 (77%) to $677,947 in 2014 from $383,505 in 2013. The increase was due to the increase in income
before income taxes of $1,026,135 (63%) to $2,652,650 in 2014 from $1,626,515 in 2013. Of the 2014 income tax provision, the estimated
current tax expense was $902,762, which was offset by an estimated deferred tax benefit of $(224,815). Of the 2013 income tax provision,
the current and deferred expenses were $227,710 and $155,795, respectively. See Note 4 to the accompanying financial statements
for additional information on income taxes.
Off-Balance Sheet Arrangement
The Company’s off-balance sheet
arrangement relates to Broadway Sixty-Eight, Ltd., an Oklahoma limited partnership. The Company does not have actual or
effective control of this entity. Management of this entity could at any time make decisions in its own best interest, which
could materially affect the Company’s net income or the value of the Company’s investment. For more information
about this entity, see Note 3 to the accompanying financial statements.