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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 half 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 $7,216,668 and cash provided by the maturities of available-for-sale securities of $6,653,823. Additional cash of $308,783
was provided by property dispositions and investment distributions for total cash provided of $14,179,274. The Company utilized
cash for the purchase of available-for-sale securities of $6,654,786, property additions of $2,528,483 and financing activities
of $3,120,029 for total cash applied of $12,303,298. Cash and cash equivalents increased $1,875,976 (17%) to $12,640,482.
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.
Refundable income taxes decreased $153,184
(46%) to $183,436 from $336,620 due to the first half 2014 current income tax provision of $1,623,195, offset by estimated tax
payments of $1,470,011 for the same period.
Accounts payable increased $113,917 (31%)
to $481,539 from $367,622. The increase was due entirely to the increased drilling activity at June 30, 2014 compared to December
31, 2013.
Deferred income taxes and other liabilities
increased $69,020 (20%) to $406,644 from $337,624 due to an increase of $60,000 in ad valorem tax accruals and an increase of
$9,020 in current deferred income taxes. Ad valorem (property) taxes are primarily for Texas properties and are accrued for the
first three quarters each year to be paid in the fourth quarter.
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 $7,216,668
in 2014, an increase of $1,759,218 (32%) from the comparable period in 2013. The increase was primarily due to increased operating
revenue, partially offset by increased exploration costs. For more information see “Operating Revenues” and “Exploration
Costs” below.
Cash applied to the purchase of property additions
in 2014 was $2,528,483, a decrease of $1,021,733 (29%) from cash applied in 2013 of $3,550,216. In both 2014 and 2013, cash applied
to property 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.
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
Six Months Ended June 30, 2014, Compared with Six Months Ended June
30, 2013
Net income increased $549,554 (16%) to $4,046,212
in 2014 from $3,496,658 in 2013. Net income per share, basic and diluted, increased $3.66 (17%) to $25.43 in 2014 from $21.77
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 $1,598,462 (18%) to $10,379,177 in 2014 from $8,780,715 in 2013. The $1,598,462 increase is due to higher
natural gas sales of $777,922; higher crude oil sales of $562,635; and an increase in miscellaneous oil and gas product sales
of $257,905.
The $562,635 (9%) increase in oil sales to
$6,608,766 in 2014 from $6,046,131 in 2013 was the result of an increase in both the volume sold and the average price per barrel
(Bbl). The volume of oil sold increased 353 Bbls to 70,555 Bbls in 2014, resulting in a positive volume variance of $30,404. This
volume increase was the net result of an increase of 24,103 Bbls for production that began after June 30, 2013, offset by a decline
of 23,750 Bbls from older properties. The average price per Bbl increased $7.54 to $93.67 per Bbl in 2014, resulting in a positive
price variance of $532,231.
The $777,922 (30%) increase in gas sales to
$3,378,998 in 2014 from $2,601,076 in 2013 was the net result of an increase in the average price per thousand cubic feet (MCF),
offset by a decline in the volume sold. The volume of gas sold decreased 25,718 MCF to 719,832 MCF from 745,550 MCF in 2013, for
a negative volume variance of $89,756. The decrease in gas volumes sold was the net result of approximately 206,000 MCF of production
declines from older wells, especially in Arkansas, partially offset by production of approximately 180,000 MCF from wells that
first produced after June 30, 2013. The average price per MCF increased $1.20 to $4.69 per MCF from $3.49 per MCF in 2013, resulting
in a positive price variance of $867,678.
Sales from the Robertson County,
Texas royalty interest properties provided approximately 22% of the Company’s first half 2014 gas sales volumes and
about 27% of the first half 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 19% of the Company’s first half 2014 gas sales volumes and about 33% of the first
half 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 $391,413 in 2014 as compared to $133,508 in 2013.
The Company received lease bonuses
of $614,894 in the first half of 2014 for leases on its owned minerals. Lease bonuses for the first half of 2013 were
$157,033. In 2014, 89% of the bonuses were for leases on owned minerals in Texas and the remainder were for owned minerals in
Oklahoma. In 2013, 85% of the bonuses were for Oklahoma leases and 15% were for Texas leases.
Operating Costs and Expenses.
Operating
costs and expenses increased $1,379,533 (32%) to $5,721,656 in 2014 from $4,342,123 in 2013. Material line item changes are discussed
and analyzed in the following paragraphs.
Production Costs.
Production costs
increased $253,051 (18%) to $1,662,489 in 2014 from $1,409,438 in 2013. Lease operating expense and transportation and compression
expense increased $166,619 (15%) to $1,242,344 in 2014 from $1,075,725 in 2013 due primarily to new wells that first produced
after June 30, 2013. Production taxes increased $86,432 (26%) to $420,145 in 2014 from $333,713 in 2013 due primarily to the increased
oil and gas sales revenues described above in the “Operating Revenues” section.
Exploration Costs.
Total exploration
expense increased $921,897 (312%) to $1,217,377 in 2014 from $295,480 in 2013. Dry hole costs increased $553,623 to $556,560 in
2014 from $2,937 in 2013. Geological and geophysical expense increased $368,273 to $660,816 in 2014 from $292,543 in 2013.
The following is a summary as of July 29,
2014, updating both exploration and development activity from December 31, 2013, for the period ended June 30, 2014.
The Company participated with
its 18% working interest in the drilling of three development wells on a Barber County, Kansas prospect. Two of the wells were
completed as commercial gas producers and the third as a commercial oil producer. Three additional development wells will be drilled
on the prospect in 2014. Capitalized costs for the period were $292,262, including $79,042 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. Both wells were completed
as commercial oil and gas producers. Capitalized costs for the period were $175,200, including $5,613 in prepaid drilling costs.
The Company participated with
its 18% working interest in the drilling of a development well on a Woods County, Oklahoma prospect. The well was completed as
a commercial gas producer. Capitalized costs for the period were $131,400, including $54,938 in prepaid drilling costs.
The Company participated with
an 11.8% working interest in the drilling of a development well on a Woods County, Oklahoma prospect. A completion is in progress.
Capitalized costs for the period were $85,775, including $46,579 in prepaid drilling costs.
The Company participated with
its 10.5% working interest in the drilling of an exploratory well on a Cimarron County, Oklahoma prospect. The well was completed
as a dry hole. Costs expensed to dry hole costs were $60,502.
The Company participated with
a 7.5% working interest in the drilling of three horizontal development wells on a Woods County, Oklahoma prospect. Completions
are in progress on all three wells. Capitalized costs for the period were $262,589.
The Company participated with
a 9% working interest in the drilling of two horizontal development wells on a Roger Mills County, Oklahoma prospect. Completions
are in progress on both wells. Capitalized costs for the period were $151,454.
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 third
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 is participating with a 12.8% working interest in a
completion attempt of a shallow zone. Capitalized costs for the period were $83,793, including $9,182 in prepaid drilling costs.
Costs of $482,882 were expensed to dry hole costs.
The Company is participating
with its 10.5% interest in the purchase of a producing oil well and two salt water disposal wells on a Seminole County, Oklahoma
prospect. One of the disposal wells will be recompleted as an oil producer. Previous plans to drill a producing well have been
delayed indefinitely, and the previously planned disposal well will not be drilled since it is no longer needed. Prepaid costs
for the period were $233,897.
The Company participated with
10.7% and 10.3% working interests in the drilling of two development wells and with a 10.3% working interest in an unsuccessful
re-entry and washdown attempt on a Woods County, Oklahoma prospect. One of the wells was completed as a commercial oil and gas
producer and a completion is in progress on the other. The Company will participate with 7% and 10.3% interests in two additional
development wells starting in November 2014. Capitalized costs for the period were $154,552, including $81,325 in prepaid drilling
costs. Costs expensed to dry hole costs for the re-entry were $13,862.
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 participated
in the drilling of an exploratory well. A completion is in progress. Capitalized costs for the period were $49,354.
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. Additional leasehold costs for the period were $24,946.
In July 2014, the Company
agreed to purchase a 14% interest in 160 net acres of leasehold on a Creek County, Oklahoma prospect for $24,500. An exploratory
well will be drilled starting in September 2014.
Depreciation, Depletion, Amortization
and Valuation Provision (DD&A).
DD&A increased $173,833 (10%) to $1,970,126 in 2014 from $1,796,293 in 2013. The
increase was due to an increase of approximately $100,000 in current year depreciation expense on oil and gas properties and
lease impairments of approximately $74,000.
Other Income, Net.
This line item increased
$33,430 (21%) to $195,799 in 2014 from $162,369 in 2013. See Note 2 to the accompanying financial statements for the analysis
of the various components of this line item. Components with significant changes are discussed in the following paragraphs.
Losses on trading securities in 2014 were
$(5,983) as compared to gains of $79,794 in 2013, a decrease of $85,777. In 2014, the Company had realized gains of $18,779 and
unrealized losses of $(24,762) from adjusting the securities to estimated fair market value. In 2013, the Company had realized
losses of $(4,032) and unrealized gains of $83,826.
Other income increased $107,878 to $141,516
in 2014 from $33,638 in 2013. Most of the increase was due to $130,701 of class action lawsuit settlements in 2014 with no similar
amounts in 2013. This increase was offset by a $23,000 decrease in other investment income to $10,000 in 2014 from $33,000 in
2013.
Provision for Income Taxes.
The provision
for income taxes increased $160,666 (13%) to $1,422,642 in 2014 from $1,261,976 in 2013. The increase was due to the higher income
before income taxes of $710,220 (15%) to $5,468,854 in 2014 from $4,758,634 in 2013. Of the 2014 income tax provision, the estimated
current tax expense was $1,623,195 and the estimated deferred tax benefit was $(200,553). Of the 2013 income tax provision, the
current and deferred tax expenses were $556,334 and $705,642, respectively. See Note 4 to the accompanying financial statements
for additional information on income taxes.
Material Changes in Results of Operations
Three Months Ended June 30, 2014, Compared with Three Months Ended June
30, 2013
.
Net income decreased $182,138 (8%) to $2,071,509
in 2014 from $2,253,647 in 2013. The material changes in the results of operations, which caused the decrease in net income, are
discussed below.
Operating Revenues.
Revenues from oil
and gas sales increased $147,568 (3%) to $5,103,967 in 2014 from $4,956,399 in 2013. The increase was the net result of a decrease
in oil sales of $188,890 (5%) to $3,351,947; an increase in gas sales of $269,178 (20%) to $1,625,050; and an increase in sales
of miscellaneous products of $67,280 to $126,970.
The $188,890 decrease in oil sales was the
result of a decrease in the volume of oil sold of 5,460 Bbls to 35,021 Bbls, for a negative volume variance of $477,586, and an
increase in the average price received of $8.24 per Bbl to $95.71, for a positive price variance of $288,696.
The $269,178 increase in gas sales was the
result of an increase in the volume of gas sold of 11,532 MCF, for a positive volume variance of $45,897, and an increase in the
average price of $0.63 per MCF to $4.61, for a positive price variance of $223,281.
Other operating revenues increased $278,988
(206%) to $414,592 in 2014 from $135,604 in 2013. This increase was due to an increase in lease bonuses for minerals in various
Oklahoma and Texas Counties of $278,988 to $413,952 in 2014 from $134,964 in 2013. Coal royalties of $640 were received in 2014
and 2013.
Production Expense.
Production expense
increased $135,956 (20%) to $817,889 in 2014 from $681,933 in 2013. Lease operating expense and transportation and compression
expense increased $99,225 to $609,877 in 2014 from $510,652 in 2013. Production taxes increased $36,731 to $208,012 in 2014 from
$171,281 in 2013.
Other Income, Net.
This line item increased
$103,353 (96%) to $211,357 in 2014 from $108,004 in 2013. See Note 2 to the accompanying financial statements for an analysis
of the components of other income, net. Components with significant changes are discussed in the following paragraphs.
Other income increased $103,167 to $133,586
in 2014 from $30,419 in 2013. Most of the increase was due to $123,186 of class action lawsuit settlements in 2014 with no similar
amounts in 2013. This increase was offset by a $20,000 decrease in other investment income to $10,000 in 2014 from $30,000 in
2013.
Provision for Income Taxes.
Provision
for income taxes decreased $133,776 (15%) to $744,695 in 2014 from $878,471 in 2013. See discussion above in “Item 2.”
and Note 4 to the accompanying financial statements for a discussion of the changes in the provision for income taxes.
There were no additional material changes
between the quarters, which were not covered in the discussion in “Item 2.” above, for the six months ended June 30,
2014.
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.