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, 2015 as filed with the Securities and Exchange Commission (hereinafter, the “2015 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 2015 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 2016, 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 $349,090 and proceeds from sale of property of $5,840. The Company utilized cash for property additions of $695,814 and financing activities of $177,853 for total cash applied of $867,827. Cash and cash equivalents decreased $518,737 to $13,418,478.
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, 2015. A discussion of these items follows.
Receivables declined $174,399 (27%) to $470,469 from $644,868. This decrease was due entirely to lower oil and gas sales receivables. Sales variances are discussed in the “Results of Operations” section below.
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 $349,090 in 2016, a decrease of $2,143,298 (86%) from the comparable period in 2015. The decrease was primarily the result of decreased oil and gas sales. For more information see “Operating Revenues” and “Operating Costs and Expenses” below.
Cash applied to the purchase of property additions in 2016 was $695,814, a decrease of $216,049 (24%) from cash applied in 2015 of $911,863. For both 2016 and 2015, cash applied to property additions was mostly related to oil and gas exploration and development activity. The decrease in property additions for 2016 is mostly due to a decline in the exploration and development drilling activity in the first quarter of 2016 versus 2015. 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 2015 Form 10-K would not be representative of the Company’s current position.
Material Changes in Results of Operations Three Months Ended March
31, 201
6
, Compared with Three Months Ended March
31, 201
5
Net income decreased $638,331 to a loss of $(620,855) in 2016 from income of $17,476 in 2015. Net income per share, basic and diluted, decreased $4.03 to a loss of $(3.92) in 2016 from income of $0.11 in 2015.
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 $1,107,411 (51%) to $1,045,537 in 2016 from $2,152,948 in 2015. Of the $1,107,411 decrease, crude oil sales decreased $705,822; natural gas sales decreased $376,810; and miscellaneous oil and gas product sales decreased $24,779.
The $705,822 (55%) decrease in oil sales to $574,064 in 2016 from $1,279,886 in 2015 was the result of a decrease in the average price per barrel (Bbl) and the volume sold. The volume of oil sold decreased 6,542 Bbls to 21,764 Bbls in 2016, resulting in a negative volume variance of $295,829. The average price per Bbl decreased $18.84 to $26.38 per Bbl in 2016, resulting in a negative price variance of $409,993. The decrease in oil volumes sold was mostly due to production declines from older wells partially offset by production of 1,819 Bbls from new wells.
The $376,810 (46%) decrease in gas sales to $442,942 in 2016 from $819,752 in 2015 was the result of a decrease in the average price per thousand cubic feet (MCF) and the volume sold. The volume of gas sold decreased 41,959 MCF to 249,415 MCF in 2016 from 291,374 MCF in 2015, for a negative volume variance of $117,905. The decrease in gas volumes sold was mostly due to production declines from older wells partially offset by production of 19,795 MCF from new wells. The average price per MCF decreased $1.03 to $1.78 per MCF in 2016 from $2.81 per MCF in 2015, resulting in a negative price variance of $258,905.
Sales from the Robertson County, Texas royalty interest properties provided approximately 21% of the Company’s first quarter gas sales volumes for 2016 and 2015. See discussion on page 11 of the 2015 Form 10-K under the subheading “Operating Revenues” for more information about these properties. Sales from Arkansas working interest properties provided approximately 13% of the Company’s first quarter 2016 gas sales volumes and about 16% of the first quarter 2015 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 $28,531 in 2016 compared to $53,310 in 2015.
The Company received lease bonuses of $1,529 in the first quarter of 2016 for leases on its owned minerals. Lease bonuses for the first quarter of 2015 were $535,214.
Operating Costs and Expenses
.
Operating costs and expenses decreased $785,032 (28%) to $2,068,697 in 2016 from $2,853,729 in 2015.
Production Costs.
Production costs decreased $159,535 (23%) in 2016 to $531,321 from $690,856 in 2015. This decrease was due to lower production taxes as a result of decreased oil and gas sales revenue and lower lease operating expense due to decreased activity and revenue. Production taxes declined $33,327 (43%) to $44,993 in 2016 from $78,320 in 2015. Lease operating expense declined $126,208 (21%) to $486,328 from $612,536 in 2015.
Exploration Costs.
Total exploration expense decreased $52,238 (35%) to $97,912 in 2016 from $150,150 in 2015. The net decrease was due to an increase in geological and geophysical expense of $98,419 to $99,473 in 2016 from $1,054 in 2015, offset by a decrease of $150,656 in dry hole costs.
The following is a summary as of April 29, 2016, updating both exploration and development activity from December 31, 2015, for the period ended March 31, 2016.
The Company participated with 10.3% and 10.7% working interests in the completion of two development wells on a Woods County, Oklahoma prospect. The wells were drilled in 2015. Both wells are commercial producers, one gas and the other oil and gas. Capitalized costs for the period were $26,819.
The Company participated with its 8.4% interest in the acquisition of additional 3-D seismic data on a Thomas County, Kansas prospect. Processing and interpretation of the data are in progress and will be followed by decisions about exploratory drilling.
The Company participated with its 10.5% interest in a 3-D seismic survey on a Thomas County, Kansas prospect. The data has been processed and is being interpreted. Decisions about exploratory drilling will follow.
The Company participated with its 16% working interest in the drilling of a step-out well on a Chase County, Nebraska prospect. The well was completed as a commercial oil producer. Capitalized costs for the period were $40,954.
The Company will participate with its 14% interest in the development of a Hansford County, Texas prospect for waterflooding. Development plans have been delayed by low oil prices, but drilling should commence in the second half of 2016. Capitalized costs for the period were $2,591.
In February and March 2016, the Company purchased a 16% interest in 12,623.82 net acres of leasehold on a Chase County, Nebraska prospect for $156,535 and paid $94,057 in seismic costs. A 3-D seismic survey of the prospect is in progress.
In March 2016, the Company purchased a 35% interest in 16,472.55 net acres of leasehold on a Crockett and Val Verde Counties, Texas prospect for $345,923. The Company is participating in the development of the prospect and a geologic study of the prospect area is underway. The Company will sell a majority of its interest prior to any exploratory drilling.
In April 2016, the Company purchased a 14% interest in three prospects in Okfuskee and Seminole Counties, Oklahoma for $57,415. An exploratory well will be drilled on each of the prospects starting in May or June 2016.
In April 2016, the Company agreed to purchase a 14% interest in 640 net acres of leasehold and 3-D seismic data on a Lavaca County, Texas prospect for $49,000. An exploratory well will be drilled on the prospect starting in June 2016.
Depreciation, Depletion, Amortization and Valuation Provision (DD&A).
DD&A decreased $556,625 (35%) to $1,013,725 in 2016 from $1,570,350 in 2015. The decrease was due primarily to a $509,004 decline in depreciation and lease impairment expense. This decrease is due to lower oil and gas sales volumes and a lower depreciable asset base. Oil sales volumes declined 23% and gas sales volumes declined 14% for the three months ended March 31, 2016, compared with the three months ended March 31, 2015. The lower depreciable asset base is a result of the $3,726,267 of long-lived asset impairment losses for fiscal 2015 and an additional $508,964 of impairment losses for the three months ended March 31, 2016. The impairment losses for 2016 and 2015 are due to lower oil and natural gas futures prices. See Note 10 – LONG-LIVED ASSETS IMPAIRMENT LOSS on page 29 of the 2015 Form 10-K for a description of the impairment loss calculation.
Other Income, Net
.
This line item increased $63,960 to a gain of $66,693 in 2016 from a gain of $2,733 in 2015. See Note 2 to the accompanying financial statements for the analysis of the various components of this line item.
Trading securities losses in 2016 were $(23,244) compared to losses of $(5,995) in 2015, a decrease of $17,259. In 2016, the Company had realized losses of $(3,920) and unrealized losses of $(19,324) from adjusting the securities to estimated fair market value. In 2015, the Company had realized losses of $(1,092) and unrealized losses of $(4,903).
Earnings from Equity Investments increased $59,635 to $71,718 from $12,083 in 2015. The increase was due primarily to $55,000 of income from Grand Woods Development, LLC.
Income Tax
Provision
/(Benefit
).
Income taxes decreased $153,773 to a $(334,083) tax benefit in 2016 from a $(180,310) tax benefit in 2015. The decrease was due to an increase in loss before income taxes of $(792,104) to $(954,938) in 2016 from $(162,834) in 2015. Of the 2016 income tax benefit, the estimated current tax benefit was $(34,028) and the estimated deferred tax benefit was $(300,055). Of the 2015 income tax benefit, the current tax expense and deferred tax benefit were $344,423 and $(524,733), 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.