The Company is affiliated by common management and ownership with Mesquite Minerals, Inc. (Mesquite), Mid-American Oil Company (Mid-American) and Lochbuie Limited
Liability Company (LLTD). The Company also owns interests in certain producing and non-producing oil and gas properties as tenants in common with Mesquite, Mid-American and LLTD.
The Company has a 33% partnership interest in Broadway Sixty-Eight, Ltd. (the “Partnership”), which it accounts for on the equity method. In using the equity method, the Company records the original investment in an entity as an asset and adjusts the asset balance for the Company
’s share of any income or loss, as well as any additional contributions to or distributions from the entity. The Company does not have actual or effective control of the Partnership. The management of the Partnership could, at any time, make decisions in their own best interests that could affect the Company’s net income or the value of the Company’s investment. The Company’s investment in the Partnership totaled $171,243 and $187,380 at December 31, 2017 and 2016, respectively.
The Partnership has an indemnity agreement under which the Company is contingently liable. See Item 8, Note 7 to the accompanying financial statements for related disclosures and additional information regarding Broadway Sixty-Eight, Ltd.
OKC Industrial Properties (“OKC”), 10%, $56,164, acquired in 1992. OKC originally owned approximately 260 acres of undeveloped land in north Oklahoma City and over time has sold all but approximately
46 acres.
Bailey Hilltop Pipeline (“Bailey”), 10%, $80,377, acquired in 2008. Bailey is a gas gathering system pipeline for the Bailey Hilltop Prospect oil and gas properties in Grady County, Oklahoma.
LIQUIDITY AND CAPITAL RESOURCES
To supplement the following discussion, please refer to the Balance Sheets and the Statements of Cash Flows included in this Form 10-K.
In
2017, as in prior years, the Company funded its business activity through the use of internal sources of capital. For the most part, these internal sources are cash flows from operations, cash, cash equivalents and available-for-sale securities. When cash flows from operating activities are in excess of those needed for other business activities, the remaining balance is used to increase cash, cash equivalents and/or available-for-sale securities. When cash flows from operating activities are not adequate to fund other business activities, withdrawals are made from cash, cash equivalents and/or available-for-sale securities. Cash equivalents are highly liquid debt instruments purchased with a maturity of three months or less. All of the available-for-sale securities are U.S. Treasury Bills.
In
2017, net cash provided by operating activities was $2,771,452. Sales (including lease bonuses), net of production costs, general and administrative costs and income taxes paid were $2,394,688, which accounted for 86% of net cash provided by operations. The remaining components provided 14% of cash flow. In 2017, net cash applied to investing activities was $5,202,162. In 2017, dividend payments and treasury stock purchases totaled $873,334 and accounted for all of the cash applied to financing activities.
Other than cash and
cash equivalents, other significant changes in working capital include the following:
Trading securities
increased $86,229 (18%) to $559,936 in 2017 from $473,707 in 2016. The net increase is due to $48,738 in unrealized gains, which represent the change in the fair value of the securities from their original cost, plus $37,491 of 2017 income.
Refundable income taxes
decreased $209,968 (39%) to $326,830 in 2017 from $536,798 in 2016.
Accounts receivable increased $65,183 (9%) to $829,824 in 2017 from $764,641 in 2016. The increase was due primarily to the use of higher product prices for oil and gas sales accrual estimates for year-end 2017 compared to 2016. Additional information about oil and gas sales for 2017 is included in the “Results of Operations” section that follows.
In 2017, the Company added a note receivable in the amount of $175,000 to provide funding to a cost method investee.
Accounts payable
increased $73,258 (45%) to $235,007 in 2017 from $161,749 in 2016. This increase was primarily due to increased drilling activity.
Discussion of Selected Material Line Items in Cash Flows.
The following is a discussion of material changes in cash flow by activity between the years end
ed December 31, 2017 and 2016. Also, see the discussion of changes in operating results under “Results of Operations” below in this Item 7.
Operating Activities
As noted above, net cash flows provided by operating activities in
2017 were $2,771,452, which, when compared to the $2,776,128 provided in 2016, represents a net decrease of $4,676. The decrease was mostly due to a decrease in lease bonus cash flows of $688,692 that was offset by an increase in oil and gas sales of $682,866. Additional discussion of the significant items follows.
The
$682,866 (13%) increase in cash received from oil and gas sales to $6,029,703 in 2017 from $5,346,837 in 2016 was the result of an increase in oil and gas sales prices partially offset by a decrease in sales volumes. See “Results of Operations” below for a price/volume analysis and the related discussion of oil and gas sales.
Cash received for lease bonuses
decreased $688,692 (79%) to $184,282 in 2017 from $872,974 in 2016.
The 2017 cash distribution from our equity investment in Broadway Sixty-Eight, Ltd. of $
49,500 was primarily for our share of operating profits. The 2016 cash distribution of $165,000 included our share of operating profits plus the profits from the sale of the last small office building on some land adjacent to our current office building. See Item 8, Note 7 to the accompanying financial statements for additional information regarding Broadway Sixty-Eight, Ltd.
Investing Activities
Net cash applied to investing activities decreased $2,428,826 (32%) to $5,202,162 in 2017 from $7,630,988 in 2016. This $2,428,826 decrease was due primarily to a $1,873,676 decrease in net cash applied to the purchase of available-for-sale securities, a $1,023,556 decrease in purchases of equity and other investments and a $290,000 increase in cash distributions from other investments offset by a $710,580 increase in purchase of property, plant and equipment. See “Equity and Other Investments” discussion on pages 8 and 9 for additional information regarding the investments purchased in 2017 and 2016.
Financing Activities
Cash applied to financing activities
decreased $137,167 (14%) to $873,334 in 2017 from $1,010,501 in 2016. Cash applied to financing activities consist of cash dividends on common stock and cash used for the purchase of treasury stock. In 2017, cash dividends paid on common stock amounted to $837,505 as compared to $921,667 in 2016. Dividends of $5.00 per share were paid in 2017 and 2016. Cash applied to purchase treasury stock decreased $53,005 to $35,829 in 2017 from $88,834 in 2016.
Forward-Looking Summary
T
he Company’s latest estimate of business to be done in 2018 and beyond indicates the projected activity can be funded from cash flow from operations and other internal sources, including net working capital. The Company is engaged in exploratory drilling. If this drilling is successful, substantial development drilling may result. Also, should other exploration projects which fit the Company’s risk parameters become available or other investment opportunities become known, capital requirements may be more than the Company has available. If so, external sources of financing could be required.
RESULTS OF OPERATIONS
As disclosed in the Statements of
Operations in Item 8 of this Form 10-K, in 2017 the Company had net income of $685,687 as compared to net loss of $(84,225) in 2016. Net income/(loss) per share, basic and diluted, was $4.35 in 2017, an increase of $4.88 per share from $(0.53) in 2016. Material line item changes in the Statements of Operations will be discussed in the following paragraphs.
Operating Revenues
Operating revenues
increased $18,452 to $6,309,590 in 2017 from $6,291,138 in 2016. Oil and gas sales increased $707,144 (13%) to $6,125,308 in 2017 from $5,418,164 in 2016. Lease bonuses and other revenues decreased $688,692 (79%) to $184,282 in 2017 from $872,974 in 2016. The increase in oil and gas sales is discussed in the following paragraphs.
The
$707,144 increase in oil and gas sales was the result of a $234,193 increase in gas sales, a $426,328 increase in oil sales and a $46,623 increase in miscellaneous oil and gas product sales. The following price and volume analysis is presented to explain the changes in oil and gas sales from 2016 to 2017. Miscellaneous oil and gas product sales of $206,593 in 2017 and $159,970 in 2016 are not included in the analysis.
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Variance
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Production
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201
7
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Price
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Volume
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201
6
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Gas
–
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MCF (000 omitted)
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806
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|
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|
|
|
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(165)
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|
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971
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$
(000 omitted)
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$
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2,346
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|
|
$
|
592
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|
|
$
|
(358)
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|
|
$
|
2,112
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|
Unit Price
|
|
$
|
2.91
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|
|
$
|
.74
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|
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|
|
|
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$
|
2.17
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Oil
–
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Bbls (000 omitted)
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77
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(8)
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|
|
|
85
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$
(000 omitted)
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|
$
|
3,572
|
|
|
$
|
732
|
|
|
$
|
(306)
|
|
|
$
|
3,146
|
|
Unit Price
|
|
$
|
46.42
|
|
|
$
|
9.52
|
|
|
|
|
|
|
$
|
36.90
|
|
The
$234,193 (11%) increase in natural gas sales to $2,346,272 in 2017 from $2,112,079 in 2016 was the result of a decrease in gas sales volumes offset by an increase in the average price received per thousand cubic feet (MCF). The average price per MCF of natural gas sales increased $0.74 per MCF to $2.91 per MCF in 2017 from $2.17 per MCF in 2016, resulting in a positive gas price variance of $591,953. A negative volume variance of $357,759 was the result of a decrease in natural gas volumes sold of 164,866 MCF to 806,575 MCF in 2017 from 971,441 MCF in 2016. The decrease in the volume of gas production was the net result of new 2017 production of about 30,000 MCF, offset by a decline of about 194,000 MCF in production from previous wells. About 29,000 MCF (19%) of this decline is from working interest wells in Robertson County, Texas, and another decline of about 43,000 MCF (28%) occurred in working interest wells in Woods County, Oklahoma. As disclosed in Supplemental Schedule 1 of the Unaudited Supplemental Financial Information included in Item 8 below, working interests in natural gas extensions and discoveries were not adequate to replace working interest reserves produced in 2017 or 2016.
The gas production for
2017 and 2016 includes production from about 100 royalty interest properties drilled by various operators in Robertson County, Texas. These properties accounted for approximately 187,000 MCF and $544,000 of the 2017 gas sales and approximately 216,000 MCF and $468,000 of the 2016 gas sales. These properties accounted for about 23% of the Company’s gas revenues in 2017 and 2016. The Company has no control over the timing of future drilling on the acreage in which we hold mineral interests.
The
$426,328 (14%) increase in crude oil sales to $3,572,443 in 2017 from $3,146,115 in 2016 was the net result of an increase in the average price per barrel (Bbl) offset by a decrease in oil sales volumes. The average price received per Bbl of oil increased $9.52 to $46.42 in 2017 from $36.90 in 2016, resulting in a positive oil price variance of $732,088. A decline in oil sales volumes of 8,286 Bbls to 76,965 Bbls in 2017 from 85,251 Bbls in 2016 resulted in a negative volume variance of $305,760. The decrease in the oil volume production was the net result of new 2017 production of about 4,000 Bbls, offset by a 13,000 Bbl decline in production from previous wells. Of the new 2017 production, approximately 1,200 Bbls (30%) was from new working interest wells in Woods County, Oklahoma. As disclosed in Supplemental Schedule 1 of the Unaudited Supplemental Financial Information included below in Item 8, working interests in oil extensions and discoveries were not adequate to replace working interest reserves produced in 2017 or 2016.
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.
Operating Costs and Expenses
Operating costs and
expenses decreased $42,735 (1%) to $6,827,906 in 2017 from $6,870,641 in 2016, primarily due to a decrease in depreciation, depletion and amortization expense. The material components of operating costs and expenses are discussed below.
Production Costs.
Production costs increased $49,264 (2%) to $2,190,020 in 2017 from $2,140,756 in 2016. The net increase was primarily the result of a $69,642 (32%) increase in gross production tax to $285,688 in 2017 from $216,046 in 2016, offset by a decrease in other production costs of $29,195 (7%) to $396,238 in 2017 from $425,433 in 2016. Of the decrease in other production costs, $46,995 was the result of decreased expenses for existing wells offset by $17,800 of expenses for new wells. Gross production taxes are state taxes, which are calculated as a percentage of gross proceeds from the sale of products from each producing oil and gas property; therefore, they fluctuate with the change in the dollar amount of revenues from oil and gas sales.
Exploration and Development Costs.
Under the successful efforts method of accounting used by the Company, geological and geophysical costs are expensed as incurred as are the costs of unsuccessful exploratory drilling. The costs of successful exploratory drilling and all development costs are capitalized. Total costs of exploration and development, excluding asset retirement obligations but inclusive of geological and geophysical costs, were $2,251,662 in 2017 and $1,110,426 in 2016. See Item 8, Note 8 to the accompanying financial statements for a breakdown of these costs. Exploration costs charged to operations were $883,593 in 2017 and $429,210 in 2016, inclusive of unsuccessful exploratory well costs of $630,219 in 2017 and $253,460 in 2016, and geological and geophysical costs of $243,251 in 2017 and $175,749 in 2016.
Update of Oil and Gas Exploration and Development Activity from December
31,
201
6
.
For the year ended December 31, 2017, the Company participated in the drilling of 14 gross exploratory working interest wells and 3 gross development working interest wells, including 2 in progress at the end of 2016, with working interests ranging from a high of 16% to a low of 8%. Of the 14 exploratory wells, 4 were completed as producing wells, 7 as dry holes and 3 were in progress. The 3 development wells were completed as producing wells.
The following is a summary as of March
7, 2018, updating both exploration and development activity from December 31, 2016, for the period ended December 31, 2017.
The Company participated with 8% and 16% working interests in the completion of two development wells that were drilled in 2016 on a Woods County, Oklahoma prospect. Both wells are commercial oil and gas producers. Capitalized costs for the period were $50,195.
The Company participated with an 11.1% working interest in the drilling of a development well on a Woods County, Oklahoma prospect. The well was completed as a commercial oil and gas producer. Capitalized costs for the period were $
60,927.
The Company participated with its 8.4% working interest in the drilling of an exploratory well on a Thomas County, Kansas prospect. The well was completed as a marginal oil producer. An additional exploratory well will be drilled on the prospect starting in March 2018. Capitalized costs for the period were $27,214.
The Company participated with its 10.5% working interest in the drilling of an exploratory well on a Thomas County, Kansas prospect. The well was completed as a dry hole. An additional exploratory well will be drilled on the prospect starting in March 2018. Dry hole costs for the period were $24,292.
The Company participated with its 18% working interest in the drilling of two step-out wells (one a re-entry) on a Kiowa County, Kansas prospect. A completion is in progress on one well and the other is awaiting completion. Prepaid drilling costs for the period were $131,400.
The Company is participating with its 14% interest in the development of a Hansford County, Texas prospect for waterflooding. Of five planned injection wells, three have been drilled, completed and are injecting water, one has been drilled and completed with water injection to commence shortly and one missed the reservoir and was plugged. There are two producing wells. A water supply well has been drilled and completed and facilities construction is complete. Capitalized costs for the period were $563,458.
The Company participated with its 14% working interest in the drilling of two exploratory wells and a salt water disposal well on a Creek County, Oklahoma prospect. One exploratory well was completed as a marginal oil producer and the other as a commercial oil producer. Capitalized costs for the period were $67,473.
The Company participated with its 16% working interest in the drilling of an exploratory well on a Chase County, Nebraska prospect. The well was completed as a dry hole. Dry hole costs for the period were $64,402.
The Company owns a 35% interest in 16,472.55 net acres of leasehold on a Crockett and Val Verde Counties, Texas prospect. The Company is participating in the development of the prospect and is currently engaged in efforts to sell a portion of its interest.
The Company participated with its 14% working interest in the drilling of an exploratory well on a Lavaca County, Texas prospect. The well was completed as a dry hole. Dry hole costs for the period were $245,212.
The Company participated with a 35% interest in the development of a Crockett County, Texas prospect on which 4,882.5 net acres of leasehold have been acquired. A geologic study of the prospect area has been completed and the Company has sold a portion of its leasehold rights, leaving it with a 12.25% interest. An exploratory well has been drilled on the prospect and a completion is in progress. Capitalized costs for the period, excluding leasehold, were $22,221. Total leasehold and geologic costs to date for the prospect are $22,856.
The Company participated with its 14% interest in a 3-D seismic survey and in the drilling of an exploratory well on a Hodgeman County, Kansas prospect. The well was completed as a dry hole. Dry hole costs for the period were $46,768.
In January 2017, the Company purchased a 14% interest in 2,443.84 net acres of leasehold on a Leflore County, Oklahoma prospect for $119,748. The Company participated in the drilling of an exploratory well on the prospect that was completed as a dry hole. Dry hole costs for the period were $123,515.
In March 2017, the Company purchased a 16% interest in 587.6 net acres of leasehold on a Harvey County, Kansas prospect for $7,521. A 3-D seismic survey of the prospect area was conducted and an exploratory well was drilled. It was completed as a dry hole. Seismic costs for the period were $8,625 and dry hole costs were $24,879.
In March 2017, the Company agreed to purchase a 13% interest in a 3-D seismic prospect covering approximately 35,000 acres in San Patricio County, Texas. The Company
’s share of land and seismic costs is estimated to be $646,000 over a two-year period. A 3-D seismic survey of the prospect area has been conducted and the data set is being processed. Exploratory drilling should start sometime in 2018. Capitalized costs for the period were $299,549 and seismic costs were $215,504.
In March 2017, the Company paid $8,800 for a 16% interest in 429.36 net acres of leasehold and a producing well on a Comanche County, Kansas prospect. A re-completion attempt of the producing well has been unsuccessful and it is under evaluation. Additional capitalized costs for the period were $26,012.
In May 2017, the Company purchased a 10.5% interest in 460.27 net acres of leasehold on a Lea County, New Mexico prospect for $26,580. An exploratory well has been drilled on the prospect and a completion is in progress. Capitalized costs for the period were $259,022.
Starting in June 2017, the Company purchased a 10.5% interest in 3,088.44 net acres of leasehold on a Coke County, Texas prospect for $96,003. An exploratory well was drilled on the prospect. A completion attempt was unsuccessful and the well will be plugged. Dry hole costs for the period were $92,815.
In September 2017, the Company agreed to take a 7% interest in a Summit County, Utah prospect and to participate in the drilling of an exploratory well on the prospect. The well is in progress. Capitalized costs for the period were $67,956.
In December 2017, the Company purchased an 11.2% interest in eleven wells and associated leasehold on a Tyler County, Texas prospect for $56,560 and paid $19,694 in prepaid workover costs. Workovers are in progress on several of the wells and others are planned in an effort to increase production.
Depreciation, Depletion, Amortization and Valuation Provisions (DD&A).
Major DD&A components are the provision for impairment of undeveloped leaseholds, provision for impairment of long-lived assets, depletion of producing leaseholds and depreciation of tangible and intangible lease and well costs. Undeveloped leaseholds are amortized over the life of the leasehold (most are 3 years) using a straight line method, except when the leasehold is impaired or condemned by drilling and/or geological interpretation of seismic data; if so, an adjustment to the provision is made at the time of impairment. The provision for impairment of undeveloped leaseholds was $363,431 in 2017 and $390,584 in 2016. The 2017 provision was due to the annual amortization of undeveloped leaseholds. The 2016 provision was due to the annual amortization of undeveloped leaseholds of $334,831 and specific leasehold impairments of $55,753.
As discussed in
Item 8, Note 10 to the accompanying financial statements, accounting principles require the recognition of an impairment loss on long-lived assets used in operations when indicators of impairment are present. Impairment evaluation is a two-step process. The first step is to measure when the undiscounted cash flows estimated to be generated by those assets, determined on a well basis, is less than the assets’ carrying amounts. Those assets meeting the first criterion are adjusted to estimated fair value. Evaluation for impairment was performed in both 2017 and 2016. The 2017 impairment loss was $426,823 and the 2016 impairment loss was $727,845. The $301,022 decrease in impairments in 2017 was mainly due to fairly stable oil and natural gas prices.
The depletion and depreciation of oil and gas properties are computed by the units-of-production method. The amount expensed in any year will fluctuate with the change in estimated reserves of oil and gas, a change in the rate of production or a change in the basis of the assets.
The Company did not participate in any horizontal working interest wells in 2016 or 2017. A horizontal well may cost five to eight times as much as a vertically drilled well. In addition, horizontal wells’ initial production rates tend to be greater and their production decline rates are usually higher than in vertical wells. The larger investment in the costlier horizontal wells and the increased production rates result in an increase in depreciation expense. The provision for depletion and depreciation declined $258,914 (16%) to $1,312,058 in 2017 from $1,570,972 in 2016. This decrease is due to the reasons discussed above. The provision also includes $81,035 for 2017 and $113,578 for 2016 for the amortization of the Asset Retirement Costs. See Item 8, Note 2 to the accompanying financial statements for additional information regarding the Asset Retirement Obligation.
Other Income
,
Net.
See Item 8, Note 11 to the accompanying financial statements for an analysis of the components of this line item for 2017 and 2016. Other income, net increased $383,805 (128%) to $683,397 in 2017 from $299,592 in 2016. The line items responsible for this net increase are described below.
Net realized and unrealized gain (loss) on trading securities
increased $21,893 to a net gain of $83,622 in 2017 from a net gain of $61,729 in 2016. Realized gains or losses result when a trading security is sold. Unrealized gains or losses result from adjusting the Company’s carrying amount in trading securities owned at the reporting date to estimated fair value. In 2017, the Company had realized gains of $34,884 and unrealized gains of $48,738. In 2016, the Company had realized losses of $20,430 and unrealized gains of $82,159.
Income from investments
increased $290,000 to $445,000 in 2017 from $155,000 in 2016.
Gains on asset sales
increased $37,560 to $59,683 in 2017 from $22,123 in 2016.
Interest income
increased $84,128 to $130,498 in 2017 from $46,370 in 2016. This increase was the result of a rise in the average interest rate and an increase in the average balance of cash equivalents and average balance of available-for-sale securities from which most of the interest income is derived. The average interest rate increased from 0.33% in 2016 to 0.43% in 2017. The average balance outstanding increased $1,566,628 to $15,412,046 in 2017 from $13,845,418 in 2016.
Provision for Income Taxes.
In 2017, the Company had an estimated income tax benefit of $582,582 as the result of a deferred tax benefit of $593,111, offset by a current tax provision of $10,529. The deferred tax benefit of $593,111 includes a $577,797 deferred tax benefit adjustment due to a decrease in the federal income tax rate at the end of 2017. In 2016, the Company had an estimated income tax benefit of $172,886 as the result of a current tax benefit of $57,676, plus a deferred tax benefit of $115,210. See Item 8, Note 6 to the accompanying financial statements for an analysis of the various components of income taxes and a discussion of the federal tax rate change.