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 2018 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 2018 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 because of new information, future developments, or otherwise. 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 2019, 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 $692,487 and cash provided by the maturities of available-for-sale debt securities of $2,473,604 for total cash provided of $3,166,091. The Company utilized cash for the purchase of available-for-sale debt securities of $5,926,812, property additions of $570,260, other investment activity of $1,867 and financing activities of $70,028 for total cash applied of $6,568,967. Cash and cash equivalents decreased $3,402,876 (53%) to $3,025,623.
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, 2018. A discussion of these items follows.
Equity securities increased $89,044 (20%) to $543,102 as of March 31, 2019 from $454,058 at December 31, 2018. The increase was the result of a $150,324 increase in the equity securities’ market value offset by $61,280 of net loss from these securities.
Refundable income taxes decreased $16,387. This decrease was due to the $16,387 tax benefit at December 31, 2018 with none at March 31, 2019.
Accounts payable decreased $150,355 (47%) to $168,032 as of March 31, 2019 from $318,387 at December 31, 2018 due to a decrease in the drilling and exploration activity at March 31, 2019 versus December 31, 2018.
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 $692,487 in the three months ended March 31, 2019, a decrease of $153,162 (18%) from the comparable period in 2018 of $845,649. The decrease was primarily due to a decrease in lease bonus income. For more information see “Operating Revenues” and “Other Income, Net” below.
Cash applied to the purchase of property additions in the three months ended March 31, 2019 was $570,260, a decrease of $248,334 (30%) from cash applied in the comparable period in 2018 of $818,594. For both 2019 and 2018, 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.
Cash applied to other investments in the three months ended March 31, 2019 was $1,867, a decrease of $46,864 (96%) from cash applied in the comparable period in 2018 of $48,731.
Cash applied to financing activities in the three months ended March 31, 2019 was $70,028, an increase of $6,852 (11%) from cash applied in the comparable period in 2018 of $63,176.
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 2018 Form 10-K would not be representative of the Company’s current position.
Material Changes in Results of Operations Three Months Ended March
31, 2019, Compared with Three Months Ended March
31, 2018
Net income increased $61,741 (23%) to $332,335 in the three months ended March 31, 2019 from $270,594 in the comparable period in 2018. Net income per share, basic and diluted, increased $0.40 to $2.12 in the three months ended March 31, 2019 from $1.72 in the comparable period in 2018.
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 $13,430 (1%) to $1,592,711 in the three months ended March 31, 2019 from $1,579,281 in 2018. Of the $13,430 increase, crude oil sales increased $1,145; natural gas sales increased $23,839; and miscellaneous oil and gas product sales decreased $11,554.
The $1,145 increase in oil sales to $981,931 in the three months ended March 31, 2019 from $980,786 in the comparable period in 2018 was the net result of a decrease in the average price per barrel (Bbl) offset by an increase in the volume sold. The volume of oil sold increased 2,077 Bbls to 18,744 Bbls in the three months ended March 31, 2019, resulting in a positive volume variance of $122,231 compared to the comparable period in 2018. The average price per Bbl decreased $6.46 to $52.39 per Bbl in the three months ended March 31, 2019, resulting in a negative price variance of $121,086 compared to the comparable period in 2018. The increase in oil volumes sold was due to production of 3,600 Bbls from new wells partially offset by production declines from older wells.
The $23,839 (4%) increase in gas sales to $565,112 in the three months ended March 31, 2019 from $541,273 in the comparable period in 2018 was the net result of an increase in the average price per thousand cubic feet (MCF) offset by a decrease in the volume sold. The volume of gas sold decreased 6,545 MCF to 192,133 MCF in the three months ended March 31, 2019 from 198,678 MCF in the comparable period in 2018, for a negative volume variance of $17,802 compared to the comparable period in 2018. The average price per MCF increased $0.22 to $2.94 per MCF in the three months ended March 31, 2019 from $2.72 per MCF in the comparable period in 2018, resulting in a positive price variance of $41,641 compared to the comparable period in 2018. The decrease in gas volumes sold was due to production of 9,700 MCF from new wells offset by production declines from older wells.
Sales from the Robertson County, Texas royalty interest properties provided approximately 32% of the Company’s gas sales volumes for the three months ended March 31, 2019 and 29% of the gas sales volumes for the comparable period in 2018. See discussion on page 11 of the 2018 Form 10-K under the subheading “Operating Revenues” for more information about these properties. Sales from Arkansas working interest properties provided approximately 12% of the Company’s gas sales volumes for the three months ended March 31, 2019 and about 11% of the gas sales volumes for the comparable period in 2018.
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 $45,668 in the three months ended March 31, 2019 compared to $57,222 in the comparable period in 2018.
The Company received lease bonuses of $7,528 in the three months ended March 31, 2019 for leases on its owned minerals compared to $145,862 in the comparable period in 2018.
Operating Costs and Expenses.
Operating costs and expenses decreased $211,651 (14%) to $1,249,627 in the three months ended March 31, 2019 from $1,461,278 in the comparable period in 2018.
Production Costs.
Production costs decreased $48,060 (8%) to $558,707 in the three months ended March 31, 2019 from $606,767 in the comparable period in 2018. This decrease was primarily the result of a decrease of $53,000 in lease operating expenses.
Exploration Costs.
Total exploration expense decreased $74,426 (96%) to $3,219 in the three months ended March 31, 2019 from $77,645 in the comparable period in 2018. The decrease was due to a decrease of $109,484 in geological and geophysical expenses, offset by an increase in other expenses of $35,058.
The following is a summary as of May 3, 2019, updating both exploration and development activity from December 31, 2018, for the period ended March 31, 2019.
The Company is participating with a 9.5% working interest in the completion of a development well on a Woods County, Oklahoma prospect. The well was drilled in 2018. Capitalized costs for the period were $37,762.
The Company is participating with its 14% interest in the acquisition of additional leasehold on a Creek County, Oklahoma 3-D seismic prospect. It is likely that one or more exploratory wells will be drilled on the prospect in 2019. Leasehold costs for the period were $1,458.
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 and its partners have entered into an agreement whereby a third party would drill two strat tests on the prospect, earning the option to drill three additional wells, purchase a 50% interest in the acreage and conduct a thermal recovery pilot test. The strat tests have been drilled and the third party has decided to proceed with the drilling of the additional wells.
The Company is participating with a 13% interest in a 3-D seismic prospect covering approximately 35,000 acres in San Patricio County, Texas. A 3-D seismic survey of the prospect area has been completed and thirteen prospects have been identified. An exploratory well was drilled on one prospect, resulting in a commercial oil and gas producer that is awaiting pipeline connection. Lease acquisition is in progress on seven prospects, and additional exploratory drilling is planned this year. Leasehold costs for the period were $4,138. Actual drilling costs of $140,384 for the period were offset by prepaid costs from 2018 for a net capitalized amount of $0.
The Company has been participating with a 50% interest in an attempt to develop shallow oil prospects in the Permian Basin. Lease acquisition is in progress on one prospect in Crane County, Texas. The Company will sell a portion of its interest prior to any drilling. Leasehold costs were $2,019 for the period.
The Company participated with its 16% working interest in the drilling of an exploratory well on a Barber County, Kansas prospect. The well has been completed and is being tested. Capitalized costs for the period were $57,133.
In October 2018, the Company entered into an agreement to acquire mineral rights in Tyler, Doddridge and Ritchie Counties, West Virginia. The Company is funding the acquisition of the mineral rights which will then be sold to a third party for a profit, with the Company retaining an interest in the minerals. Costs for the period were $198,186.
The Company is participating with its 10.5% working interest in the completion of an exploratory well on an Oldham County, Texas prospect. The well was drilled in 2018. Capitalized costs for the period were $144,160, including $13,125 of additional leasehold costs.
The Company participated with 17.1% and 17.5% working interests in successful recompletions of two wells on a McClain County, Oklahoma prospect. Capital costs for the period were $15,596.
Depreciation, Depletion, Amortization and Valuation Provision (DD&A).
DD&A decreased $91,491 (28%) to $234,841 in the three months ended March 31, 2019 from $326,332 in the comparable period in 2018. The decrease was due primarily to revisions in reserve estimates and $44,700 less impairment of non-producing leaseholds for 2019 versus 2018.
Other Income, Net.
This line item increased $50,159 (55%) to $140,558 in the three months ended March 31, 2019 from $90,399 in the comparable period in 2018. See Note 2 to the accompanying financial statements for the various components of this line item.
Income Tax Provision.
Income tax provision increased $75,165 (90%) to $158,835 in the three months ended March 31, 2019 from $83,670 in the comparable period in 2018. The increase was due to an increase in Income Before Income Tax Provision of $136,906 (39%) to $491,170 as compared to $354,264 in the comparable period in 2018. See Note 4 to the accompanying financial statements for additional information on income taxes.
Off-Balance Sheet Arrangement
The Company’s off-balance sheet arrangements relate to Broadway Sixty-Eight, LLC, an Oklahoma limited liability company, and Grand Woods Development, LLC, an Oklahoma limited liability company. The Company does not have actual or effective control of these entities. Management of these entities could at any time make decisions in their own best interest, which could materially affect the Company’s net income or the value of the Company’s investment. For more information about these entities and the related off-balance sheet arrangements, see Note 3 to the accompanying financial statements.