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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 2019 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 7 of the 2019 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
COVID-19
In March 2020, the World Health Organization declared the COVID-19 outbreak a pandemic. Governments have tried to slow the spread of the virus by imposing social distancing guidelines, travel restrictions and stay-at-home orders, which have caused a significant decrease in activity in the global economy and the demand for oil and to a lesser extent natural gas and NGLs. As a result, the price for oil decreased significantly. While oil prices have recovered to a limited degree, there is still ongoing volatility in the market.
We are unable to predict the impact that the ongoing COVID-19 pandemic will have on us, including on our financial position, operating results, liquidity and ability to obtain financing, in future reporting periods, due to numerous uncertainties. These uncertainties include the severity of the virus, the duration of the outbreak, governmental or other actions taken to combat the virus (which could include limitations on our operations or the operations of our customers and vendors and other business partners), operators deciding to slow down, shut in or defer maintenance on producing wells, and the effect that the COVID-19 pandemic will have on the demand for natural gas, NGLs and oil. Drilling and capital expenditures have been greatly reduced
The health of our employees, customers, contractors and vendors, and our ability to meet staffing needs in our operations and certain critical functions, are vital to our operations, and the effect of the pandemic on these persons and our staffing needs cannot be predicted. Currently, our workforce has been largely unaffected. Employees are working in the corporate office with adequate social distancing measures in place, wearing face coverings as needed in common areas and utilizing telework options as needed. We do not anticipate any significant impact on liquidity due to workforce safety. Further, the impacts of a potential worsening of global economic conditions and the continued disruptions to, and volatility in, the credit and financial markets as well as other unanticipated consequences remain unknown. In addition, we cannot predict the impact that COVID-19 will have on our customers, vendors and contractors; however, any material effect on these parties could adversely impact us.
Collectively, these factors have contributed to significant negative global economic impacts, including a significant drop in demand for hydrocarbon products, potentially causing the US and other global economies to fall into a recession that could extend throughout 2020 and beyond. A recession could likely extend the time for the current crude oil markets to absorb excess supplies, resulting in suppressed crude oil prices for a number of future quarters.
Our profitability has been and will likely continue to be significantly affected by this decreased demand and lower commodity price environment. The decline in commodity prices and our future estimated production levels could lead to additional material impairments of our long-lived assets, right of use, equity method investments and right-of-use assets. It is likely that additional impairments could be triggered if the COVID-19 pandemic leads to a continued and sustained reduction in global economic activity and demand for energy. We continue to evaluate all cash management strategies, maintaining conservative choices in short-term investments to protect cash reserves and liquidity.
On March 27, 2020, Congress passed the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act. Included in the act was the Paycheck Protection Program (“PPP”) implemented by the Small Business Administration (“SBA”) to provide small businesses with funds to pay up to eight weeks of payroll costs. Based on the understanding of the guidelines and information provided at the time, the Company applied for and received a PPP loan in the amount of $174,600 from the SBA to cover payroll costs. Subsequent to receiving the funds, the Company evaluated additional guidance issued by the SBA, and on May 7, 2020, the Company repaid the loan in full together with accrued interest.
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 nine months of 2020, 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 $873,884 and cash provided by the maturities of available-for-sale debt securities of $25,082,211. Additional cash of $39,762 was provided by property dispositions and equity method investments for total cash provided of $25,995,857. The Company utilized cash for the purchase of available-for-sale debt securities of $8,079,535; property additions of $1,441,743; other investments activity of $512,415; and financing activities of $783,077 for total cash applied of $10,816,770. Cash and cash equivalents increased $15,179,087 to $17,917,425.
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, 2019. A discussion of these items follows.
Available-for-sale debt securities decreased $17,002,676 (92%) to $1,515,234 as of September 30, 2020 from $18,517,910 at December 31, 2019. The decrease was due to the decision to free up capital for new investments as a result of significant decreases in interest rates.
Refundable income taxes increased $188,596 (171%) to $298,595 as of September 30, 2020 from $109,999 at December 31, 2019. This increase was primarily due to reduced revenues and an increase in long-lived assets impairments for the nine months ended September 30, 2020.
During the period, the Company added a $58,852 note receivable in January and a $39,235 note receivable in July from Grand Woods, LLC, (the LLC), an equity method investee. See Note 4 to the accompanying financial statements for additional information about the investment.
Accounts payable decreased $16,269 (10%) to $140,499 as of September 30, 2020 from $156,768 at December 31, 2019. This decrease was primarily due to a decrease in drilling activity at September 30, 2020 versus December 31, 2019.
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 $873,884 in the nine months ended September 30, 2020, a decrease of $1,300,756 (60%) from the comparable period in 2019. The decrease was primarily due to decreased operating revenues and other income for the nine months ended September 30, 2020 compared to 2019. For more information see “Operating Revenues” and “Operating Costs and Expenses” below.
Cash applied to the purchase of property, plant and equipment in the nine months ended September 30, 2020 was $1,441,743, a decrease of $63,550 (4%) from cash applied in the comparable period in 2019 of $1,505,293. In both 2020 and 2019, cash applied to property, plant and equipment 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 purchase of available-for-sale debt securities in the nine months ended September 30, 2020 was $8,079,535, a decrease of $17,598,460 (69%) from cash applied in the comparable period in 2019 of $25,677,995. The decrease was to provide access to capital for use in other projects and investments as a result of the decreased interest revenue brought on by the depressed interest rates resulting from COVID-19.
Cash applied to other investments in the nine months ended September 30, 2020 was $512,415, an increase of $508,682 from cash applied in the comparable period of 2019 of $3,733. The increase was primarily due to a new $500,000 investment in Genlith, Inc. (“Genlith”), which is approximately 2% ownership. Genlith identifies and structures investments in the new energy economy through corporate ventures, advisory and fund management. For details on other investments, see Note 4 – EQUITY METHOD AND OTHER INVESTMENTS AND RELATED COMMITMENTS AND CONTINGENT LIABILITIES, INCLUDING GUAR-ANTEES.
Cash applied to financing activities in the nine months ended September 30, 2020 was $783,077, a decrease of $394,170 (33%) from cash applied in the comparable period in 2019 of $1,177,247. This category is made up of dividends paid to stockholders and purchase of treasury stock. Dividends decreased from $7.00 per share in 2019 to $5.00 per share in 2020, resulting in a decrease of $301,494 in dividends paid. The Company purchased $92,676 of treasury stock through the nine months ended September 30, 2019, with none in the comparable period of 2020.
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 2019 Form 10-K would not be representative of the Company’s current position.
Material Changes in Results of Operations Nine Months Ended September 30, 2020, Compared with Nine Months Ended September 30, 2019
Net income/(loss) decreased $2,682,555 to a loss of $1,807,136 in the nine months ended September 30, 2020 from income of $875,419 in the comparable period in 2019. Net income/(loss) per share, basic and diluted, decreased $17.12 to a loss of $11.54 in the nine months ended September 30, 2020 from income of $5.58 in the comparable period in 2019.
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 $1,719,943 (36%) to $2,993,027 in the nine months ended September 30, 2020 from $4,712,970 in the comparable period in 2019. The $1,719,943 decrease is due to a decrease in crude oil sales of $1,286,743, natural gas sales of $389,095, and miscellaneous oil and gas product sales of $44,105.
The $1,286,743 (40%) decrease in oil sales to $1,952,859 in the nine months ended September 30, 2020 from $3,239,602 in the comparable period in 2019 was the net result of a decrease in the average price per barrel (Bbl) and a decrease in the volume sold. The average price per Bbl decreased $17.72 to $35.80 per Bbl in the nine months ended September 30, 2020, resulting in a negative price variance of $967,175 compared to 2019. The volume of oil sold decreased 5,701 Bbls to 54,557 Bbls in the nine months ended September 30, 2020, resulting in a negative volume variance of $319,568 compared to 2019. The net decrease in oil volumes sold was due to a decline of 13,400 Bbls during the period from older wells, partially offset by new production of 7,700 Bbls.
The $389,095 (29%) decrease in gas sales to $947,653 in the nine months ended September 30, 2020 from $1,336,748 in the comparable period in 2019 was the net result of a decrease in the average price per thousand cubic feet (MCF) and a decrease in the volume sold. The average price per MCF decreased $0.49 to $1.88 per MCF in the nine months ended September 30, 2020, resulting in a negative price variance of $246,160 compared to 2019. The volume of gas sold decreased 60,310 MCF to 503,928 MCF in the nine months ended September 30, 2020, resulting in a negative volume variance of $142,935 compared to 2019. The net decrease in gas volumes sold was due to production declines from older wells, partially offset by production of 15,000 MCF from several new working and royalty interest wells. Second quarter shut-ins contributed to the decrease in volumes for both oil and gas.
Sales from the Robertson County, Texas royalty interest properties provided approximately 28% of the Company’s gas sales volumes for the nine months ended September 30, 2020 and 32% of the gas sales volumes for the comparable period in 2019. See discussion on page 11 of the 2019 Form 10-K, under the subheading “Operating Revenues,” for more information about these properties. Sales from Arkansas working interest properties provided approximately 11% of the Company’s gas sales volumes for the nine months ended September 30, 2020 and 12% of the gas sales volumes for the comparable period in 2019.
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. Spot market prices dropped significantly in the first and second quarters primarily due to the impact of COVID-19 on demand for oil and gas products. Such lower prices will negatively affect our results of operation and financial condition and will continue to do so as long as prices remain at depressed levels.
Sales of miscellaneous oil and gas products were $92,515 in the nine months ended September 30, 2020 as compared to $136,620 in the comparable period in 2019.
The Company received lease bonuses of $82,221 in the nine months ended September 30, 2020 for leases on its owned minerals compared to $89,101 in the comparable period in 2019. In the nine months ended September 30, 2020, all of lease bonuses were for leases on owned minerals in Texas.
Operating Costs and Expenses. Operating costs and expenses increased $1,473,033 (35%) to $5,659,498 in the nine months ended September 30, 2020 from $4,186,465 in the comparable period of 2019. Material line item changes are discussed and analyzed in the following paragraphs.
Production costs decreased $362,626 (21%) to $1,370,699 in the nine months ended September 30, 2020 from $1,733,325 in the comparable period in 2019, due to decreases in lease operating expenses and gross production taxes.
Exploration costs increased $92,424 (153%) to $152,973 in the nine months ended September 30, 2020 from $60,549 in the comparable period in 2019, due to increases in geological and geophysical expenses and dry hole and plugging costs.
The following is a summary as of November 3, 2020, updating both exploration and development activity from December 31, 2019, for the period ended September 30, 2020.
The Company is participating with its 14% interest in the acquisition of additional leasehold and exploratory drilling on a Creek County, Oklahoma 3-D seismic project. There are currently seven active prospects within the project. Exploratory wells were drilled on two of the prospects in 2019. The two wells were completed in 2020, one as a commercial oil producer and the other as a dry hole. Three development wells have been drilled on the first prospect and exploratory wells have been drilled on two additional prospects. Completions are in progress on all five of these wells. Two additional exploratory wells are planned, and additional development drilling is likely. Leasehold costs for the period were $9,097 and additional capitalized costs were $161,149. Dry hole costs of $31,180 were written off to expense.
The Company owns a 35% interest in 16,472.55 net acres of leasehold on a Crockett and Val Verde Counties, Texas prospect. Most of the acreage is underlain by a shallow heavy oil zone. The Company plans to participate with a 10.5% interest in the re-entry, completion and testing of a previously drilled test well on the prospect with the intention of conducting a thermal recovery pilot test.
The Company has been participating with a 13% interest in a 3-D seismic project covering approximately 35,000 acres in San Patricio County, Texas. Fourteen prospects have been identified, and exploratory wells were successfully completed on two of these in 2019. Leasing is complete on six additional prospects. An exploratory well has been drilled on one of these and is awaiting completion. Also, additional processing of the 3-D seismic data is currently in progress and almost complete. Leasehold costs for the period were $32,381, additional capitalized costs were $151,334 and geophysical costs were $13,485.
The Company has been participating with a 50% interest in an attempt to develop oil prospects in the Permian Basin. Lease acquisition is in progress on a Nolan County, Texas prospect. The Company is currently involved in negotiations to sell a portion of its interest in the prospect. Geological costs for the period were $40,163 and leasehold costs were $175,153.
The Company participated in an attempt to restore commercial production from a well that was drilled and completed in 2019 on a Murray County, Oklahoma prospect. The effort was unsuccessful, as was an attempt to re-complete in another zone. The well is under evaluation.
In August 2020, the Company purchased a 10.5% interest in 637.58 net acres of leasehold on a Lincoln County, Oklahoma prospect for $30,126. An exploratory well was drilled on the prospect and completed as a dry hole. Dry hole costs for the period were $21,362.
The Company is participating in the drilling of four horizontal development wells on fee minerals located in Kingfisher County, Oklahoma. The Company has a 3.2% working interest in three of the wells and a 3.5% working interest in the fourth. All four wells have been drilled with casing set and are scheduled for completion in the first quarter of 2021. Prepaid costs for the period were $709,845
The Company largely curtailed its exploration and development activity due to the historic collapse of oil prices in March and April, 2020. With the recent improvement in the outlook for both oil and gas prices, it has cautiously resumed drilling activity on some of its prospects.
Depreciation, Depletion, Amortization and Valuation Provision (DD&A). DD&A increased $1,737,250 (153%) to $2,869,968 in the nine months ended September 30, 2020 from $1,132,718 in the comparable period in 2019, due to an increase in long-lived assets impairments of $2,052,107, which was offset by decreases in depreciation, depletion and non-producing leasehold impairments that totaled approximately $321,000. See Note 10 – LONG-LIVED ASSETS IMPAIRMENT LOSS on page 29 of the 2019 Form 10-K for a description of the impairment loss calculation.
Other Income, Net. This line item increased $36,829 (13%) to $329,125 in the nine months ended September 30, 2020 from $292,296 in the comparable period in 2019. See Note 3 to the accompanying financial statements for an analysis of the components of this item.
Equity securities gains were $235,113 in the nine months ended September 30, 2020 compared to gains of $37,111 in the comparable period in 2019. In the nine months ended September 30, 2020, the Company had unrealized gains of $147,999 from adjusting securities, held at September 30, to estimated fair market value and net realized trading gains of $87,114. In the nine months ended September 30, 2019, the Company had unrealized losses of $17,968 and net realized trading gains of $55,079.
Gain on the sale of assets increased $9,603 to $19,025 in the nine months ended September 30, 2020 from $9,422 in the comparable period in 2019.
Interest income decreased $267,664 (65%) to $145,282 in the nine months ended September 30, 2020 from $412,946 in the comparable period in 2019. This was due to decreased interest rates on available-for-sale debt securities and other interest-bearing accounts.
Equity losses in investees decreased $82,734 to $57,839 in the nine months ended September 30, 2020 from $140,573 in the comparable period in 2019.
Other income increased $14,266 to $22,274 in the nine months ended September 30, 2020 from $8,008 in the comparable period in 2019, mostly due to an increase in other investment income to $13,548 in 2020 from $2,000 in 2019.
Income Tax Provision/(Benefit). Income taxes decreased $481,947 to a benefit of $447,186 in the nine months ended September 30, 2020 from a provision of $34,761 in the comparable period in 2019. The income tax decrease was the result of a $3,164,502 decrease in the pre-tax income to a loss of $2,254,322 in the nine months ended September 30, 2020 from a pre-tax income of $910,180 in the comparable period in 2019. See Note 5 to the accompanying financial statements for additional information on income taxes.
Material Changes in Results of Operations Three Months Ended September 30, 2020, Compared with Three Months Ended September 30, 2019
Net loss increased $557,510 to a loss of $737,048 in the three months ended September 30, 2020 from loss of $179,538 in the comparable period in 2019. The significant changes in the statements of operations are discussed below.
Operating Revenues. Revenues from oil and gas sales decreased $78,627 (6%) to $1,196,134 in the three months ended September 30, 2020 from $1,274,761 in the comparable period in 2019 due to decreases in oil and other product sales of $156,017 and $1,516, respectively, offset by a $78,906 increase in gas sales.
The decrease in oil sales was the net result of a decrease in the average price received of $16.89 per Bbl to $35.80, for a negative price variance of $361,350, and an increase in the volume of oil sold of 3,897 Bbls to 21,397 Bbls, for a positive volume variance of $205,333. See the “Results of Operations” section above for the nine months ended September 30, 2020 for additional discussion of the oil sales variances.
The increase in gas sales was the result of an increase in the average price of $0.69 per MCF to $2.51, for a positive price variance of $108,141, and a decrease in the volume of gas sold of 16,063 MCF to 158,598 MCF, for a negative volume variance of $29,235. See the “Results of Operations” section above for the nine months ended September 30, 2020 for additional discussion of gas sales variances.
Operating Costs and Expenses. Operating costs and expenses increased $589,883 (38%) to $2,140,105 in the three months ended September 30, 2020 from $1,550,222 in the comparable period in 2019. The increase was the net result of an increase in depreciation, depletion, amortization and valuation provisions (DD&A) of $671,328; an increase in exploration costs charged to expense of $62,119; a decrease in production costs of $117,075; and a decrease in general administrative and other expense (G&A) of $26,489. The significant changes in these line items are discussed below.
Production costs decreased $117,075 (21%) to $432,403 in the three months ended September 30, 2020 from $549,478 in the comparable period in 2019 due to decreases in lease operating expenses and production taxes.
Exploration costs increased $62,119 to $77,803 in the three months ended September 30, 2020 from $15,684 in the comparable period in 2019. Most of the increase is due to a $45,500 increase in dry hole and abandonment costs for the three months ended September 30, 2020 compared to 2019.
DD&A increased $671,328 (115%) to $1,253,044 in the three months ended September 30, 2020 from $581,716 in the comparable period in 2019. Impairment losses for the three months ended September 30, 2020 were $1,106,570, versus $300,000 in the comparable period in 2019. The impairment losses were offset by decreases in depreciation, depletion and amortization provisions of $135,242. See Note 10 – LONG-LIVED ASSETS IMPAIRMENT LOSS on page 29 of the 2019 Form 10-K for a description of the impairment loss calculation.
Other Income, Net. See Note 3 to the accompanying financial statements for an analysis of the components of other income, net. In the three months ended September 30, 2020, this line item increased $45,908 (157%) to $75,137 from $29,229 in the comparable period in 2019.
Equity securities increased $136,515 in the three months ended September 30, 2020 to gains of $85,724 compared to losses of $50,791 in the comparable period in 2019. The increase was due to an increase in realized gains of $19,920 and an increase in unrealized gains of $116,595.
Interest income decreased $114,452 (92%) to $9,380 in the three months ended September 30, 2020 from $123,832 in the comparable period in 2019. The decrease was due to decreased interest rates on available-for-sale debt securities and other interest-bearing accounts.
Equity losses in investees decreased $25,524 to $19,325 in the three months ended September 30, 2020 from $44,849 in the comparable period in 2019.
Income Tax Provision/(Benefit). Income taxes decreased $66,320 to a benefit of $130,983 in the three months ended September 30, 2020 from a benefit of $64,663 in comparable period in 2019. The decrease was due to the decrease in income before income taxes of $623,830 to a loss of $868,031 in the three months ended September 30, 2020 from loss of $244,201 in the comparable period in 2019. See discussions above in “Results of Operations” section and Note 5 to the accompanying financial statements for additional explanation of the changes in the provision for income taxes.
Off-Balance Sheet Arrangements
The Company’s off-balance sheet arrangements relate to Broadway Sixty-Eight, LLC, an Oklahoma limited liability company, Grand Woods Development, LLC, an Oklahoma limited liability company, and QSN Office Park, 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 4 to the accompanying financial statements.