EARTHSTONE ENERGY INC - Quarter Report: 2008 August (Form 10-Q)
UNITED
STATES
SECURITIES AND EXCHANGE
COMMISSION
Washington,
D.C. 20549
FORM
10-Q
|
þ
|
QUARTERLY
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the Quarterly Period Ended June 30, 2008
|
o
|
TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
Commission
file number: 0-7914
BASIC
EARTH SCIENCE SYSTEMS, INC.
633
Seventeenth St, Suite 1645
Denver,
Colorado 80202-3625
Telephone
(303) 296-3076
|
Incorporated
in Delaware
|
IRS
ID# 84-0592823
|
Check
whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to the filing requirements for the past
90 days. Yes þ
No o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.
Large
accelerated filer o Accelerated
filer o
Non-accelerated
filer o (Do
not check if a smaller reporting
company) Smaller reporting
company þ
Check
whether the issuer is a shell company (as defined in Rule 12b-2 of the
Exchange Act).
Yes o No þ
Shares of
common stock outstanding on August 14, 2008: 17,465,585
BASIC EARTH SCIENCE
SYSTEMS, INC.
FORM
10-Q
INDEX
|
PART
I. FINANCIAL INFORMATION
|
Page
|
|
|
Item 1.
|
Financial
Statements
|
3
|
|
June 30,
2008 (Unaudited) and March 31, 2008
|
3
|
|
|
Three
Months Ended June 30, 2008 and 2007 (Unaudited)
|
5
|
|
|
Three
Months Ended June 30, 2008 and 2007 (Unaudited)
|
6
|
|
|
June
30, 2008 (Unaudited)
|
7
|
|
|
Item 2.
|
11
|
|
|
13
|
||
|
Item 3.
|
15
|
|
|
Item 4.
|
15
|
|
|
PART
II. OTHER INFORMATION
|
||
|
Item 1.
|
16
|
|
|
Item 2.
|
16
|
|
|
Item 3.
|
16
|
|
|
Item 4.
|
16
|
|
|
Item 5.
|
16
|
|
|
Item 6.
|
16
|
|
|
17
|
PART I – FINANCIAL INFORMATION
Item 1. Financial
Statements
Basic Earth Science Systems,
Inc.
Page
1 of 2
|
June
30,
|
March
31,
|
|||||||
|
2008
|
2008
|
|||||||
|
(Unaudited)
|
||||||||
|
Assets
|
||||||||
|
Current
assets:
|
||||||||
|
Cash
and cash equivalents
|
$ | 4,593,000 | $ | 5,571,000 | ||||
|
Accounts
receivable:
|
||||||||
|
Oil
and gas sales
|
1,789,000 | 1,110,000 | ||||||
|
Joint
interest and other receivables, net of $41,000 and $50,000 in
allowance
|
563,000 | 236,000 | ||||||
|
Other
current assets
|
317,000 | 280,000 | ||||||
|
Total
current assets
|
7,262,000 | 7,197,000 | ||||||
|
Oil
and gas property, full cost method:
|
||||||||
|
Proved
property
|
31,042,000 | 29,050,000 | ||||||
|
Unproved
property
|
1,268,000 | 2,515,000 | ||||||
|
Accumulated
depletion
|
(18,727,000 | ) | (18,515,000 | ) | ||||
|
Net
oil and gas property
|
13,583,000 | 13,050,000 | ||||||
|
Support
equipment and other non-current assets, net of $313,000 and $299,000 in
accumulated depreciation, respectively
|
437,000 | 443,000 | ||||||
|
Total
non-current assets
|
14,020,000 | 13,493,000 | ||||||
|
Total
assets
|
$ | 21,282,000 | $ | 20,690,000 | ||||
See
accompanying notes to unaudited consolidated financial
statements.
Basic
Earth Science Systems, Inc.
Consolidated
Balance Sheets
Page 2 of 2
|
June
30,
|
March
31,
|
|||||||
|
2008
|
2008
|
|||||||
|
(Unaudited)
|
||||||||
|
Liabilities
and Shareholders' Equity
|
||||||||
|
Current
liabilities:
|
||||||||
|
Accounts
payable
|
$ | 780,000 | $ | 1,443,000 | ||||
|
Accrued
liabilities
|
1,982,000 | 2,586,000 | ||||||
|
Total
current liabilities
|
2,762,000 | 4,029,000 | ||||||
|
Long-term
liabilities:
|
||||||||
|
Deferred
tax liability
|
3,215,000 | 2,800,000 | ||||||
|
Asset
retirement obligation
|
1,941,000 | 1,877,000 | ||||||
|
Total
long-term liabilities
|
5,156,000 | 4,677,000 | ||||||
|
Total
liabilities
|
7,918,000 | 8,706,000 | ||||||
|
Shareholders’
equity:
|
||||||||
|
Preferred
stock, $.001 par value, 3,000,000 authorized, and none issued or
outstanding
|
— | — | ||||||
|
Common
stock, $.001 par value, 32,000,000 shares authorized, and 17,465,585
shares issued and outstanding
|
17,000 | 17,000 | ||||||
|
Additional
paid-in capital
|
22,798,000 | 22,798,000 | ||||||
|
Treasury
stock (349,265 shares); at cost
|
(23,000 | ) | (23,000 | ) | ||||
|
Accumulated
deficit
|
(9,428,000 | ) | (10,808,000 | ) | ||||
|
Total
shareholders’ equity
|
13,364,000 | 11,984,000 | ||||||
|
Total
liabilities and shareholders’ equity
|
$ | 21,282,000 | $ | 20,690,000 | ||||
See
accompanying notes to unaudited consolidated financial
statements.
Basic Earth Science
Systems, Inc.
(Unaudited)
|
Three
Months Ended
|
||||||||
|
June
30,
|
||||||||
|
2008
|
2007
|
|||||||
|
(As
restated)
|
||||||||
|
Revenues:
|
||||||||
|
Oil
and gas sales
|
$ | 3,312,000 | $ | 1,603,000 | ||||
|
Well
service revenue
|
7,000 | 11,000 | ||||||
|
Total
revenues
|
3,319,000 | 1,614,000 | ||||||
|
Expenses:
|
||||||||
|
Oil and gas production
|
566,000 | 494,000 | ||||||
|
Production tax
|
282,000 | 126,000 | ||||||
|
Well servicing expenses
|
9,000 | 11,000 | ||||||
|
Depreciation and depletion
|
221,000 | 177,000 | ||||||
|
Accretion of asset retirement obligation
|
13,000 | 27,000 | ||||||
|
Asset retirement expense
|
(46,000 | ) | 17,000 | |||||
|
General and administrative
|
303,000 | 168,000 | ||||||
|
Total
expenses
|
1,348,000 | 1,020,000 | ||||||
|
Income
from operations
|
1,971,000 | 594,000 | ||||||
|
Other
Income (Expense):
|
||||||||
|
Interest and other income
|
8,000 | 33,000 | ||||||
|
Interest and other expenses
|
(3,000 | ) | ― | |||||
|
Total
other income
|
5,000 | 33,000 | ||||||
|
Income
before income taxes
|
1,976,000 | 627,000 | ||||||
|
Current
income tax expense
|
181,000 | 50,000 | ||||||
|
Deferred
income tax expense
|
415,000 | 290,000 | ||||||
|
Total
income tax expense
|
596,000 | 340,000 | ||||||
|
Net
income
|
$ | 1,380,000 | $ | 287,000 | ||||
|
Per
share amounts:
|
||||||||
|
Basic
|
$ | 0.08 | $ | 0.02 | ||||
|
Diluted
|
$ | 0.08 | $ | 0.02 | ||||
|
Weighted
average common shares outstanding:
|
||||||||
|
Basic
|
17,465,585 | 16,955,240 | ||||||
|
Diluted
|
17,468,898 | 17,133,137 | ||||||
See
accompanying notes to unaudited consolidated financial
statements.
Basic Earth Science
Systems, Inc.
(Unaudited)
|
Three
Months Ended
|
||||||||
|
June
30,
|
||||||||
|
2008
|
2007
|
|||||||
|
(As
restated)
|
||||||||
|
Cash
flows from operating activities:
|
||||||||
|
Net
income
|
$
|
1,380,000
|
$
|
287,000
|
||||
|
Adjustments
to reconcile net income to net cash provided by (used in) operating
activities:
|
||||||||
|
Depreciation
and depletion
|
221,000
|
177,000
|
||||||
|
Deferred
tax expense
|
415,000
|
290,000
|
||||||
|
Accretion
of asset retirement obligation
|
13,000
|
27,000
|
||||||
|
Change
in:
|
||||||||
|
Accounts
receivable, net
|
(1,006,000)
|
162,000
|
||||||
|
Other
assets
|
(48,000)
|
24,000
|
||||||
|
Accounts
payable and accrued liabilities
|
(122,000)
|
(387,000)
|
||||||
|
Other
|
—
|
2,000
|
||||||
|
Net
cash provided by operating activities
|
853,000
|
582,000
|
||||||
|
Cash
flows from investing activities:
|
||||||||
|
Oil
and gas property
|
(1,839,000)
|
(47,000)
|
||||||
|
Support
equipment
|
8,000
|
(2,000)
|
||||||
|
Proceeds
from sale of oil and gas property and equipment
|
―
|
6,000
|
||||||
|
Other
|
―
|
(7,000)
|
||||||
|
Net
cash used in investing activities
|
(1,831,000)
|
(50,000)
|
||||||
|
Cash
and cash equivalents:
|
||||||||
|
Increase
in cash and cash equivalents
|
(978,000)
|
532,000
|
||||||
|
Balance,
beginning of year
|
5,571,000
|
2,523,000
|
||||||
|
Balance,
end of year
|
$
|
4,593,000
|
$
|
3,055,000
|
||||
|
Supplemental
disclosure of cash flow information:
|
||||||||
|
Cash
paid for interest
|
$
|
3,000
|
$
|
―
|
||||
|
Cash
paid for income tax
|
$
|
50,000
|
$
|
―
|
||||
|
Non-cash:
|
||||||||
|
Increase
in oil and gas property due to asset retirement obligation
|
$
|
13,000
|
$
|
―
|
||||
See
accompanying notes to unaudited consolidated financial
statements.
Basic Earth Science
Systems, Inc.
June
30, 2008
The
accompanying interim financial statements of Basic Earth Science Systems, Inc.
(sometimes referred to as “the Company” “we” “our” or “us”) are unaudited.
However, in the opinion of management, the interim data includes all
adjustments, consisting of normal recurring adjustments, necessary for a fair
presentation of the results for the interim period.
At the
directive of the Securities and Exchange Commission to use “plain English” in
its public filings, the Company will use such terms as “we”, “our” and “us” in
place of Basic Earth Science Systems, Inc. or “the Company.” When such terms are
used in this manner throughout this document they are in reference only to the
corporation, Basic Earth Science Systems, Inc. and its subsidiaries, and are not
used in reference to the board of directors, corporate officers, management, or
any individual employee or group of employees.
The
financial statements included herein have been prepared by the Company pursuant
to the rules and regulations of the Securities and Exchange Commission. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations. We believe the
disclosures made are adequate to make the information not misleading and suggest
that these condensed financial statements be read in conjunction with the
financial statements and notes hereto included in our Form 10-KSB for the year
ended March 31, 2008.
Forward-Looking
Statements
This Form
10-Q includes “forward-looking statements” within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E
of the Securities Exchange Act of 1934, as amended. All statements other than
statements of historical fact included in this Form 10-Q, including, without
limitation, the statements under both “Notes to Consolidated Financial
Statements” and “Item 2. Management’s Discussion and Analysis or Plan of
Operation” located elsewhere herein regarding the Company’s financial position
and liquidity, its strategies, financial instruments, and other matters, are
forward-looking statements. Although we believe that the expectations reflected
in such forward-looking statements are reasonable, we can give no assurance that
such expectations will prove to have been correct. Important factors that could
cause actual results to differ materially from our expectations are disclosed in
this Form 10-Q.
1.
Presentation of Condensed Consolidated Financial Statements
As
discussed in our 2008 Annual Report on Form 10-KSB, we discovered during the
preparation and review of our 2008 income tax provision that errors occurred in
calculating the GAAP cost basis of our oil and gas properties in determining tax
liability and the estimated deferred tax asset for percentage depletion
carryforward. These errors impacted our previously filed financial statements
for fiscal years ended March 31, 2007 and 2006 and our previously filed interim
financial statements for those years and the first three quarters of 2008. For
further information concerning the restatement and details concerning restated
amounts, please refer to our recently filed Annual Report on Form 10-KSB for the
fiscal year ended March 31, 2008.
The
following table summarizes the impact of these corrections to our consolidated
condensed statement of operations for the fiscal quarter ending as of June 30,
2007, as previously presented in Footnote 13 – Quarterly Financial Data (Unaudited)
of our Annual Report on Form 10-KSB. There was no impact to our 2008
interim Net Cash provided by Operating Activities due to the correction of the
above errors.
|
Impact
to the Income Statement
|
Three
Months ended June 30, 2007
|
|||||||||||
|
(Unaudited)
|
As
reported
|
Adjustment
|
As
restated
|
|||||||||
|
Provision
for deferred income taxes
|
$ | 165,000 | $ | 125,000 | $ | 290,000 | ||||||
|
Total
income taxes
|
215,000 | 125,000 | 340,000 | |||||||||
|
Net
Income
|
$ | 412,000 | $ | (125,000 | ) | $ | 287,000 | |||||
|
Per
share amounts:
|
||||||||||||
|
Basic
|
$ | 0.02 | $ | (0.00 | ) | $ | 0.02 | |||||
|
Diluted
|
$ | 0.02 | $ | (0.00 | ) | $ | 0.02 | |||||
2. Summary of Significant Accounting
Policies and Recent Accounting
Pronouncements
Use of Estimates.
The preparation of financial statements in conformity with generally
accepted accounting principles requires us to make estimates and assumptions
that affect the actual amounts of assets and liabilities at the date of the
financial statements and the actual amounts of revenues and expenses during the
reporting period. We base these estimates on assumptions that we understand are
reasonable under the circumstances. The estimated results that are produced by
this effort will differ under different assumptions or conditions. We
understand that these estimates are necessary and that actual results could vary
significantly from the estimated amounts for the current and future periods.
There are many factors, including global events, which may influence the
production, processing, marketing, and valuation of crude oil and natural gas. A
reduction in the valuation of oil and gas properties resulting from declining
prices or production could adversely impact depletion rates and ceiling test
limitations. We understand the following accounting policies and estimates are
necessary in the preparation of our consolidated financial statements: the
carrying value of our oil and gas property, the accounting for oil and gas
reserves, the estimate of our asset retirement obligations, and the estimate of
our income tax assets and liabilities.
Cash and Cash
Equivalents. For purposes of the Consolidated Balance Sheets and
Statements of Cash Flows, we consider all highly liquid investments with a
maturity of ninety days or less when purchased to be cash
equivalents.
Oil and Gas Property.
We utilize the full cost method of accounting for costs related to our oil and
gas property. Capitalized costs included in the full cost pool are depleted on
an aggregate basis over the estimated lives of the properties using the
units-of-production method. These capitalized costs are subject to a ceiling
test that limits such pooled costs to the aggregate of the present value of
future net revenues attributable to proved oil and gas reserves discounted at
10 percent plus the lower of cost or market value of unproved properties
less any associated tax effects. If the full cost pool of capitalized oil and
gas property costs exceeds the ceiling, we will record a ceiling test write-down
to the extent of such excess. This write-down is a non-cash charge to earnings.
If required, it reduces earnings and impacts shareholders’ equity in the period
of occurrence and results in lower depreciation and depletion in future periods.
The write-down may not be reversed in future periods, even though higher oil and
gas prices may subsequently increase the ceiling.
Oil and Gas
Reserves. The determination of depreciation and depletion expense as well
as ceiling test write-downs, if any, related to the recorded value of our oil
and gas properties are highly dependent on the estimates of the proved oil and
gas reserves attributable to these properties. Oil and gas reserves include
proved reserves that represent estimated quantities of crude oil and natural gas
which geological and engineering data demonstrate with reasonable certainty to
be recoverable in future years from known reservoirs under existing economic and
operating conditions. There are numerous uncertainties inherent in estimating
oil and gas reserves and their values, including many factors beyond our
control. Accordingly, reserve estimates are often different from the quantities
of oil and gas ultimately recovered and the corresponding lifting costs
associated with the recovery of these reserves. Ninety-five percent and
eighty-seven percent of our reported oil and gas reserves at March 31, 2008
and June 30, 2008, respectively, are based on estimates prepared by an
independent petroleum engineering firm. The remaining five and thirteen percent,
respectively, of our oil and gas reserves were prepared in-house.
Asset Retirement
Obligations. We have obligations related to the plugging and abandonment
of our oil and gas wells, the removal of equipment and facilities, and returning
the land to its original condition. SFAS No. 143, “Accounting for Asset
Retirement Obligations” requires that we estimate the future cost of this
obligation, discount this cost to its present value, and record a corresponding
asset and liability in our Consolidated Balance Sheets. The values ultimately
derived are based on many significant estimates, including the ultimate expected
cost of the obligation, the expected future date of the required cash
expenditures, and inflation rates. The nature of these estimates requires us to
make judgments based on historical experience and future expectations related to
timing. We review the estimate of our future asset retirement obligations
quarterly. These quarterly reviews may require revisions to these estimates
based on such things as changes to cost estimates or the timing of future cash
outlays. Any such changes that result in upward or downward revisions in the
estimated obligation will result in an adjustment to the related capitalized
asset and corresponding liability on a prospective basis.
We
recognize two components on our consolidated statement of operations; accretion
of asset retirement obligations and asset retirement
expense. Accretion of asset retirement obligation reflects the
periodic accretion of the present value of future plugging and abandonment
costs. Asset retirement expense reflects the actual current period
gains and losses on plugging and abandonment costs relative to previously
estimated future costs. Since our initial adoption of FASB No. 143 we
have closed gains and losses on asset retirements to the income statement as a
component of asset retirement expense.
Income Taxes.
We account for income taxes in accordance with SFAS No. 109,
“Accounting for Income Taxes”. Accordingly, deferred tax liabilities and assets
are determined based on the temporary differences between the financial
statements and tax bases of assets and liabilities, using enacted tax rates in
effect for the year in which the differences are expected to
reverse.
Projections
of future income taxes and their timing require significant estimates with
respect to future operating results. Accordingly, the net deferred tax liability
is continually re-evaluated and numerous estimates are revised over time. As
such, the net deferred tax liability may change significantly as more
information and data is gathered with respect to such events as changes in
commodity prices, their effect on the estimate of oil and gas reserves, and the
depletion of these long-lived reserves.
On
April 1, 2007 we adopted FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109
(FIN 48). The adoption of FIN 48 had no impact on our consolidated financial
statements. We are subject to U.S. federal income tax and income tax from
multiple state jurisdictions. The tax years remaining subject to examination by
tax authorities are fiscal years 2004 through 2006. We recognize interest and
penalties related to uncertain tax positions in income tax expense. As of June
30, 2008, we made no provisions for interest or penalties related to uncertain
tax positions.
Earnings Per
Share. Our earnings per share is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Diluted
earnings per share is calculated by dividing net income by the diluted weighted
average number of common shares. The diluted weighted average number of common
shares is computed using the treasury stock method for common stock that may be
issued for outstanding stock options.
Off
Balance Sheet Transactions, Arrangements, or Obligations
We have
no material off balance sheet transactions, arrangements or
obligations.
Recent
Accounting Pronouncements
In
December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business
Combinations” (“SFAS 141R”). SFAS 141R will significantly change the accounting
for business combinations in a number of areas including the treatment of
contingent consideration, contingencies, acquisition costs, research and
development assets and restructuring costs. In addition, under SFAS 141R,
changes in deferred tax asset valuation allowances and acquired income tax
uncertainties in a business combination after the measurement period will impact
income taxes. SFAS 141R is effective for fiscal years beginning after
December 15, 2008. The adoption of the provisions of SFAS 141R is not
expected to have a material effect on our financial position, results of
operations, or cash flows.
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option
for Financial Assets and Financial Liabilities”, providing companies with an
option to report selected financial assets and liabilities at fair value. The
Standard’s objective is to reduce both complexity in accounting for financial
instruments and the volatility in earnings caused by measuring related assets
and liabilities differently. Generally
accepted accounting principles have required different measurement attributes
for different assets and liabilities that can create artificial volatility in
earnings. SFAS 159 helps to mitigate this type of accounting-induced volatility
by enabling companies to report related assets and liabilities at fair value,
which would likely reduce the need for companies to comply with detailed rules
for hedge accounting. SFAS
159 also establishes presentation and disclosure requirements designed to
facilitate comparisons between companies that choose different measurement
attributes for similar types of assets and liabilities. The
Standard requires companies to provide additional information that will help
investors and other users of financial statements to more easily understand the
effect of our choice to use fair value on its earnings. It also requires
entities to display the fair value of those assets and liabilities for which the
Company has chosen to use fair value on the face of the balance sheet. The
adoption of the provisions of SFAS 159 does not have a material effect on our
financial position, results of operations, or cash flows.
In
September 2006,
the FASB issued SFAS Statement No. 157,
“Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework
for measuring fair value in accordance with generally accepted accounting
principles and expands disclosures about fair value measurements. SFAS 157 is
effective for fiscal years beginning after November 15,
2007. The adoption of the provisions of SFAS 157 does not have a material effect
on our financial position, results of operations, or cash flows.
In
July 2006, the FASB issued FIN No. 48, “Accounting for Uncertainty in
Income Taxes — An Interpretation of SFAS 109”. FIN 48 clarifies the accounting
for uncertainty in income taxes recognized in an enterprise’s financial
statements in accordance with SFAS 109, “Accounting for Income Taxes”. FIN 48
also prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. In addition, FIN 48 provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. The provisions of FIN 48 are to be applied
to all tax positions upon initial adoption of this standard. Only
tax positions that meet the more-likely-than-not recognition threshold at the
effective date may be recognized or continue to be recognized as an adjustment
to the opening balance of retained earnings (or other appropriate components of
equity) for that fiscal year. The
provisions of FIN 48 are effective for fiscal years beginning after
December 15, 2006. We
adopted FIN 48 effective April 1, 2007. See
Note 9, Income Taxes, for further discussion.
Liquidity
and Capital Resources
Liquidity
Outlook. Our primary source of funding is the net cash flow from the sale
of our oil and gas production. The profitability and cash flow generated by our
operations in any particular accounting period will be directly related to:
(a) the volume of oil and gas produced and sold, (b) the average realized
prices for oil and gas sold, and (c) lifting costs. Assuming that oil
prices do not decline significantly from current levels, we believe the cash
generated from operations will enable us to meet our existing and normal
recurring obligations. In addition, as mentioned in the “Bank Debt” section
below, we currently have $4,000,000 of unused borrowing capacity.
Working Capital.
At June 30, 2008, we had a working capital surplus of $4,500,000 (a
current ratio of 2.63:1) compared to a working capital surplus at March 31, 2008
of $3,168,000 (a current ratio of 1.79:1). The increase is a result of our
improved cash position due to increases in price and production of oil and gas
during the quarter ended June 30, 2008.
Cash Flow.
Net cash provided by operating activities increased 47% from $582,000 in
the quarter ended June 30, 2007 (“2007”) to $853,000 in the quarter ended June
30, 2008 (“2008”). This increase was primarily due to increased oil and gas
revenue and accounts receivable, offset by increases in depletion and deferred
taxes.
Net cash
used in investing activities increased 3,562% from $50,000 during 2007 to
$1,831,000 in the quarter ended June 30, 2008. The difference relates primarily
to timing of cash payments relating to expenditures of the drilling and
completion of the new wells in DJ Basin of Colorado.
Credit
Line. Our current banking relationship, established in March 2002,
is with American National Bank (“the Bank”), located in Denver, Colorado.
Effective January 3, 2006 we amended the existing loan agreement to
increase the line of credit amount from $1,000,000 to $20,000,000 with a
concurrent borrowing base increase from $1,000,000 to $4,000,000. Effective
December 31, 2006 the loan agreement was amended again to extend the
maturity date of the credit agreement to December 31, 2008.
During
the year ended March 31, 2008, we utilized none of our credit facility. Our
effective annual interest rate at June 30, 2008 was WSJ prime plus 0.25%. On
June 30, 2008, we had no outstanding principal balance on the line of credit
with the entire $4,000,000 available for borrowing. If necessary, we may borrow
funds to reduce payables, finance re-completion or drilling efforts, fund
property acquisitions, or pursue other opportunities we cannot envision at this
time.
Capital
Expenditures
During
the quarter ended June 30, 2008 (2008), we estimate that, on an accrual basis,
we spent $640,000 (net of $118,000 in plugging and abandonment costs) on various
projects compared to $47,000 for the same period in 2007. During 2008
our capital expenditures were primarily focused in the DJ Basin of Colorado
where 82% of these funds were invested. These projects were funded
with internally generated cash flow from operations. These amounts
are not consistent with the amounts presented on the consolidated statement of
cash flows under investing activities for expenditures on oil and gas property
in that the amounts contained therein are presented on a cash basis and not on
an accrual basis as stated above.
We are
continually evaluating exploration, development and acquisition opportunities in
an effort to grow our oil and gas reserves. At present cash flow levels and
available borrowing capacity, we expect to have sufficient funds available for
our share of any additional acreage, seismic and/or drilling cost requirements
that might arise from these opportunities. However, we may alter or vary all or
part of these planned capital expenditures based upon changes in circumstances,
unforeseen opportunities, inability to negotiate favorable acquisition, farmout
or joint venture terms, lack of cash flow, lack of additional funding, if
necessary, and/or other events which we are not able to anticipate.
Contemplated
Activities
In
addition to the discussion in Capital Expenditures described above, we
anticipate pursuing the following activities during the remainder of fiscal
2009.
As
previously disclosed, we are concluding a year-long, sixteen well development
drilling and completion program on our Antenna Federal project. While the
majority of wells have been drilled to the Codell formation, five wells were
drilled to the deeper J-Sand formation. We expect to have a 2% to 52.5% revenue
interest in Codell production and a 13.125% to 52.5% revenue interest in J-Sand
production (depending on actual well location). Production equipment has been
installed and at this time all of the wells are up and running. While initial
completion work has begun on four wells, stimulation has only occurred on one
well. We expect to spend an additional $600,000 for our share of the cost of
completing these wells. Kerr-McGee Oil & Gas Onshore, LP is the operator of
this project.
In
Montana, the Company and its 50% partner expect to drill a vertical Red River
test on the South Flat Lake prospect in the second quarter of fiscal 2009. If
successful, it is possible that as many as 4 development wells could be drilled.
The initial well is expected to cost approximately $1.35 million to drill. While
we now own, and could participate for our 50% interest in this prospect, if we
and our partner sell a portion of this prospect as intended, our interest would
be proportionately reduced. We expect to be the operator of this
property.
In the
June 2005 quarter, we acquired a 20% interest in 13,000 acres in our Banks
prospect in McKenzie County, North Dakota. While initial efforts were
discouraging, during the intervening period, the success of new techniques by
various companies has given new life to the area. After evaluating
several proposals, we and our partners have executed a farmout agreement with an
unrelated, private, third-party. Under the terms of this agreement,
the third party will drill two horizontal Bakken wells on the Banks acreage and
carry us and our partners for a 32.5% carried working interest “to the
tanks”. In exchange, the third party will earn 67.5% interest in all
of our Banks acreage. After the first two wells have been drilled,
Basic will have the right to participate in subsequent wells for our 32.5%
working interest (proportionately reduced to our original 20% working interest
or approximately 6.5%, and subject to proportionate reduction based on
contributed acreage within a specific drilling spacing unit). Based
on assurances received from the third party, we expect drilling operations to
commence within 60 to 90 days.
We are
continually evaluating other drilling and acquisition opportunities for possible
participation. Typically, at any one time, several opportunities are in various
stages of due diligence. Our policy is to not disclose the specifics of a
project or prospect, nor to speculate on such ventures, until such time as those
various opportunities are finalized and undertaken. We caution that the absence
of news and/or press releases should not be interpreted as a lack of development
or activity.
We may
alter or vary all, or part, of these contemplated activities based upon changes
in circumstances, unforeseen opportunities, inability to negotiate favorable
acquisition, farmout, joint venture or loan terms, lack of cash flow, lack of
funding and/or other events which we are not able to
anticipate.
Divestitures/Abandonments
During
the quarter ended June 30, 2008 we completed plugging one operated well which
began in the prior quarter.
Three Months Ended June 30, 2008
Compared to Three Months Ended June 30, 2007
Overview.
Net income for the three months ended June 30, 2008 (“2008”) was
$1,380,000 compared to net income of $287,000, as restated, for the three months
ended June 30, 2007 (“2007”), an increase of 381%.
Revenues.
Oil and gas sales revenue increased $1,703,000 (106%) net of $6,000 in water
disposal revenue in 2008 from 2007. Oil sales revenue increased $1,519,000
(112%), and gas sales revenue increased $184,000 (74%) in 2008 from
2007. These increases resulted largely from the increased price
during the quarter.
Volumes and
Prices. Oil sales volumes increased 7%, from 22,300 barrels in 2007 to
23,900 barrels in 2008 while there was an increase of 98% in the average price
per barrel from $60.77 in 2007 to $120.11 in 2008. Gas sales volume increased
26% from 34.2 million cubic feet (MMcf) in 2007 to 43.1 MMcf in 2008, while
the average price per Mcf increased 38%, from $7.30 in 2007 to $10.08 in 2008.
The increase in gas sales volume is primarily due to bringing offline wells in
the Antenna Federal property in Weld County, Colorado back online, as well as
the production of new wells in the same property. On an equivalent barrel
(BOE) basis, sales volume increased 11% from 28,000 BOE in 2007 to 31,000
BOE in 2008.
Expenses.
Oil and gas production expense increased $72,000 (15%) in 2008 over 2007. Oil
and gas production expense is comprised of two components: routine lease
operating expenses and workovers. Routine expenses typically include such items
as daily well maintenance, utilities, fuel, water disposal,minor surface
equipment repairs and marketing and transportation costs. Workovers, on the
other hand, which primarily include downhole repairs, are generally random in
nature. Although workovers are expected, they can be much more frequent in some
wells than others and their cost can be significant. Therefore, workovers
account for more dramatic fluctuations in oil and gas production expense from
period to period.
Routine
lease operating expense increased 59,000 (15%) from $394,000 in 2007 to $453,000
in 2008 while workover expense increased $13,000 (13%) from $100,000 in 2007 to
$113,000 in 2008. Routine lease operating expense per BOE decreased 1% from
$14.07 in 2007 to $14.61 in 2008 while workover expense per BOE increased 1%
from $3.57 in 2007 to $3.65 in 2008.
Production
taxes, which are generally a percentage of sales revenue, increased $156,000
(124%) in 2008 over 2007 primarily due to the influence of higher oil prices and
understandably higher gross revenues. Production taxes, as a percent of sales
revenue stayed consitent at 8% in 2007 and 2008. The overall lifting
cost per BOE increased 23% from $22.19 in 2007 to $27.27 in 2008.
Depreciation
and depletion expense increased $44,000 (25%) in 2008 over 2007 as a result of
an increase in the full cost pool depletable base.
With
respect to asset retirement obligations, during the quarter just ended, we
experienced a net gain of $46,000 which is reflected as a negative asset
retirement expense. This treatment is consistent with our existing accounting
policies.
General
and administrative expense increased $135,000 (80%) in 2008 over 2007. Increases
in the number of office personnel and consultants, as well as additional
expenses associated with the expansion of our board of directors and related
compensation plan. G&A expense per BOE increased 63% from $6.00 in 2007 to
$9.77 in 2008. However, as a percent of total sales revenue, G&A expense
decreased from 10% in 2007 to 9% in 2008.
Income Tax
Expense. For the three months ended June 30, 2008 we recorded income tax
expense of $415,000. This includes a current year expense of $596,000 and a
deferred tax provision of $243,000. Our effective income tax rate
decreased from 54.2% for the quarter ended June 30, 2007 to 30.0% for 2008. Our
effective income tax rate was lower for 2008 primarily due to an increase in
estimated deductions for statutory depletion.
Liquids and Natural Gas Production,
Sales Price and Production Costs
The
following table shows selected financial information for the quarter ended June
30 in the current and prior year. Certain prior year amounts may have been
reclassified to conform to current year presentation.
|
Three
Months Ended
|
||||||||
|
June
30, 2008
|
||||||||
|
2008
|
2007
|
|||||||
|
Sales
volume:
|
||||||||
|
Oil (barrels)
|
23,911
|
22,300
|
||||||
|
Gas (mcf)
|
43,072
|
34,200
|
||||||
|
Revenue:
|
||||||||
|
Oil
|
$
|
2,872,000
|
$
|
1,353,000
|
||||
|
Gas
|
434,000
|
250,000
|
||||||
|
Total
revenue1
|
3,306,000
|
1,603,000
|
||||||
|
Total
production expense2
|
848,000
|
620,000
|
||||||
|
Gross
profit
|
$
|
2,458,000
|
$
|
983,000
|
||||
|
Depletion
expense
|
$
|
221,000
|
$
|
174,000
|
||||
|
Average
sales price3
|
||||||||
|
Oil
(per barrel)
|
$
|
120
|
$
|
61
|
||||
|
Gas
(per mcf)
|
$
|
10
|
$
|
7
|
||||
|
Average
production expense2,3,4
|
$
|
27
|
$
|
22
|
||||
|
Average
gross profit3,4
|
$
|
79
|
$
|
35
|
||||
|
Average
depletion expense3,4
|
$
|
7
|
$
|
6
|
||||
|
Average
general and administrative expense3,4
|
$
|
10
|
$
|
6
|
||||
|
1
|
Net
of $6,000 in water disposal revenue, as compared to total revenues of
$3,312,000
|
|
|
2
|
Operating
expenses, including production tax
|
|
|
3
|
Averages
calculated based upon non-rounded figures
|
|
|
4
|
Per
equivalent barrel (6 Mcf of gas is equivalent to 1 barrel of
oil)
|
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
As a
crude oil and natural gas producer, our revenue, cash flow from operations,
other income and profitability, reserve values, access to capital and future
rate of growth are substantially dependent upon the prevailing prices of crude
oil and natural gas. Declines in commodity prices will materially adversely
affect our financial condition, liquidity, ability to obtain financing and
operating results. Lower commodity prices may reduce the amount of crude oil and
natural gas that we can produce economically. Prevailing prices for such
commodities are subject to wide fluctuation in response to relatively minor
changes in supply and demand and a variety of additional factors beyond our
control, such as global, political and economic conditions. Historically, prices
received for crude oil and natural gas production have been volatile and
unpredictable, and such volatility is expected to continue. Most of our
production is sold at market prices. Generally, if the commodity indexes fall,
the price that we receive for our production will also decline. Therefore, the
amount of revenue that we realize is partially determined by factors beyond our
control.
Item 4.
Controls and Procedures
The
Company maintains a system of disclosure controls and procedures that are
designed for the purpose of ensuring that information required to be disclosed
in its SEC reports is recorded, processed, summarized and reported within the
time periods specified in the SEC’s rules and forms, and that such information
is accumulated and communicated to the Company’s management, including the Chief
Executive Officer and the Chief Financial Officer, as appropriate to allow
timely decisions regarding required disclosures.
For the
quarter ended June 30, 2008 we carried out an evaluation, under the supervision
and with the participation of the Company’s Chief Executive Officer and
Principal Accounting Officer, of the effectiveness of the design and operation
of the Company’s disclosure controls and procedures. Based upon that evaluation,
it was concluded that the Company’s disclosure controls and procedures are
effective for the purposes discussed above.
There
have been no changes in the Company’s internal control over financial reporting
that occurred during the Company’s quarter ended June 30, 2008 that has
materially affected, or is reasonably likely to materially affect, the Company’s
internal control over financial reporting.
PART II – OTHER INFORMATION
None.
On April
1, 2008, pursuant to the terms of Restricted Stock Agreements dated April 7,
2007, two of our directors became fully vested in 7,571 shares of our common
stock, each. Based on a price of $1.585 on the date of grant, these shares serve
as partial compensation to our independent directors for services performed
during the past fiscal year at an aggregate fair value of $12,000
each.
In
connection with the award and vesting of the subject shares, we relied upon the
exemption from federal registration under Section 4(2) of the Securities Act of
1933, as amended, based on our belief that the issuance of such shares did not
involve a public offering. In executing the Restricted Stock Agreement, each
director acknowledged that he has such knowledge and experience in financial and
business matters so that he was capable of evaluating the risks of the
investment. Any certificates evidencing the subject shares shall contain a
restrictive investment legend noted thereon.
None.
None.
None.
|
Exhibit
No.
|
Document
|
|
|
Certification
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Ray
Singleton, Chief Executive Officer).
|
||
|
Certification
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Joseph
Young, Principal Accounting Officer).
|
||
|
Certification
Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (Ray Singleton, Chief Executive
Officer).
|
||
|
Certification
Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (Joseph Young, Principal Accounting
Officer).
|
Other
exhibits and schedules are omitted because they are not applicable, not required
or the information is included in the financial statements or notes
thereto.
|
BASIC
EARTH SCIENCE SYSTEMS, INC.
|
||||
|
By:
/s/ Ray Singleton
|
||||
|
Ray
Singleton
|
||||
|
President
and Chief Executive Officer
|
||||
|
By: /s/
Joseph Young
|
||||
|
Joseph
Young
|
||||
|
Principal
Accounting Officer
|
||||
Date:
August 14, 2008