RESERVE PETROLEUM CO - Quarter Report: 2015 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended March 31, 2015

Commission File Number 0-8157

THE RESERVE PETROLEUM COMPANY

(Exact Name of Registrant as Specified in Its Charter)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  R     No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  R     No  ☐

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 (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of May 8, 2015, 158,553 shares of the registrant’s $.50 par value common stock were outstanding.

PART I – FINANCIAL INFORMATION 

See Accompanying Notes

See Accompanying Notes

See Accompanying Notes

THE RESERVE PETROLEUM COMPANY

NOTES TO FINANCIAL STATEMENTS

March 31, 2015

(Unaudited)

Note 1 – BASIS OF PRESENTATION

The accompanying balance sheet as of December 31, 2014, which has been derived from audited financial statements, the unaudited interim financial statements and these notes have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, certain disclosures normally included in financial statements prepared in accordance with the accounting principles generally accepted in the United States of America (“GAAP”) have been omitted. The accompanying financial statements and notes thereto should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

In the opinion of Management, the accompanying financial statements reflect all adjustments (consisting only of normal recurring accruals), which are necessary for a fair statement of the results of the interim periods presented. The results of operations for the current interim periods are not necessarily indicative of the operating results for the full year.

Note 2 – OTHER INCOME / (LOSS), NET

The following is an analysis of the components of Other Income / (Loss), Net:

Note 3 – INVESTMENTS AND RELATED COMMITMENTS AND CONTINGENT LIABILITIES, INCLUDING GUARANTEES

Equity Investment consists of a 33% ownership interest in Broadway Sixty-Eight, Ltd. (the “Partnership”), an Oklahoma limited partnership, which owns and operates an office building in Oklahoma City, Oklahoma. Although the Company invested as a limited partner, it agreed, jointly and severally, with all other limited partners to reimburse the general partner for any losses suffered from operating the Partnership. The indemnity agreement provides no limitation to the maximum potential future payments. To date, no monies have been paid with respect to this agreement.

Note 4 – PROVISION FOR INCOME TAXES

In 2015 and 2014, the effective tax rate was less than the statutory rate, primarily as a result of allowable depletion for tax purposes in excess of the cost basis in oil and gas properties and the corporate graduated tax rate structure.

Excess federal percentage depletion, which is limited to certain production volumes and by certain income levels, reduces estimated taxable income projected for any year. The federal excess percentage depletion estimates will be updated throughout the year until finalized with the detail well-by-well calculations at year-end. When a provision for income taxes is recorded, federal excess percentage depletion benefits decrease the effective tax rate. The benefit of federal excess percentage depletion is not directly related to the amount of pre-tax income recorded in a period. Accordingly, in periods where a recorded pre-tax income is relatively small, the proportional effect of these items on the effective tax rate may be significant.

Note 5 – ASSET RETIREMENT OBLIGATION

The Company records the fair value of its estimated liability to retire its oil and natural gas producing properties in the period in which it is incurred (typically the date of first sale). The estimated liability is calculated by obtaining current estimated plugging costs from the well operators and inflating it over the life of the property. Current year inflation rate used is 4.08%. When the liability is first recorded, a corresponding increase in the carrying amount of the related long-lived asset is also recorded. Subsequently, the asset is amortized to expense over the life of the property and the liability is increased for the change in its present value which is currently 3.25%.

A reconciliation of the Company’s asset retirement obligation liability is as follows:

Note 6 – FAIR VALUE MEASUREMENTS

Inputs used to measure fair value are organized into a fair value hierarchy based on the observability of the inputs. Level 1 inputs consist of quoted prices in active markets for identical assets. Level 2 inputs are inputs, other than quoted prices, for similar assets that are observable. Level 3 inputs are unobservable inputs.

Recurring Fair Value Measurements

Certain of the Company’s assets are reported at fair value in the accompanying balance sheets on a recurring basis. The Company determined the fair value of the available-for-sale securities using quoted market prices for securities with similar maturity dates and interest rates. At March 31, 2015 and December 31, 2014, the Company’s assets reported at fair value on a recurring basis are summarized as follows:

Non-Recurring Fair Value Measurements

The Company’s asset retirement obligation represents a non-recurring fair value liability. The fair value of the non-financial liability incurred in the quarter ended March 31, was $7,542 in 2015 and $26,651 in 2014 and was calculated using Level 3 inputs. See Note 5 above for more information about this liability and the inputs used for calculating fair value.

The impairment losses in the quarter ended March 31 of $556,734 for 2015, with none for 2014, also represents non-recurring fair value expenses calculated using Level 3 inputs. See Note 10 – LONG-LIVED ASSETS IMPAIRMENT LOSS on page 29 of the 2014 Form 10-K for a description of the impairment loss calculation.

Fair Value of Financial Instruments

The Company’s financial instruments consist primarily of cash and cash equivalents, trade receivables, marketable securities, trade payables and dividends payable. At March 31, 2015 and December 31, 2014, the historical cost of cash and cash equivalents, trade receivables, trade payables and dividends payable are considered to be representative of their respective fair values due to the short-term maturities of these items.

Note 7 – NEW ACCOUNTING PRONOUNCEMENTS

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”). ASU 2014-09 clarifies the principles for recognizing revenue and develops a common revenue standard under U.S. GAAP under which an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ASU 2014-09 is effective for the Company beginning January 1, 2018. The new standard allows application either retrospectively to each prior reporting period presented or as a cumulative-effect adjustment as of the date of adoption. Management is currently assessing the adoption method and the impact ASU 2014-09 will have on the Company, but it is not expected to have a material effect on the Company’s financial position, results of operations or cash flows.

On April 7, 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2015-03, Interest - Imputation of Interest (“ASU 2015-03”). The standard requires that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts or premiums. ASU 2015-03 is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. The Company currently has no debt nor any plans to issue any debt. Accordingly, adoption of ASU 2015-03 will have no effect on the Company’s financial position, results of operations or cash flows.

There were no other accounting pronouncements issued and none that became effective since December 31, 2014 that were directly applicable to the Company.

This discussion and analysis should be read with reference to a similar discussion in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 as filed with the Securities and Exchange Commission (hereinafter, the “2014 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 2014 Form 10-K.

We caution you not to place undue reliance on these forward looking statements, which speak only as of the date of this Form 10-Q, and we undertake no obligation to update this information. You are urged to carefully review and consider the disclosures made in this and our other reports filed with the Securities and Exchange Commission that attempt to advise interested parties of the risks and factors that may affect our business.

Financial Conditions and Results of Operations

Liquidity and Capital Resources

Please refer to the Balance Sheets and the Condensed Statements of Cash Flows in this Form 10-Q to supplement the following discussion. In the first quarter of 2015, 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 $2,492,388. The Company utilized cash for property additions of $911,863, other investment of $4,440 and financing activities of $23,013 for total cash applied of $939,316. Cash and cash equivalents increased $1,553,072 to $16,756,630.

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, 2014. A discussion of these items follows.

Refundable income taxes increased $155,583 (101%) to $309,976 from $154,393 due to the first quarter 2015 current income tax provision of $344,423 offset by estimated tax payments of $500,006 for the same period.

Receivables declined $989,889 (46%) to $1,152,467 from $2,142,356. This decrease was due entirely to lower oil and gas sales receivables. Sales variances are discussed in the “Results of Operations” section below.

Accounts payable decreased $607,619 (74%) to $211,391 from $819,010 due to a decline in the drilling activity in the quarter ended March 31, 2015 compared to the quarter ended December 31, 2014.

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 $2,492,388 in 2015, a decrease of $771,945 (24%) from the comparable period in 2014. The decrease was primarily the result of decreased oil and gas sales. For more information see “Operating Revenues” and “Operating Costs and Expenses” below.

Cash applied to the purchase of property additions in 2015 was $911,863 a decrease of $406,764 (31%) from cash applied in 2014 of $1,318,627. For both 2015 and 2014, cash applied to property additions was mostly related to oil and gas exploration and development activity. The decrease in property additions for 2015 is mostly due to a decline in the exploration and development drilling activity in the first quarter of 2015 versus 2014. See the subheading “Exploration Costs” in the “Results of Operations” section below for additional information.

Conclusion. Management is unaware of any additional material trends, demands, commitments, events or uncertainties, which would impact liquidity and capital resources to the extent that the discussion presented in the 2014 Form 10-K would not be representative of the Company’s current position.

Material Changes in Results of Operations Three Months Ended March 31, 2015, Compared with Three Months Ended March 31, 2014

Net income decreased $1,957,227 (99%) to $17,476 in 2015 from $1,974,703 in 2014. Net income per share, basic and diluted, decreased $12.29 to $0.11 in 2015 from $12.40 in 2014.

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 decreased $3,122,262 (59%) to $2,152,948 in 2015 from $5,275,210 in 2014. Of the $3,122,262 decrease, crude oil sales decreased $1,976,933; natural gas sales decreased $934,196; and miscellaneous oil and gas product sales decreased $211,133.

The $1,976,933 (61%) decrease in oil sales to $1,279,886 in 2015 from $3,256,819 in 2014 was the result of a decrease in the average price per barrel (Bbl) and the volume sold. The volume of oil sold decreased 7,227 Bbls to 28,306 Bbls in 2015, resulting in a negative volume variance of $662,355. The average price per Bbl decreased $46.43 to $45.22 per Bbl in 2015, resulting in a negative price variance of $1,314,578. The decrease in oil volumes sold was mostly due to production declines from older wells partially offset by production of 7,266 Bbls from new wells.

The $934,196 (53%) decrease in gas sales to $819,752 in 2015 from $1,753,948 in 2014 was the result of a decrease in the average price per thousand cubic feet (MCF) and the volume sold. The volume of gas sold decreased 76,331 MCF to 291,374 MCF in 2015 from 367,705 MCF in 2014, for a negative volume variance of $364,099. The decrease in gas volumes sold was mostly due to production declines from older wells partially offset by production of 77,220 MCF from new wells. The average price per MCF decreased $1.96 to $2.81 per MCF in 2015 from $4.77 per MCF in 2014, resulting in a negative price variance of $570,097.

Sales from the Robertson County, Texas royalty interest properties provided approximately 21% of the Company’s first quarter gas sales volumes for 2015 and 2014. See discussion on page 11 of the 2014 Form 10-K under the subheading “Operating Revenues” for more information about these properties. Sales from Arkansas working interest properties provided approximately 16% of the Company’s first quarter 2015 gas sales volumes and about 18% of the first quarter 2014 gas sales volumes.

For both oil and gas sales, the price change was mostly the result of a change in the spot market prices upon which most of the Company’s oil and gas sales are based. These spot market prices have had significant fluctuations in the past and these fluctuations are expected to continue.

Sales of miscellaneous oil and gas products were $53,310 in 2015 compared to $264,443 in 2014.

The Company received lease bonuses of $535,214 in the first quarter of 2015 for leases on its owned minerals. Lease bonuses for the first quarter of 2014 were $200,942.

Operating Costs and Expenses. Operating costs and expenses increased $45,785 (2%) to $2,853,729 in 2015 from $2,807,944 in 2014.

Production Costs. Production costs decreased $153,744 (18%) in 2015 to $690,856 from $844,600 in 2014. This decrease was due primarily to lower production taxes as a result of decreased oil and gas sales revenue. Production taxes declined $133,815 (63%) to $78,319 in 2015 from $212,134 in 2014. The remaining $19,929 decrease was due to lower lease operating expense.

Exploration Costs. Total exploration expense decreased $507,321 (77%) to $150,150 in 2015 from $657,471 in 2014. The net decrease was due to a decrease in geological and geophysical expense of $656,891 to $1,054 in 2015 from $657,945 in 2014, offset by an increase of $149,570 in dry hole costs.

The following is a summary as of April 30, 2015, updating both exploration and development activity from December 31, 2014, for the period ended March 31, 2015.

The Company will participate with its 18% working interest in the drilling of three development wells on a Barber County, Kansas prospect in the second half of 2015.

The Company participated with its 16% working interest in the drilling of a development well on a Woods County, Oklahoma prospect. A completion is in progress. Capitalized costs for the period were $68,800.

The Company is participating with an 8% working interest in the completion of a development well that was drilled in 2014 on a Woods County, Oklahoma prospect.

The Company participated with its 10.5% working interest in the drilling of an exploratory well on a Cimarron County, Oklahoma prospect. The well was completed as a dry hole. The Company will participate in the drilling of another exploratory well starting in May 2015. Costs expensed to dry hole costs were $66,531.

The Company is participating with its 10.5% working interest in the completion of an exploratory well that was drilled in 2014 on a Logan County, Oklahoma prospect. Capitalized costs for the period were $57,578.

The Company participated with its 10.5% working interest in the drilling of a development well on a Seminole County, Oklahoma prospect. The well is awaiting completion. The Company will participate in operations to plug back and stimulate a salt water disposal well, repair casing in one producing well and install a submersible pump in another producing well on the prospect.

The Company will participate with its 10.5% working interest in the drilling of a development well on a Seminole County, Oklahoma prospect starting in May 2015.

The Company participated in the drilling of two exploratory wells on a Creek County, Oklahoma prospect. The first well was completed as a dry hole and the second is awaiting completion. Dry hole costs for the period were $26,981 and capitalized costs were $27,013.

The Company participated with its 8.4% interest in a 3-D seismic survey on a Thomas County, Kansas prospect. Several structures have been identified and an exploratory well will be drilled starting in May or June 2015.

In April 2015, the Company purchased a 16% interest in 1861 net acres of leasehold on a Chase County, Nebraska prospect for $40,191. The Company is participating in an exploratory well that is currently drilling.

Depreciation, Depletion, Amortization and Valuation Provision (DD&A). DD&A increased $702,718 (81%) to $1,570,350 in 2015 from $867,632 in 2014. The increase was due primarily to $556,734 of long–lived asset impairment losses for 2015 with none for 2014. The impairment losses for 2015 are due to lower oil and natural gas futures prices at March 31, 2015 compared to December 31, 2014. Oil prices have declined approximately 50% and natural gas prices have declined approximately 33% during the first quarter of 2015. See Note 10 – LONG-LIVED ASSETS IMPAIRMENT LOSS on page 29 of the 2014 Form 10-K for a description of the impairment loss calculation. The remaining $145,984 increase was due primarily to increased depreciation and lease impairment expense.

Other Income / (Loss), Net. This line item increased $18,291 to a gain of $2,733 in 2015 from a loss of $(15,558) in 2014. See Note 2 to the accompanying financial statements for the analysis of the various components of this line item.

Trading securities losses in 2015 were $(5,995) compared to losses of $(45,925) in 2014, a decrease of $39,930. In 2015, the Company had realized losses of $(1,092) and unrealized losses of $(4,903) from adjusting the securities to estimated fair market value. In 2014, the Company had realized gains of $16,732 and unrealized losses of $(62,657).

Income Tax Provision / (Benefit). Income taxes decreased $858,257 to a $(180,310) tax benefit in 2015 from a $677,947 tax provision in 2014. The decrease was due to the decrease in income / (loss) before income taxes of $2,815,484 (106%) to $(162,834) in 2015 from $2,652,650 in 2014. Of the 2015 income tax provision, the estimated current tax expense was $344,423, which was offset by an estimated deferred tax benefit of $(524,733). Of the 2014 income tax provision, the current tax expense and deferred tax benefit were $902,762 and $(224,815), respectively. See Note 4 to the accompanying financial statements for additional information on income taxes.

Off-Balance Sheet Arrangement

The Company’s off-balance sheet arrangement relates to Broadway Sixty-Eight, Ltd., an Oklahoma limited partnership. The Company does not have actual or effective control of this entity. Management of this entity could at any time make decisions in its own best interest, which could materially affect the Company’s net income or the value of the Company’s investment. For more information about this entity, see Note 3 to the accompanying financial statements.

Not applicable.

As defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”), the term “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure.

The Company’s Principal Executive Officer and Principal Financial Officer evaluated the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, they concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2015.

Internal Control over Financial Reporting

As defined in Rule 13a-15(f) and 15d-15(f) of the Exchange Act, the term “internal control over financial reporting” means a process designed by, or under the supervision of, the issuer’s principal executive and principal financial officers, or persons performing similar functions, and effected by the issuer’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes, in accordance with generally accepted accounting principles and includes those policies and procedures that:

The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. There were no changes in the Company’s internal control over financial reporting during the quarter ended March 31, 2015 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

During the quarter ended March 31, 2015, the Company did not have any material legal proceedings brought against it or its properties.

Not applicable.

¹The Company has no formal equity security purchase program or plan. The Company acts as its own transfer agent, and most purchases result from requests made by shareholders receiving small odd lot share quantities as the result of probate transfers.

None.

Not applicable.

None.

The following documents are exhibits to this Form 10-Q. Each document marked by an asterisk is filed electronically herewith.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized.