RESERVE PETROLEUM CO - Quarter Report: 2016 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

For the Quarterly Period Ended June 30, 2016

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     ☑     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     ☑     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 August 5, 2016, 158,077 shares of the Registrant’s $.50 par value common stock were outstanding. 

PART I – FINANCIAL INFORMATION

THE RESERVE PETROLEUM COMPANY

BALANCE SHEETS

See Accompanying Notes

THE RESERVE PETROLEUM COMPANY

BALANCE SHEETS

See Accompanying Notes

THE RESERVE PETROLEUM COMPANY

STATEMENTS OF OPERATIONS

(Unaudited)

See Accompanying Notes 

THE RESERVE PETROLEUM COMPANY

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

See Accompanying Notes

THE RESERVE PETROLEUM COMPANY

NOTES TO FINANCIAL STATEMENTS

June 30, 2016

(Unaudited)

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, 2015 as filed with the Securities and Exchange Commission (hereinafter, the “2015 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 2015 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 half of 2016, the Company continued to fund its business activity through the use of internal sources of cash. The Company had cash provided by operations of $618,710 and cash provided by the maturities of available-for-sale securities of $8,642,053. Additional cash of $21,395 was provided by property dispositions and $155,000 from investment distributions for total cash provided of $9,437,158. The Company utilized cash for the purchase of available-for-sale securities of $8,641,014, property additions of $1,018,028, investment activity of $280,000 and financing activities of $955,863 for total cash applied of $10,894,905. Cash and cash equivalents decreased $1,457,747 (10%) to $12,479,468.

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, 2015. A discussion of these items follows.

Receivables increased $48,665 (8%) to $693,533 from $644,868. This increase was due entirely to higher oil and gas sales receivables. Sales variances are discussed in the “Results of Operations” section below.

Deferred income taxes and other liabilities increased $56,159 (146%) to $94,652 from $38,493 due to an increase of $40,000 in ad valorem tax accruals and an increase of $16,159 in current deferred income taxes. Ad valorem (property) taxes are primarily for Texas properties and are accrued for the first three quarters each year to be paid in the fourth quarter.

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 $618,710 in 2016, a decrease of $2,377,957 (79%) from the comparable period in 2015. The decrease was primarily due to decreased operating revenue, partially offset by decreased production and exploration costs. For more information see “Operating Revenues” and “Exploration Costs” below.

Cash applied to the purchase of property additions in 2016 was $1,018,028, a decrease of $195,987 (16%) from cash applied in 2015 of $1,214,015. In both 2016 and 2015, cash applied to property additions was mostly related to oil and gas exploration and development activity. See the subheading “Exploration Costs” in the “Results of Operations” section below for additional information.

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 2015 Form 10-K would not be representative of the Company’s current position.

Material Changes in Results of Operations Six Months Ended June 30, 2016, Compared with Six Months Ended June 30, 2015

Net income/(loss) decreased $522,421 to a net loss of $(473,629) in 2016 from $48,792 net income in 2015. Net income/(loss) per share, basic and diluted, decreased $3.30 to $(2.99) net loss in 2016 from $0.31 net income in 2015.

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 $1,844,063 (44%) to $2,389,933 in 2016 from $4,233,996 in 2015. The $1,844,063 decrease is due to lower crude oil sales of $1,112,392; lower natural gas sales of $692,329; and a decrease in miscellaneous oil and gas product sales of $39,342.

The $1,112,392 (44%) decrease in oil sales to $1,444,200 in 2016 from $2,556,592 in 2015 was the result of a decrease in both the volume sold and the average price per barrel (Bbl). The volume of oil sold decreased 9,478 Bbls to 44,636 Bbls in 2016, resulting in a negative volume variance of $447,741. This volume decrease was the net result of an increase of 2,162 Bbls for production that began after June 30, 2015, offset by a decline of 11,640 Bbls from older properties. The average price per Bbl decreased $14.89 to $32.35 per Bbl in 2016, resulting in a negative price variance of $664,651.

The $692,329 (44%) decrease in gas sales to $881,352 in 2016 from $1,573,681 in 2015 was the result of a decrease in both the volume sold and the average price per thousand cubic feet (MCF). The volume of gas sold decreased 100,891 MCF to 495,190 MCF from 596,081 MCF in 2015, for a negative volume variance of $266,352. The decrease in gas volumes sold was the net result of approximately 121,000 MCF of production declines from older wells, partially offset by production of approximately 20,000 MCF from wells that first produced after June 30, 2015. The average price per MCF decreased $0.86 to $1.78 per MCF from $2.64 per MCF in 2015, resulting in a negative price variance of $425,977.

Sales from the Robertson County, Texas royalty interest properties provided approximately 20% of the Company’s first half 2015 and 2016 gas sales volumes. See discussion on page 11 of the 2015 Form 10-K under the subheading “Operating Revenues” for more information about these properties. Sales from Arkansas working interest properties provided approximately 30% of the Company’s first half 2015 and 2016 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 $64,381 in 2016 as compared to $103,723 in 2015.

The Company received lease bonuses of $48,885 in the first half of 2016 for leases on its owned minerals. Lease bonuses for the first half of 2015 were $647,442. In 2016, most of the bonuses were for leases on owned minerals in Texas. In 2015, most of the bonuses were for leases on owned minerals in Oklahoma.

Operating Costs and Expenses. Operating costs and expenses decreased $1,739,955 (33%) to $3,476,709 in 2016 from $5,216,664 in 2015. Material line item changes are discussed and analyzed in the following paragraphs.

Production Costs. Production costs decreased $305,566 (23%) to $1,048,850 in 2016 from $1,354,416 in 2015. Lease operating expense and transportation and compression expense decreased $243,855 (20%) to $949,359 in 2016 from $1,193,214 in 2015. Production taxes decreased $61,711 (38%) to $99,491 in 2016 from $161,202 in 2015 due primarily to the decline in oil and gas sales revenues described above in the “Operating Revenues” section.

Exploration Costs. Total exploration expense decreased $186,328 (53%) to $167,422 in 2016 from $353,750 in 2015. Dry hole costs decreased $257,057 to $20,025 in 2016 from $277,082 in 2015. Geological and geophysical expense increased $70,729 to $147,397 in 2016 from $76,668 in 2015.

The following is a summary as of August 2, 2016, updating both exploration and development activity from December 31, 2015, for the period ended June 30, 2016.

The Company participated with 10.3% and 10.7% working interests in the completion of two development wells on a Woods County, Oklahoma prospect. The wells were drilled in 2015. Both wells are commercial producers, one gas and the other oil and gas. Capitalized costs for the period were $38,940.

The Company participated with its 8.4% interest in the acquisition of additional 3-D seismic data on a Thomas County, Kansas prospect. The Company is participating in the drilling of an exploratory well on the prospect that is in progress. Capitalized costs for the period were $17,867.

The Company participated with its 10.5% interest in a 3-D seismic survey on a Thomas County, Kansas prospect and in the drilling of an exploratory well on the prospect. Capitalized costs for the period were $26,800.

The Company participated with its 16% working interest in the drilling of a step-out well on a Chase County, Nebraska prospect. The well was completed as a commercial oil producer. Capitalized costs for the period were $40,880.

The Company is participating with its 14% interest in the development of a Hansford County, Texas prospect for waterflooding. Drilling is in progress on the initial well. Capitalized costs for the period were $2,591.

In February and March 2016, the Company purchased a 16% interest in 12,623.82 net acres of leasehold on a Chase County, Nebraska prospect for $156,535 and paid $94,057 in seismic costs. A 3-D seismic survey of the prospect has been completed. The Company will participate in the drilling of an exploratory well starting in August 2016.

In March 2016, the Company purchased a 35% interest in 16,472.55 net acres of leasehold on a Crockett and Val Verde Counties, Texas prospect for $345,923. The Company is participating in the development of the prospect and a geologic study of the prospect area has been completed. Efforts to market a portion of the Company’s interest are in progress. Geological and geophysical costs for the period were $10,535.

In April 2016, the Company purchased a 14% interest in three prospects in Okfuskee and Seminole Counties, Oklahoma for $57,415. The Company participated in the drilling of an exploratory well on one of the prospects that was completed as a dry hole, and will participate in the drilling of an exploratory well on a second prospect starting in August 2016.

In May 2016, the Company purchased a 14% interest in 640 net acres of leasehold and 3-D seismic data on a Lavaca County, Texas prospect for $56,000. An exploratory well will be drilled on the prospect starting in August 2016.

In July 2016, the Company purchased a 16% interest in 2,071.6 net acres of leasehold on a Kingman County, Kansas prospect for $26,516. The Company will participate in the re-entry and washdown of two old wellbores on the prospect starting in September 2016.

Depreciation, Depletion, Amortization and Valuation Provision (DD&A). DD&A decreased $1,237,172 (46%) to $1,424,317 in 2016 from $2,661,489 in 2015. The decrease is due to lower oil and gas sales volume (see “Operating Revenues” above) and a lower depreciable asset base. The lower depreciable asset base is a result of the $3,726,267 of long-lived asset impairment losses for fiscal 2015 and an additional $508,964 of impairment losses for the three months ended March 31, 2016. The impairment losses for 2016 and 2015 are due to lower oil and natural gas futures prices. See Note 10 – LONG-LIVED ASSETS IMPAIRMENT LOSS on page 29 of the 2015 Form 10-K for a description of the impairment loss calculation.

Other Income, Net. This line item increased $176,210 (191%) to $268,477 in 2016 from $92,267 in 2015. See Note 2 to the accompanying financial statements for the analysis of the various components of this line item. Components with significant changes are discussed in the following paragraphs.

Gains on trading securities in 2016 were $1,720 compared to gains of $13,570 in 2015, a decrease of $11,850. In 2016, the Company had realized gains of $9,323 and unrealized losses of $(7,603) from adjusting the securities to estimated fair market value. In 2015, the Company had realized losses of $(15,650) and unrealized gains of $29,220. 

Other income increased $155,541 (182%) to $210,664 in 2016 from $55,123 in 2015. The increase was mostly due to $210,000 in other investment income in 2016 compared to $50,000 in 2015.

Income Tax Provision/(Benefit). Income taxes decreased $4,739 to a $(295,785) tax benefit in 2016 from a $(291,046) tax benefit in 2015. Of the 2016 income tax benefit, the estimated current tax expense was $10,655 and the estimated deferred tax benefit was $(306,440). Of the 2015 income tax benefit, the estimated current tax expense was $412,651 and the estimated deferred tax benefit was $(703,697). See Note 4 to the accompanying financial statements for additional information on income taxes.

Material Changes in Results of Operations Three Months Ended June 30, 2016, Compared with Three Months Ended June 30, 2015

Net income increased $115,910 (370%) to $147,226 in 2016 from $31,316 in 2015. The material changes in the results of operations, which caused the increase in net income, are discussed below.

Operating Revenues. Revenues from crude oil and natural gas sales decreased $736,652 (35%) to $1,344,396 in 2016 from $2,081,048 in 2015. This was due to decreases in crude oil sales of $406,570; natural gas sales of $315,519; and sales of miscellaneous products of $14,563.

The $406,570 decrease in crude oil sales was the result of a decrease in the volume of oil sold of 2,935 Bbls to 22,872 Bbls, for a negative volume variance of $145,194, and a decrease in the average price received of $11.43 per Bbl to $38.04, for a negative price variance of $261,376.

The $315,519 decrease in natural gas sales was the result of a decrease in the volume of gas sold of 58,932 MCF to 245,775 MCF, for a negative volume variance of $145,562, and a decrease in the average price of $0.69 per MCF to $1.78, for a negative price variance of $169,957.

Other operating revenues decreased $65,577 (58%) to $47,356 in 2016 from $112,933 in 2015. This decrease was due to a decrease in lease bonuses for minerals in Oklahoma of about $112,000, offset by an increase of Texas lease bonuses of about $47,000.

Production Expense. Production expense decreased $146,031 (22%) to $517,529 in 2016 from $663,560 in 2015. Lease operating expense and transportation and compression expense decreased $117,646 to $463,031 in 2016 from $580,677 in 2015. Production taxes decreased $28,385 to $54,498 in 2016 from $82,883 in 2015.

Exploration Costs. Total exploration expense decreased $134,090 (66%) to $69,510 in 2016 from $203,600 in 2015. Dry hole costs decreased $106,402 to $21,585 in 2016 from $127,987 in 2015. Geological and geophysical expense decreased $27,688 to $47,925 in 2016 from $75,613 in 2015.

Other Income, Net. This line item increased $112,250 (125%) to $201,784 in 2016 from $89,534 in 2015. See Note 2 to the accompanying financial statements for an analysis of the components of other income, net. Components with significant changes are discussed in the following paragraphs.  

Other income increased $90,144 (179%) to $140,369 in 2016 from $50,225 in 2015. This was mostly due to an increase of $90,000 in income from other investments.

Income Tax Provision/(Benefit). Income tax provision increased $149,034 to $38,298 in 2016 from a tax benefit of $(110,736) in 2015. See discussion above in “Item 2.” and Note 4 to the accompanying financial statements for a discussion of the changes in the provision for income taxes.

There were no additional material changes between the quarters, which were not covered in the discussion in “Item 2.” above, for the six months ended June 30, 2016.

Off-Balance Sheet Arrangements

The Company’s off-balance sheet arrangements relate to Broadway Sixty-Eight, Ltd., an Oklahoma limited partnership, and Grand Woods Development, LLC, an Oklahoma limited liability company. The Company does not have actual or effective control of these entities. Management of these entities could at any time make decisions in their own best interest, which could materially affect the Company’s net income or the value of the Company’s investment.

For more information about 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 June 30, 2016.

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 June 30, 2016 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 June 30, 2016, the Company did not have any material legal proceedings brought against it or its properties.

Not applicable.

ISSUER PURCHASES OF EQUITY SECURITIES

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 stockholders 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.

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