RESERVE PETROLEUM CO - Quarter Report: 2020 June (Form 10-Q)

PART I – FINANCIAL INFORMATION

THE RESERVE PETROLEUM COMPANY

NOTES TO FINANCIAL STATEMENTS

June 30, 2020

(Unaudited)

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 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, intangible assets, equity method investments and right-of-use assets. It is likely 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 new guidance issued by the SBA, and on May 1, 2020, the Company determined to repay 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 half 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 $839,965, cash provided by the maturities of available-for-sale debt securities of $18,517,910 and cash provided by property dispositions of $10,898 for total cash provided of $19,368,773. The Company utilized cash for the purchase of available-for-sale debt securities of $6,564,302, property additions of $164,641, other investment activity of $12,415 and financing activities of $783,077 for total cash applied of $7,524,435. Cash and cash equivalents increased $11,844,338 (433%) to $14,582,676 due to the transfer of cash from available-for-sale debt securities to cash equivalent accounts.

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.

Accounts receivable decreased $699,649 (72%) to $268,733 as of June 30, 2020 from $968,382 at December 31, 2019 due to decreased oil and gas prices and volumes and interest receivable.

During the period, the Company added a $58,853 note receivable from Grand Woods, LLC, (the LLC), an equity method investee. See Note 4 to the accompanying financial statements for additional information about the investment.

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 $839,965 in the six months ended June 30, 2020, a decrease of $654,052 (44%) from the comparable period in 2019 of $1,494,017. The decrease was primarily due to a decrease in oil and gas prices and quantities sold. For more information see “Operating Revenues” and “Other Income” below.

Cash applied to the purchase of property additions in 2020 was $164,641 in the six months ended June 30, 2020, a decrease of $1,094,213 (87%) from cash applied in the comparable period in 2019 of $1,258,854. The decrease is primarily due to the collapse of oil prices resulting from the demand destruction caused by COVID-19. 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 2019 Form 10-K would not be representative of the Company’s current position.

Material Changes in Results of Operations Six Months Ended June 30, 2020, Compared with Six Months Ended June 30, 2019

Net income decreased $2,125,045 to a net loss of $(1,070,088) in the six months ended June 30, 2020 from net income of $1,054,957 in the comparable period in 2019. Net income/(loss) per share, basic and diluted, decreased $13.55 to a net loss of $(6.83) per share in the six months ended June 30, 2020 from net income of $6.72 per share 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 $1,641,316 (48%) to $1,796,893 in 2020 from $3,438,209 in 2019. This was due to decreases in crude oil sales of $1,130,727, natural gas sales of $468,001 and sales of miscellaneous products of $42,588.

The $1,130,727 (49%) decrease in oil sales to $1,186,824 in the six months ended June 30, 2020 from $2,317,551 in the comparable period in 2019 was the net result of a decrease in the volume sold and a decrease in the average price per barrel (Bbl). The volume of oil sold decreased 9,869 Bbls to 33,160 Bbls in the six months ended June 30, 2020, resulting in a negative volume variance of $531,544. This volume decrease was the net result of 5,340 Bbls of production that began after June 30, 2019, offset by a decline, partially due to shut-ins, of 15,209 Bbls from older properties. The average price per Bbl decreased $18.07 to $35.79 per Bbl in the six months ended June 30, 2020 from $53.86 per Bbl in the comparable period in 2019, resulting in a negative price variance of $599,183.

The $468,001 (46%) decrease in gas sales to $550,030 in the six months ended June 30, 2020 from $1,018,031 in the comparable period in 2019 was the result of a decrease in the volume sold and a decrease in the average price per thousand cubic feet (MCF). The volume of gas sold decreased 44,247 MCF to 345,330 MCF in the six months ended June 30, 2020 from 389,577 MCF in the comparable period in 2019, for a negative volume variance of $115,485. The decrease in gas volumes sold was the net result of approximately 51,100 MCF of production declines from older wells, partially offset by production of approximately 6,900 MCF from wells that first produced after June 30, 2019. The average price per MCF decreased $1.02 to $1.59 per MCF in the six months ended June 30, 2020 from $2.61 per MCF in the comparable period in 2019, resulting in a negative price variance of $352,516.

Sales from the Robertson County, Texas royalty interest properties provided approximately 26% of the Company’s gas sales volumes for the six months ended June 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 six months ended June 30, 2020 and approximately 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 quarter for a variety of reasons, including but not limited to the impact of COVID-19 on demand for oil and gas products. Following the first quarter, oil prices decreased even further. 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 products were $60,039 in the six months ended June 30, 2020 compared to $102,627 in the comparable period in 2019.

The Company received lease bonuses of $82,221 in the six months ended June 30, 2020 for leases on its owned minerals with $89,097 in the comparable period in 2019. In 2020, the bonuses were for leases on owned minerals in Texas.

Operating Costs and Expenses. Operating costs and expenses increased $883,151 (34%) to $3,519,393 in the six months ended June 30, 2020 from $2,636,242 in the comparable period in 2019. Material line item changes are discussed and analyzed in the following paragraphs.

Production costs decreased $245,551 (21%) in the six months ended June 30, 2020 to $938,296 from $1,183,847 in the comparable period in 2019. This was the result of decreases in lease operating and handling charges of $183,491 and production taxes of $62,059.

Exploration costs increased $30,305 (68%) to $75,170 in the six months ended June 30, 2020 from $44,865 in the comparable period in 2019. This was primarily due to an increase in plugging costs of about $26,000 in the six months ended June 30, 2020 from $4,316 in the comparable period in 2019.

DD&A increased $1,065,922 (193%) to $1,616,924 in the six months ended June 30, 2020 from $551,002 in the comparable period. This was mostly due to the $1,312,328 long-lived assets impairment in the first quarter.

The following is a summary as of August 6, 2020, updating both exploration and development activity from December 31, 2019, for the period ended June 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, resulting in one successful completion and another completion that was suspended due to low oil prices but is now in progress. Two development wells have been drilled on one of the prospects and are awaiting completion, and an exploratory well is in progress on another. Five additional exploratory wells are planned, and possibly two development wells. Leasehold costs for the period were $7,327. Additional capitalized costs were $27,839.

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 drilling of two test wells on the prospect with the intention of conducting a thermal recovery pilot test at one of the locations.

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 and an exploratory well will be drilled on one of these starting in August 2020. Additional processing of the 3-D seismic data is currently in progress. Leasehold costs for the period were $24,587 and geophysical costs were $13,485.

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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 $28,913 and leasehold costs were $11,050.

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 and the well will be re-completed in another zone.

In July 2020, the Company agreed to purchase a 10.5% interest in 637.58 net acres of leasehold on a Lincoln County, Oklahoma prospect for $30,126. An exploratory well will be drilled on the prospect starting in August 2020.

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 is cautiously resuming drilling on some of its prospects.

Other Income, Net. This line item decreased $9,079 (3%) to $253,988 in the six months ended June 30, 2020 from $263,067 in the comparable period in 2019. The decrease was primarily due to a decline of $153,212 in interest income, offset by an increase in realized and unrealized gains from Equity Securities of $61,487 and a decrease in losses from Equity Investments of $57,210. See Note 3 to the accompanying financial statements for the analysis of the various components of this line item.

Income Tax Provision/(Benefit). Income tax provision decreased $415,490 to a tax benefit of $(316,203) in the six months ended June 30, 2020 from a tax provision of $99,424 in the comparable period in 2019. Of the 2020 income tax benefit, the estimated current tax expense was $14,209 and the estimated deferred tax credit was $(330,412). Of the 2019 income tax provision, the estimated current tax expense was $78,694 and the estimated deferred tax expense was $20,730. See Note 5 to the accompanying financial statements for additional information on income taxes.

Material Changes in Results of Operations Three Months Ended June 30, 2020, Compared with Three Months Ended June 30, 2019

Net income decreased $650,754 to $71,868 in the three months ended June 30, 2020 from $722,622 in the comparable period in 2019. The material changes in the results of operations, which caused the decrease in net income, are discussed below.

Operating Revenues. Revenues from crude oil and natural gas sales decreased $1,244,867 (67%) to $600,631 in the three months ended June 30, 2020 from $1,845,498 in the comparable period in 2019. This was due to decreases in crude oil sales of $983,389, natural gas sales of $223,743 and sales of miscellaneous products of $37,735.

The $983,389 decrease in crude oil sales was the net result of a decrease in the volume of oil sold of 8,506 Bbls to 15,779 Bbls, for a negative volume variance of $467,819, and a decrease in the average price received of $32.68 per Bbl to $22.32, for a negative price variance of $515,570.

The $223,743 decrease in natural gas sales was the net result of a decrease in the volume of gas sold of 41,811 MCF to 155,634 MCF, for a negative volume variance of $95,911, and a decrease in the average price of $0.82 per MCF to $1.47, for a negative price variance of $127,832.

Operating Costs and Expenses. Operating costs and expenses decreased $439,383 (32%) to $947,232 in the three months ended June 30, 2020 from $1,386,615 in the comparable period in 2019. This was mostly due to declines in production costs of $237,411 and the Depreciation, Depletion, Amortization and Valuation provision of $225,241, offset by an increase in G&A expense of $33,210. There were no long-lived assets impairment for the three months ended June 30, 2020, versus $66,791 for the comparable period in 2019. 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 $145,869 (119%) to $268,377 in the three months ended June 30, 2020 from $122,508 in the comparable period in 2019. The increase was mostly due to realized and unrealized gains on trading securities of $219,357, offset by a decrease in interest income of $100,801. See Note 3 to the accompanying financial statements for an analysis of the components of other income, net.

Income Tax Provision/(Benefit). Income taxes decreased $90,681 to a tax benefit of $(150,092) in the three months ended June 30, 2020 from a tax benefit of $(59,411) in the comparable period in 2019. See discussion above in “Item 2.” and Note 5 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, 2020.

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.

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, 2020.

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, 2020 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, 2020, the Company did not have any material legal proceedings brought against it or its properties.

Not applicable.

None.

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.