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

PART I – FINANCIAL INFORMATION 

THE RESERVE PETROLEUM COMPANY

NOTES TO FINANCIAL STATEMENTS

March 31, 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 has decreased significantly.

We are unable to predict the impact that the 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), the possibility of 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.

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. 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.

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 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 $626,703, maturities of available-for-sale debt securities of $6,499,519 and property dispositions of $10,898 for total cash provided of $7,137,120. The Company utilized cash for the purchase of available-for-sale debt securities of $6,564,302, property additions of $54,238 and other investment activity of $12,415 for total cash applied of $6,630,955. Cash and cash equivalents increased $506,165 (18%) to $3,244,503.

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.

Equity securities decreased $69,831 (13%) to $475,244 as of March 31, 2020 from $545,075 at December 31, 2019. The decrease was the result of a $51,853 decrease in the equity securities’ market value and a $17,978 net loss from these securities.

Refundable income taxes decreased $180,307 to a tax payable of $70,309. This decrease was due to the effect of the long-lived asset impairment on deferred taxes.

Accounts receivable decreased $329,005 (34%) to $639,377 as of March 31, 2020 from $968,382 at December 31, 2019. The decrease was due to decreased oil and gas prices and volumes.

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.

Accounts payable decreased $4,391 (3%) to $152,377 as of March 31, 2020 from $156,768 at December 31, 2019 due to lower drilling and exploration activity at March 31, 2020 versus December 31, 2019.

Discussion of Significant Changes in the Condensed Statements of Cash Flows. As noted in the first paragraph above, net cash provided by operating activities was $626,703 in the three months ended March 31, 2020, a decrease of $65,784 (9%) from the comparable period in 2019 of $692,487. The decrease was primarily due to a decrease in oil and gas prices. For more information see “Operating Revenues” and “Other Income/(Loss), Net” below.

Cash applied to the purchase of property additions in the three months ended March 31, 2020 was $54,238, a decrease of $516,022 (90%) from cash applied in the comparable period in 2019 of $570,260. For both 2020 and 2019, cash applied to property additions was related to oil and gas exploration and development activity. See the subheading “Exploration Costs” in the “Results of Operations” section below for additional information.

Cash applied to financing activities in the three months ended March 31, 2019 was $70,028, with none in the comparable period in 2020.

Conclusion. Management is unaware of any additional material trends, demands, commitments, events or uncertainties, which would impact liquidity and capital resources to the extent that the discussion presented in the 2019 Form 10-K would not be representative of the Company’s current position.

Material Changes in Results of Operations Three Months Ended March 31, 2020, Compared with Three Months Ended March 31, 2019

Net income decreased $1,474,291 to a net loss of $(1,141,956) in the three months ended March 31, 2020 from net income of $332,335 in the comparable period in 2019. Net income/(loss) per share, basic and diluted, decreased $9.41 to a net loss of $(7.29) in the three months ended March 31, 2020 from net income of $2.12 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 $396,449 (25%) to $1,196,262 in the three months ended March 31, 2020 from $1,592,711 in 2019. Of the $396,449 decrease, crude oil sales decreased $147,338; natural gas sales decreased $244,258; and miscellaneous oil and gas product sales decreased $4,853.

The $147,338 (15%) decrease in oil sales to $834,593 in the three months ended March 31, 2020 from $981,931 in the comparable period in 2019 was the result of a decrease in the average price per barrel (Bbl) and a decrease in the volume sold. The volume of oil sold decreased 1,363 Bbls to 17,381 Bbls in the three months ended March 31, 2020, resulting in a negative volume variance of $71,408 compared to the comparable period in 2019. The average price per Bbl decreased $4.37 to $48.02 per Bbl in the three months ended March 31, 2020, resulting in a negative price variance of $75,930 compared to the comparable period in 2019. The decrease in oil volumes sold was due to a decline in production of 2,300 Bbls from older wells, partially offset by production from new wells.

The $244,258 (43%) decrease in gas sales to $320,854 in the three months ended March 31, 2020 from $565,112 in the comparable period in 2019 was the result of a decrease in the average price per thousand cubic feet (MCF) and a decrease in the volume sold. The volume of gas sold decreased 2,436 MCF to 189,687 MCF in the three months ended March 31, 2020 from 192,133 MCF in the comparable period in 2019, for a negative volume variance of $7,162 compared to the comparable period in 2019. The average price per MCF decreased $1.25 to $1.69 per MCF in the three months ended March 31, 2020 from $2.94 per MCF in the comparable period in 2019, resulting in a negative price variance of $237,096 compared to the comparable period in 2019. The decrease in gas volumes sold was due to a decline in production of 10,673 MCF from older wells, partially offset by production of 8,237 MCF from new wells.

Sales from the Robertson County, Texas royalty interest properties provided approximately 28% of the Company’s gas sales volumes for the three months ended March 31, 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 three months ended March 31, 2020 and about 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 oil and gas products were $40,815 in the three months ended March 31, 2020 compared to $45,668 in the comparable period in 2019.

The Company received lease bonuses of $82,221 in the three months ended March 31, 2020 for leases on its owned minerals compared to $7,528 in the comparable period in 2019.

Operating Costs and Expenses. Operating costs and expenses increased $1,322,534 (106%) to $2,572,161 in the three months ended March 31, 2020 from $1,249,627 in the comparable period in 2019. The increase was primarily due to the significant impairments described below.

Production Costs. Production costs decreased $8,140 (1%) to $550,567 in the three months ended March 31, 2020 from $558,707 in the comparable period in 2019. This decrease was primarily the result of a decrease of $13,000 in production taxes, offset by lease operating and gathering charges.

Exploration Costs. Total exploration expense increased $40,246 to $43,465 in the three months ended March 31, 2020 from $3,219 in the comparable period in 2019.

The following is a summary as of May 6, 2020, updating both exploration and development activity from December 31, 2019, for the period ended March 31, 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 suspended pending an improvement in oil prices. Five additional exploratory wells are planned, and possibly two development wells. Leasehold costs for the period were $5,000. Additional capitalized costs were $1,466.

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 exploratory wells have been proposed on two. Lease acquisition is in progress on another prospect. Leasehold costs for the period were $16,569.

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 $13,913 and leasehold costs were $7,075.

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 has been unsuccessful and the well is under evaluation.

The Company has largely curtailed its exploration and development activity due to the historic collapse of oil prices in March and April, 2020, and does not plan to resume it until the price situation improves. The planned activity discussed above will likely be postponed at least until the fourth quarter of 2020 and possibly until 2021.

Depreciation, Depletion, Amortization and Valuation Provision (DD&A). DD&A increased $1,291,163 (550%) to $1,526,004 in the three months ended March 31, 2020 from $234,841 in the comparable period in 2019. The increase was from long-lived asset impairments of $1,312,328 due to historically low oil futures prices.

Other Income/(Loss), Net. This line item decreased $154,947 to $(14,389) in the three months ended March 31, 2020 from $140,558 in the comparable period in 2019. See Note 3 to the accompanying financial statements for the various components of this line item.

Income Tax Provision. In the three months ended March 31, 2020, the Company had an estimated income tax benefit of $166,111 as the result of a deferred tax benefit of $346,421 and a current tax provision of $180,310. In the comparable period in 2019, the Company had an estimated income tax provision of $158,835 as the result of a deferred tax provision of $122,454 and a current tax provision of $36,381. See Note 5 to the accompanying financial statements for additional information on income taxes.

Off-Balance Sheet Arrangement

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 March 31, 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 March 31, 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 March 31, 2020, the Company did not have any material legal proceedings brought against it or its properties.

Not applicable.

None.

None.

Not applicable.

None.

ITEM 6.     EXHIBITS

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.